BP (BP.) has been found to have acted with gross negligence in the 2010 Macondo oil spill, which has led to shares dramatically selling off. Unquestionably, this is negative news, but the considerations below support the notion that shares are currently overselling.
We continue to view BP shares as attractively priced and it remains our top pick
We are lowering our U.S. fair value estimate by $1 per ADS, while our British valuation is unchanged as this negative development is offset by the recent weakening of the British pound. Today's announcement neither impairs BP's financial health nor materially scuppers the notion that growing cash flows will lead to increasing shareholder distributions.
Given the implications of today’s ruling, we our updating our valuation to assume BP's Clean Water Act fine will be $2,600 per barrel spilled, the midpoint between maximum fines under gross negligence/non-gross negligence scenarios. We continue to assume 3.65 million net barrels were discharged, which is an average of two of the key U.S. government estimates. Taken together, this equates to a total CWA fine of $9.4 billion. Previously, we had assumed BP would settle the CWA penalty for $4 billion, or the maximum statutory per-barrel fine of $1,100 in the absence of gross negligence.
How much worse could the CWA fine ultimately be? The $17.6 billion maximum fine discussed above is $8.2 billion more than our new CWA forecast. In other words, the absolute worst-case scenario would reduce our valuation by a further 17p per share.
Two key dynamics are likely to lessen the blow of the CWA fine, whatever it ultimately turns out to be. First, this fine is likely to involve a term structure for payments, similar to the $4.5 billion DOJ/SEC deal reached in 2012. That settlement has a five-year payment structure. Second, the ability to appeal any legal ruling provides BP with the ability to delay and even manage future cash outflows. We continue to assume BP pays its Clean Water Act fine over a five-year period beginning in 2017.
Given that no initial fine will be levied until 2015 at the earliest and that such a fine will surely be appealed, BP's near-term financial health and cash flow growth are by no means at risk. Unchanged are that major near-term Macondo cash flows will be DOJ/SEC settlement payments – $2 billion of payments between now and the end of 2016 – and business/economic loss (BEL) claims. With more than $4 billion in the $20 billion trust available to pay BEL claims, it still looks like near-term cash outflows through 2016 will be about $1 billion annually.
Despite being unquestionably negative news, our take is shares are overreacting relative to the valuation impact this ruling is likely to have. We continue to view BP shares as attractively priced and it remains our top pick of the oil majors.
