Interactive Investor

BP's Gulf of Mexico oil spill: One year on

20th April 2011 00:00

Fiona Bond from interactive investor

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It was one of the unforgettable images of last year; plumes of smoke billowing out of the Gulf of Mexico following the Deepwater Horizon rig explosion.

The disaster on 20 April, which took the lives of 11 men aboard the rig, changed the face of BP overnight and thrust the deepwater drilling industry into the spotlight.

Prior to the disaster, BP was Britain's largest company, with a stockmarket value of £122 billion.

However, within two months of what became the largest oil spill in US history, BP's shares had lost almost 50% of their value and plummeted to a 13-year low.

Just five days before disaster struck, BP chairman Carl-Henric Svanberg told investors at his first annual general meeting that BP was an "inspiring challenge".

He wasn't wrong.

"Unprecedented" crisis

At BP's annual general meeting earlier this month, Svanberg took to the stage to tell investors: "In the past 12 months, BP has been through a crisis, almost unprecedented in corporate history."

Within 24 hours of the explosion which caused oil to spew from the Macondo well into the Gulf waters, BP and its ability to respond to an unfolding crisis was played out in front of the world's eyes.

The FTSE 100-listed major immediately mobilised a flotilla of vessels and resources and initiated a plan for the drilling of a relief well, and at its peak involved over 48,000 people, 6,500 vessels and 2,500 miles of boom - a response which Svanberg has since called "without precedence and has been recognised as such".

BP went on to establish a $20 billion (£12.27 billion) claims fund in June to span the next three-and-a-half years, which would see it make initial payments of $3 billion in the third quarter of 2010, followed by $2 billion in the fourth quarter and thereafter $1.25 billion per quarter.

To date, it has paid out over $5 billion to individuals, businesses and government entities and for environmental restoration; $138 million of grants to the Gulf Coast states and provided $500 million for the Gulf of Mexico Research Initiative.

"(It) became a crucial step in responding to the accident and marked a turning point," Svanberg said of the compensation fund.

However, it wasn't until mid-July - almost three months since the leak began - that BP stopped the gush of oil for the first time.

But the battle was far from over.

Political storm

BP came under fierce fire for its handling of the crisis, most notably in the US where local residents were incensed by the behaviour of chief executive Tony Hayward.

PR gaffes - including the infamous "I just want my life back" comment - earned him the unwanted moniker of "the most hated man in America" in one US tabloid, and tarnished further the already struggling reputation of the oil giant.

The Obama administration was soon dragged into the storm, with the President sharpening his criticism of Hayward in a bid to appease growing American anger.

In the wake of the sustained criticism, Hayward announced his decision to step down. In his place came BP's first American chief executive in the form of Bob Dudley.

Andy Inglis, in charge of the exploration and production division that was responsible for the safety of offshore drilling activities, also became a casualty of the disaster.

Tony Shepard, analyst at Charles Stanley, told Interactive Investor: "They've done a lot in terms of changing the top hierarchy which should certainly help with the politics as in the investigations in the US continue."

However, it wasn't enough to appease the droves of protestors at BP's 2011 AGM, with residents of the Gulf of Mexico lambasting the company for not doing enough to mitigate the after effects of the spill.

BP has also had to face the threat of manslaughter charges in connection with the disaster, prompting analysts at Collins Stewart to cut their recommendation from 'hold' to 'sell'.

Prosecutors are believed to be examining statements made by BP managers, including Hayward, during congressional hearings last year on the spill, according to Bloomberg.

While analysts agree that a criminal change could be difficult to prove, the very mention of manslaughter in itself is enough to spook the market.

Who's to blame?

When the Deepwater Horizon rig explosion hit, it was BP's name that rang out from the headlines. The company was quick to take responsibility for its action, stating that as one of the responsible parties under US law, it would pay all legitimate claims resulting from the spill.

But while the company has admitted accountability for its actions, stating it "has not - and will not - shy away from its responsibilities", it has been keen to remind investors and the media alike that there are other parties involved.

"It is important to remember that both our own investigation and the presidential commission found that the accident had a number of causes and involved a number of parties. Some may think that this accident related to just one company. They are wrong," said Svanberg.

Both Transocean, the offshore drilling firm responsible for running the Deepwater Horizon rig, and US conglomerate Haliburton, responsible for cementing the well, have both been named.

In January, a presidential oil spill commission's final report outlined faults by all three parties in the run up to the disaster.

"Do we have a single company, BP, that blundered with fatal consequences, or a more pervasive problem of a complacent industry?" commission co-chairman William Reilly said in a statement. "Given the documented failings of both Transocean and Halliburton, both of which serve the offshore industry in virtually every ocean, I reluctantly conclude we have a system-wide problem."

BP said the findings supported its own in which it the explosion was the result of "multiple companies, work teams and circumstances involved over time" and Svanberg said earlier this month that the board is "committed to ensuring that all of the parties involved bear their share of the burden".

A trial against all three, and other smaller parties, is set to begin in February 2012.

However, with the trial another 10 months away, Charles Stanley analyst Shepard warns that the wait could be unsettling.

"BP has made a lot of changes to its structure from an investor's point of view. However, the problem is there's probably another year of uncertainty surrounding the costs and claims of the spill as investigations are ongoing, which could be unsettling for investors."

New strategy

In a bid to win investor support amid all the uncertainty, BP has made a concerted effort to overhaul its strategy and balance sheet.

