Ahead of Earnings, BP Investors Still Fear Oil Spill Costs

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BP’s (NYSE:BP) Gulf of Mexico disaster was the worst offshore spill in U.S. history. It began on April 20, 2010, when an undersea well exploded 50 miles off the Louisiana coast, killing 11 workers and spewing millions of barrels of crude oil into the ocean. Marshes, fisheries, and beaches stretching from Louisiana to Florida were polluted, harming local tourism and fishing. The oil producer has acknowledged responsibility for the oil spill, spending more than $25 billion on cleaning up the marshes, fisheries, and beaches along the coast and compensating victims.

That spending is just the tip of the company’s spill-bill iceberg — $42.4 billion has been spent or earmarked for spending on clean-up, compensation, fines, and other costs. BP has even sold assets that generated $5 billion of cash flow a year to pay those expenses. The recompense that the United States legal system has exacted from the company, along with the tens of billions of dollars company executives promised President Barack Obama they would set aside for cleanup and compensation, profoundly changed the company. When BP sold $39 billion worth of assets, assets that generated $5 billion per year, the company lost one-fifth of its pre-2010 earnings power, dropping BP from second largest oil company by assets to the fifth.

Even though more than three years have passed, the company’s shares remain around 30 percent below the level at which they were trading before the Macondo well exploded. And, BP shareholders got a further shock last quarter; the company warned that restitution-related costs grew by $1.4 billion during the three-month period, leaving the $20-billion fund set up to compensate oil spill victims close to exhausted: just $300 million remained. At the time, the company said any future restitution payments would be deducted straight from earnings.

Third-quarter earnings are scheduled to be released October 29, and BP is expected to reveal that its spill bill for the Gulf of Mexico grew to $43 billion, around a billion dollars higher than the $42.4 billion the company’s disaster-related costs totaled in July when it last updated shareholders. Further hurting results is the fact that analysts expected a 37 percent drop in profits thanks to slumping refinery margins.

The biggest driver of skyrocketing spill costs is victim compensation. The sideshow of BP’s civil trial in the district court in New Orleans has been the company’s efforts to convince Judge Carl Barbier to tighten the standards by which the court-appointed administrator Patrick Juneau evaluated compensation claims made by the individuals and business harmed by the 2010 Gulf of Mexico oil spill.

In May 2012, BP and the lawyers for the victims of the Deepwater Horizon oil spill reached an accord to settled the class action lawsuit. Instead of the $20-billion fund created by BP, the agreement called for the court to administer the compensation payments to those Gulf Coast residents who endured the months-long oil leak that befouled beaches, killed wildlife, and disrupted the economies of their states. At that time, the company — which had already paid more than $6 billion from the original fund to about 200,000 individuals and businesses — estimated that payouts related to plaintiffs’ claims would cost just $7.8 billion. But by July the company’s estimate rose to $9.6 billion.

When the restitution payments started to overshoot its original estimate, BP began to contest the manner in which restitution payments were awarded, arguing that court-appointed fund administrator Patrick Juneau has compensated “fictitious and inflated losses.” For months, the company petitioned the court to freeze payouts while the administrator’s payout formula was reexamined, but for some time, Barbier denied that request.

However, at the beginning of October, the 5th U.S. Circuit Court of Appeals in New Orleans directed Barbier — who had approved of Juneau’s evaluation methods back in March — to halt payments on claims that do not meet stricter standards and issued an injunction, preventing further compensation from being paid until the terms of the settlement were tightened. At the time of the injunction BP had already accounted for claims that had been paid out or processed, and the appeals court could even prevent a portion of the processed claims from being paid.

Still, Deutsche Bank analyst Lucas Herrmann told the Telegraph that BP could increase the provision set aside for spill-related costs by a further $1 billion, although RBC Capital Markets analyst Peter Hutton cited a lower figure of $500 million. “BP will increase the provision on anything that has been agreed to be paid out, but I think the sensitivity will be lower because what investors disliked was this ‘no end in sight’ liability,” Hutton told the publication. “The October ruling has at least put a line in the sand.”

Now, the pressing concern for analysts is the size of the civil penalties that will be assigned once the trial comes to an end early next year. At issue now, in the second phase of the three-part trial, is how much oil spilled from the blown out well, and whether the company responded correctly once oil began to spill. Penalties will be decided upon in the next phase.

Hutton expects that BP’s underlying profits, which exclude one-time charges related to the spill, will amount to $3.17 billion for the third quarter, down from $5.02 billion in the year-ago quarter. He also said that earnings from the company’s refining and marketing arm could have declined by 75 percent. “We expect this to have been a challenging quarter for BP with results depressed,” Herrmann wrote in a research note obtained by the Telegraph.

The only good news is BP has begun to recover from the post-2010 paralysis that prevented the company from looking for oil and gas deposits. After the spill, the company’s exploration activity nearly halted, a problem for the company’s very existence because exploration activity is the driving force of any oil company.

As company executive vice president for exploration, Mike Daly, told financial analysts earlier this month, BP expects to drill between 16 and 18 wells, more than three times the number of wells drilled in the past three years. These wells are “new-field wildcat tests, not appraisals“ of known areas, he said, according to the New York Times.

Of course, the description of the company’s exploration activity likely did little to alleviate the concerns of shareholders or analysts. “In terms of quantified success, it is still early days,” said Hutton told the publication. “It is the drilling that counts,” and BP is still trying to catch up to rivals like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX). But, as Daly told the Times in an interview, BP was “hit by a truck” after the 2010 spill.

Follow Meghan on Twitter @MFoley_WSCS

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