BP struggles to cap compensation bill

Investors wary as oil giant announces an extra $1.4bn to cover claims from the Macondo disaster and Russian revenues fall

More than three years after the Macondo well exploded, the shadow of the Gulf of Mexico disaster appears to be lengthening. Investors are used to the spiralling cost of the accident in April 2010, in which 11 people died, but they were still rattled by BP's announcement yesterday that it had increased its provision for compensation claims by $1.4bn (£913m) in the second quarter, to $9.6bn.

More worryingly, BP warned that the final compensation cost could be "significantly higher" as the oil giant is likely to keep receiving new claims until next April.

Shareholders were so concerned about this turn of events that they sent the company's stock down by more than 5 per cent at one point, its biggest decline in a single day in more than 18 months. The shares ended the day down 15.95p at 451.45p.

BP gave shareholders a second cause for disappointment yesterday, as it unveiled a disappointing 25 per cent drop in underlying profits, excluding exceptional items, to $2.7bn for the second quarter. This is well below the consensus analyst forecast of $3.4bn.

The group's bottom line was hit by an oil price that was 5 per cent lower, on average, in the period compared with the year before. BP also suffered a decline in revenues as a result of the disposals, totalling more than $50bn, which it has made since the spill to help finance the cost, as well as higher-than-expected tax charges.

The most notable income loss came from the reduced contribution from Russia. BP reported a lower-than-expected $218m profit contribution for the period from its 20 per cent stake in Russia's Rosneft, which the company acquired as part of the cash-and-shares sale of its TNK-BP joint venture in Russia in March. But the Rosneft contribution was well below the $452m payout BP received from the TNK-BP stake last year, when it still owned half the business.

Including exceptional items, BP's second-quarter profits rebounded from $104m to $2.4bn in the second quarter, after BP made billions of dollars of writedowns this time last year. The $1.4bn rise in compensation costs pushed up the net charge for the spill to $42.4bn at the end of the second quarter, when other costs such as the clean-up were included. BP's chief executive, Bob Dudley, put on a brave face: "We are seeing growth in production from new high-margin projects and are making good progress in exploration and delivery."

And analysts agreed that the so-called upstream business of oil and gas production is basically sound, if a little slimmed down after a prolonged period of disposals. Underlying oil production – adjusted for the impact of divestments – was up 4.4 per cent on the year before, BP said.

"The core upstream division was actually ahead of consensus and that's still going great guns. Fundamentally, I think BP is still moving forward," said Jason Kenney, a Santander analyst.

BP has also made good on its promise to return a large portion of the proceeds from the TNK-BP sale to investors, buying back about $2.4bn of its shares so far.

But in view of its lost income from Russia, where its exposure is now limited to the Rosneft stake, and its Gulf of Mexico compensation costs, BP is largely governed by forces over which it appears to have very little control.

The company has tried unsuccessfully to freeze compensation payments being made under the settlement it agreed last year with private sector plaintiffs over the Gulf of Mexico oil spill. It says that the office of Patrick Juneau, the claims administrator, has interpreted the settlement in a way that opens the door to "absurd" payments to people not affected by the spill.

BP is continuing to challenge Mr Juneau's interpretation but has warned that even if it succeeds, the total cost of the settlement would be "significantly higher" than $9.6bn because that figure does not reflect business economic claims not yet received or processed. BP has just $300m left in its compensation fund. The company has said that claims beyond what that fund can cover will be taken straight off future profits, so investors are expecting a hefty hit to the bottom line in the coming quarters.

Keith Bowman, an analyst at Hargreaves Lansdown Stockbrokers, said BP also remains hostage to other forces outside its control – the "oil price, government appetite for tax revenues and the strength of the broader global economy".

But the biggest problem remains whether BP will be found guilty of being grossly negligent, rather than simply negligent, with respect to the oil spill. A verdict of gross negligence would add tens of billions to its costs. That's why the company's shares continue to trade at a 40 per cent discount compared with those of its peers.

Legal saga: Investors face a long wait

BP's giant court case in New Orleans, Louisiana, will resume in September and will cover state claims related to economic restoration, damage to natural resources and the Clean Water Act.

The company has already budgeted for nearly $43bn (£28bn) in legal, clean-up and other costs. However, the bill could soar by up to $50bn if BP is found to have been grossly negligent, rather than just negligent. In that case, the maximum penalty under the Clean Water Act alone could rise from $4.5bn to about $21bn.

That worst-case scenario receded a little last week, after Halliburton – BP's cement contractor in the Gulf of Mexico – pleaded guilty to destroying evidence that would have worked in BP's favour.

However, the company is by no means in the clear. And with the case set to drag on for months, it is likely to be a long time before shareholders can sit comfortably and the share price has a chance of recovering to a level worthy of an oil company of this size.

In numbers

$2.7bn BP profit for second quarter of 2013, down from $3.6bn a year ago.

$42bn BP's total provision so far for compensation, clean-up and other costs relating to the Gulf of Mexico oil spill.

$1.4bn The amount BP's provision for compensation claims rose in the second quarter, taking the figure to $9.6bn.

$218m Profit from BP's stake in Russian giant Rosneft. A year ago its Russian joint venture TNK-BP added $452m to BP's bottom line.