BP's troubles have only just begun

The cost of mollifying the US and cleaning-up will force the company to cut investment and sell assets

David Strahan
Sunday 20 June 2010 00:00
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As BP reels from its toughest week yet since the sinking of the Deepwater Horizon rig, investors warn that the longer-term outlook for the embattled company is likely to worsen.

Even as the share price bounced towards the end of last week – at a softening of President Obama's "boot-on-neck" rhetoric, after the company agreed to pay $20bn into an escrow account to fund compensation claims – shareholders point out that BP's liabilities remain unquantifiable, hobbling oil production for years.

BP officials may struggle to imagine things could get much worse, after a week in which the chief executive, Tony Hayward, received the congressional equivalent of a public flogging; damning email evidence emerged suggesting staff had repeatedly cut corners on safety at the "nightmare well"; and BP was forced to scrap its dividend for the rest of the year. But even though the share price has almost halved since disaster struck on 20 April, experts say the longer-term impact on the company could be even more serious.

There was relief in the markets that the agreement to pay $20bn into the independently controlled account over three years had bought some breathing space for BP. But the $20bn is only intended to cover compensation claims. Clean-up costs could add $8bn this year, and fines another $20bn, depending on the eventual size of the slick – and estimates continue to escalate.

President Obama has also made it clear he expects the company to pick up the wages bill for workers laid off as a result of the US moratorium on offshore drilling – despite the fact his ban suggests safety problems in the Gulf of Mexico are industry-wide not company specific – and this makes BP's liabilities effectively open-ended. "It would be reckless to assume $20bn is all BP has to worry about", says Neil Woodford, the highly rated fund manager of Invesco Perpetual.

There is little doubt BP, which made $14bn profit last year, is good for the money – but not without squeezing its exploration and production activities. To pay for the compensation, BP plans to cut its capital expenditure by $2bn this year, and raise $10bn through asset sales, as well as saving $8bn by scrapping the dividend. If disaster costs rise, it may be forced to cut investment further, and even sell off prized deepwater oil fields – one of the few remaining areas of potential production growth. As a result, BP's output may be shrinking just at the time – around the middle of this decade – when many forecasts predict global production will peak.

The Deepwater Horizon disaster is also likely to squeeze the oil production of other companies in the Gulf of Mexico, as a result of the moratorium on deepwater drilling imposed by the administration. Energy consultants, Douglas-Westwood, estimate that if the moratorium lasts two years, output in 2015 could be 400,000 barrels a day, 25 per cent lower than otherwise, further cutting supply at about the same time the consultancy expects global production to peak.

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