In July, the oil major announced a $30 billion asset disposal programme, primarily in the upstream business. To date, it has offloaded $24 billion worth of assets and has until the end of the year to meet its target; one which analysts believe will be easily attained.

George Godber, fund manager at Matterley, said: "The disposal programme was effective on two levels. Firstly it assisted in paying down debt and therefore easing perceived financing concerns. Secondly, it has resulted in a repositioned, slimmed down company with higher quality assets capable of generating superior returns and growth than it has in the past."

At last week's AGM, Svanberg said the events of 2010 had forced it to re-set the company and "do things differently".

"BP is going through a fundamental change. We have a new organisation, an organisation which is functionally based rather than asset based. This is not a simple re-shuffling of the packs of cards, it is the change which any company would go through in these circumstances," he announced.

He said BP's three priorities were refocusing its strategy, restoring the company's reputation and gaining long term value for shareholders.

As so over the last few months, BP has put in a place a comprehensive programme to strengthen safety and risk management within the company. To start with, it created a safety and operational risk organisation, headed by Mark Bly who led BP's internal investigation of the accident.

In addition, BP revamped its management structure, introducing three divisions in the upstream; exploration, developments and production in a bid to create "greater clarity and accountability".

"We intend to build on our strengths," chief executive Bob Dudley said earlier this month. "In the interests of perspective, it is important to understand that beyond the Gulf of Mexico accident, BP's global operations performed well last year."

Looking ahead, BP has said it is planning for its future by looking at the trends in the industry. The company has estimated that demand for energy will grow by as much as 1.7% per year and projects that 93% of the growth will come from the emerging, non-OECD economies.

It will continue to invest in exploration, particularly in deepwater, stating that exploration remains one of its "distinctive strengths" and by which it turns prospects into value. It plans to double its investment in exploration over the next few years but as well as looking at well-established locations such as Angola, Egypt, Azerbaijan and, indeed, the Gulf of Mexico, it will also test new provinces in Jordan, Brazil, the South China Sea and Australia.

However, it is the company's recent strategic move - the first under Dudley's reign - that has stolen the spotlight and posed another thorn in BP's side.

Russian roulette

In January, BP announced a $16 billion share swap and Arctic exploration deal with Russian giant Rosneft.

But before long the deal had attracted fierce opposition from the Russian consortium behind its TNK-BP joint venture, resulting in it being blocked by the courts.

Alfa-Access-Renova (AAR) fought the deal on the basis that it breached its own shareholder agreement with BP which states that all business opportunities must be pursued through TNK-BP. However, BP won a short reprieve earlier this month when it was granted a one-month extension to its share swap deal.

Godber said of the deal: "Yes it has adversely affected BP; the share price has underperformed Shell by 12.5% since the deal was announced in January."

Despite this, Svanberg has maintained that in order to meet the ever-growing global demand for energy, Russia is an important place for BP to be.

"It is in the interests of BP's long-term growth in value that we build on the major and unique position with in Russia. Access to the Arctic is a substantial prize. We are therefore pleased that we have extended the deadline for concluding our business with Rosneft."

However, when probed on what the likely outcome would be next month, Svanberg admitted the company "had to be realistic".

"Exactly how it will unfold I don't want to speculate. I can assure you we will do what we can to land it in a good way," he added.

But IHS Global Insight Russian energy analyst Andrew Neff said BP miscalculated the extent to which Rosneft would be able to bring political pressure to bear when the inevitable dispute between BP and AAR flared up.

"BP should have known that AAR would not stand idly by and the UK supermajor did not put up much of a protest when AAR alleged that BP had violated the terms of the TNK-BP shareholder agreement."

Neff said the picture now shows that BP's expertise is not seen as irreplaceable by either Rosneft or the Russian government, forcing it into what he calls some "fairly humiliating bridge-building" with both Rosneft and AAR.

"The supermajor now intends to continue with arbitration but again the clock is ticking. With Macondo still fresh and the escape from Russian oblivion to find, BP's shareholders are likely to be in vocal form."

Where next?

After all the furore sounding its annual general meeting and events in Russia, it's back to basics for BP later this month when it publishes its first-quarter results.

Shepard at Charles Stanley forecasts earnings of around $5.7 billion compared to $5.6 billion a year ago. Production volumes are expected to be somewhat lower and as a result it will have less leverage from the higher oil prices which are currently 32% higher than this time last year and sat at near-record highs.

"Exploration and production profit may be similar to last year's level of $8.1 billion. We expect a stronger performance from the downstream operations on the back of better indicated refining margins and efficiencies which could drive a profit of $1.5 billion compared to $0.8 billion a year ago.

"The quarterly dividend was reinstated in the fourth quarter at seven cents per share and we expect this to be maintained through the year."

BP itself said in the immediate future, 2011 would mark a year of "consolidation" for the company as it fouses on completing its $30 billion divestment programme, meeting its commitments in the US and "bringing new rigour" to the way it manages risk.

"Given analyst forecasts at present remain below spot oil price we see clear potential for earnings progression and this will feed through positively to the share price. Further to this, the disposal programme allows for a cost story to emerge. These points combined should allow BP to grow faster that many of its peers," Godber added.

With a view to the future, BP's upstream portfolio has 32 project start-ups planned by the end of 2016. These have the potential to contribute around one million barrels a day to total production, which should more than offset natural declines in the portfolio.

Godber concluded: "It will take a long time for investor confidence to be restored and the Rosneft situation has not helped. BP trades at a discount to Shell, however, its asset base is sound and it has positive earnings momentum.

"Over time we expect a re-rating of the shares."

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