Investor Profit Opportunity Emerges Out of the Gulf Oil Crisis
Companies / Oil Companies Jun 16, 2010 - 06:13 PM GMTBy: Mark_McMillan
When will there be good news to follow the bad news of a BP platform explosion, sinking, 6-month moratorium on new drilling and now up to 60,000 barrels per day spill into the Gulf of Mexico? I don't have an exact answer to that question. While BP has been the primary focus of President Barack Obama's outrage, there are many companies that have been punished in sympathy with BP's plight.
BP Plc (BP) has given up fifty percent of its market cap since mid-April, prior to the Gulf incident. BP was trading above sixty dollars and closed at $29.20 at its low on June 9th. In a bid to appease public outrage over the spill, it appears BP will place $20 billion into an escrow account to ensure payment for damages. This may take some pressure off of BP and President Obama in the short term but it doesn't solve all the problems facing BP.
For the record, BP earned $63B in profits over the last three years. In other words, $20B is only one year's worth of profits. A loss of $20B is hardly something to cause a bankruptcy for this industry giant. BP also has about $15 billion in cash at this time, so coming up with the funds won't prove to be particularly difficult. It is the unknowns that caused the stock price to slide. How much will the full bill to clean-up the spill really cost BP? Could BP be forced into bankruptcy over this?
My take is that the British government has to walk a tight rope here. The FTSE is the main British stock exchange. About 12% of all cash paid as dividends by companies trading on the FTSE are dividends paid by BP. It is by far the largest and most important company trading on the FTSE. It was considered a very safe stock with a consistent and safe dividend payment of $2.5 billion quarterly which is $10 billion annually. This is considered a "widows and orphans" type of security that many income dependent investors are holding. The disposition of these dividends as well as the market cap of BP affects the British economy. The British government will be keenly interested in protecting BP since it will be protecting British subjects.
Factoring in that Britain is the U.S. staunchest ally means that President Obama will only push the matter so far. Whatever happens, BP will not be forced into bankruptcy because the holders of BP common shares lose first, which means the British economy could actually be tipped into recession. In fact, delaying dividend payments would actually hurt the British economy, but I would think that this is inevitable in the short term. Any negative effect on the British economy would be happening to a country running even larger deficits (as a percentage of GDP) than the United States. In other words, Britain has to worry about its sovereign debt being downgraded.
The Gulf disaster occurred at a deep water site. An investigation is likely to determine that the disaster could have been prevented. BP has a history of neglecting maintenance on their properties in order to maximize profits. I would expect that BP will have to improve their maintenance/safety record which will affect their profitability, but given how significant their profits have been, it won't be particularly material. It will decrease profits from obscene to huge.
The obvious play then is to buy BP's beaten down stock and hold on for the long term. Where is the bottom for BP? It was likely put in at the intraday trading low of $29.00. Any buy near the $30.00 area is an excellent price but there is a better way to play this tragedy.
What do we know at this time? The United States Government will enforce, to a great degree, a moratorium on "new" drilling in the Gulf of Mexico. What won't be said is how many "existing" contracts for drilling and existing programs will be allowed to continue/go forward while the moratorium is in effect. The oil companies will all voice the need to continue drilling, and decree any moratorium as causing the price of oil to spike further. The reality is that the oil companies and the U.S. government already know that most projects will be allowed to continue because the gate to determine whether they would be halted or continued will be left specifically vague.
There are probably 100,000 people who make their living from Gulf oil projects. Deep-water drilling is the new frontier that allows new supply to be brought on line and takes several years to accomplish. Some of those people will be out of work during the moratorium. Some of them will be put to work on the clean-up effort. Obama has authorized 17,000 National Guard troops to help at the containment/clean-up effort along the coastlines. There are another 13,000 people working on that effort. Do you think that some of the displaced workers will be available to help in the clean-up/containment area?
What companies have taken a hit and whose services will be needed in the near term and when the moratorium is over? One company would be the next most high profile company associated with the Gulf spill. That company is Transocean Ltd (RIG). They have the necessary trained personnel to actually manage the drilling efforts. Their engineers were on the platform and apparently voiced concerns over continued drilling and were over-ruled by BP. RIG's stock price has also fallen 50% but has been recovering modestly since the June 9th low. RIG opened today at $47.92 and is a buy under $49.00.
My favorite company affected by the Gulf spill is Hornbeck Offshore Services (HOS). They are a Louisiana-based oil services company that has a fleet of vessels to support drilling and transportation efforts in the Gulf. This company is well positioned when the moratorium is lifted and its vessels and crews could be engaged for the clean-up and containment efforts. Even if their business was 100% curtailed for six-months, the stock price dive of 50% wasn't warranted. The company's assets and revenue stream are worth much more than where the stock is currently trading. There is support for the stock at $13.65 and there should be safety in buying the stock under $15.00. We are placing it in our value portfolio at a price of $14.50 where it opened today.
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By Mark McMillan
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