Expensive Decision

Jim Brown
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BP agreed to a record $18.7 billion settlement with the U.S. government, five Gulf Coast states and more than 500 local governments. That brings the total cost to BP for the Deepwater Horizon disaster to $53.8 billion and still rising. This creates an entirely new risk/reward metric to offshore drilling.

BP was facing record fines in the court case that has run for three years and still not reached a final conclusion. Judge Carl Barbier found BP grossly negligent in the 3.2 million barrel oil spill. Codefendant Anadarko Petroleum (APC) was not a part of the BP settlement and still faces the potential for a $1 billion fine even though Anadarko was a silent partner and had no say or control in the operations of the well. The judge did rule that Anadarko did not have any civil responsibility and was indemnified by BP in their contracts.

The full details of the settlement are not known and will be kept under seal until the court releases the details for public comment. After the comment period the judge will rule on the settlement proposal. Many lawyers said BP was getting off easy and the government should have held out for more money after the gross negligence finding.

BP did win on several fronts. The majority of the settlement will be tax deductible. Fines are not deductible but settlements as compensation for damages are deductible. Secondly the company agreed to stagger payments over 18 years and that is a major win for BP. It keeps them from having to liquidate tens of billions in assets to pay for a court award in a lump sum. By spreading out the payments to roughly $1 billion a year it will allow BP to continue business as usual and make the payments out of their annual profits. This will allow BP to continue exploration and continue paying dividends.

The settlement also frees BP of the cloud of uncertainty. Over the last five years BP has sold roughly one third of its assets to pay damages and claims in other settlements. There are analysts that believe BP could be an acquisition target now that the uncertainty is gone. However, with a market cap of $125 billion and $60 billion in debt there are only a couple of entities that could make a run at the company. Exxon is constantly rumored as a potential suitor and Exxon has a $350 billion market cap. With oil prices are decade lows and the uncertainty removed this would be a prime opportunity for Exxon to grab an entire portfolio of first class reserves.

However, the UK government told BP earlier this year that it would oppose the acquisition of BP by a foreign company. The government was on the defensive after Shell announced the acquisition of BG Group Plc. BP has also war-gamed strategies with Morgan Stanley to defend against a potential takeover.

Exxon and BP have a lot of assets in the same regions. Exxon and BP have major reserves in the Gulf of Mexico and both companies have joint ventures with Rosneft in Russia. BP owns 20% of OAO Rosneft and Putin could also object to a change in control.

I think an acquisition of BP is highly unlikely but I could easily see the company sell off some strategic assets to raise cash for settlement payments. The outlook for BP is positive and the 5% rally on the settlement news is just a start. I would look for a move over $42 as a buy signal.

Little did the operators on the Deepwater Horizon in April 2010 realize that they were making decisions that would cost BP $55 billion and come close to breaking up the blue chip company. Some hard hat looked at a dial and questioned the readings and made the decision to continue the process because they thought the readings were wrong. That could go down as the most expensive decision in history.

Active Rigs

Active drilling rigs rose +3 to 859 for the week ended on Friday and the second consecutive week of gains. Oil rigs rose +12 for the week to 640. Active gas rigs fell -9 to 219. Active rigs have now declined -1,069 since the high of 1,931 in September. That is a -60% drop. Active offshore rigs rose +1 to 29 and -31 off their peak.

Oil Inventories

Crude inventories rose unexpectedly +2.4 million barrels to 465.4 million.

Refinery utilization rose from 94.0% last week to 95.0% and the highest point in 2015. Imports rose +748,000 bpd. U.S. production declined -9,000 barrels to 9.595 mbpd. Demand was flat at +249,000 bpd.

Cushing inventories rose slightly to 56.4 million.

Gasoline inventories fell -1.8 million barrels to 216.7 million. Gasoline demand rose by +76,000 bpd and imports declined -136,000 bpd.

Distillate inventories rose +0.4 million barrels to 135.8 million. Demand rose +296,000 bpd. Imports rose +45,000 bpd.

In the graphic below green represents a recent high and yellow a recent low.

Jim Brown

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