The Future of BP

There is a lot of speculation around over what will happen to BP once the dust – or rather the oil – settles after this Macondo spill.  Here’s my prediction: nothing.

A browse of any website discussing the subject will turn up what I hope is a minority of Americans gleefully hoping that BP will be forced into bankrupcy.  This is probably the worst outcome for anyone, not least those who expect to claim compensation of some sort: bankrupt companies tend not to be very good at settling legal claims, and if it is the claims and compensation which bankrupt them in the first place, there’s going to be a pecking order of claimants of whom the top few will receive handsome packages whilst the rest get nothing.  I read in an article in The Economist years ago that the asbestos claims went much the same way: a few high-profile multi-million dollar payouts to individuals which sent the companies under, leaving the rest with nothing.

Also, I think people vastly underestimate the financial might of BP.  Its profits in 2009, a very bad year for the oil companies, were $13.96bn and in 2008 – a very good year – were $25.59bn.  So we can say a typical year’s profit is about $20bn.  The cleanup and other costs of this disaster are estimated to be between $10bn-$30bn.  BP has said it will pay all legitimate costs, and I am certain that it will make good on this promise, but you can bet your life they will have a team of crack lawyers ensuring that only compensation for those things directly caused by the spill will be paid, and all others fought tooth and nail in the courts.  For example, via The Hayride I came across this article:

VENICE (Louisiana) – LOUISIANA’S charter fishermen are slamming US media coverage of the Gulf oil spill for doing more damage to the tourism industry than the slick itself, with livelihoods at risk.

‘Before the spill, I had three days open this month. Now I got all kinds of days open,’ charter boat captain Chris Wilson told AFP, as he cut up a dozen-strong bounty of speckled trout, channel bass and even yellowfin tuna he caught with clients.

Venice Marina, proudly proclaiming itself ‘The Fishing Capital of the World’ is all deserted but for Mr Wilson – the only fisherman preparing a catch – and some bored restaurant staff standing around the empty wharf-side bar.

But Mr Wilson’s friend and Venice Marina’s former owner Dave Ballay does not blame the mammoth and growing oil slick in the nearby Gulf of Mexico. Instead, people here blame the media, which day after night for over two weeks has detailed the doom and gloom facing the coast and its beleaguered residents.

‘Ninety-five per cent of the state of Louisiana’s waters are still fishable,’ Mr Ballay said with a bemused but angered tone.

And as the guys at The Hayride said themselves:

[I]f these guys think that, even though BP has said it will pay all “legitimate” claims arising out of this disaster, the company is going to cough up for losses which have come out of the agenda-driven media’s overblowing the spill without a fight, they have another thing coming. A perfectly-clean Florida beach which can’t draw tourists because Charlie Crist declared a state of emergency and swore off offshore drilling ever again, creating the impression of pollution where there probably won’t be any, isn’t going to have a “legitimate claim” against BP. They might have one against Fox News or CNN or Charlie Crist, but not BP. And BP will fight that claim, as they should.

Quite.  Also, you can also bet your life that BP will be expecting Transocean and Halliburton to be coughing up for a portion of the costs if it transpires that they were at fault at any point before or during the spill.  The Halliburton cement casing seems to be coming under scrutiny at the moment, and I expect the significance of this will become apparent sooner or later as no doubt will other factors.  The legal wranglings over who was to blame for this are likely to drag out for months if not years, and the compensation claims will be challenged and fought over even longer periods.

So let’s assume that the total claimed costs of the spill are $30bn of which $10bn BP manages to hive off onto somebody else or get chucked out of court, leaving them with a bill of $20bn.  As we’ve just seen this equates to an average year’s profits, but will be paid out not at once but over the next decade with about half in the next 2-3 years, say.  So from 2010-2013 BP will be paying about $3.3bn per year (16.5% of annual profit) followed by $1.4bn (7% of annual profit) from 2014-2020.  This is not good for investors, but it’s not enough to bankrupt the company.

According to their annual report for 2009, BP were sitting on an $8.3bn pile of cash.  They have spent $1.25bn on the cleanup so far, some of which has already been spent on addressing claims and cleanup costs which will form part of the $20bn total cost.  Assuming they’ve been spending on full flow for 6 weeks now, they can afford to keep going like this for another 10 months using the cash they have lying about in their sock drawer.  Even supposing they did run out of cash, BP could easily borrow more, issue bonds, or sell an asset or two.  In other words, the immediate costs of the spill are not going to bankrupt BP either.

So the next issue to consider is the drop in BP share price, which has been significant, especially once attempts to top-kill the well failed (incidentally, those of us watching the live video feed knew this had failed a couple of days before the media and the markets.  If I’d known how, and if what people say about those with “inside” information is true, I could have made a killing.  Maybe.).  The company has lost 38% of its value since the spill, but its market capitalisation is still $120bn.  It is a wounded giant, and it is haemorrhaging fast, but it is still a formidable beast.

But it is interesting to look at what is happening with the share price.  I have captured the graph as it stands today (click the graph for a bigger version):

Share prices often reflect uncertainty rather than the scale of what is actually happening.  Up until the top kill attempt failed, everyone was hoping BP could stop the flow of oil and limit the amount of oil needed to clean up.  Until they failed to do so, nobody knew what the final costs might be.  Nobody wanted to offload their shares and find the well had been capped and the cleanup costs were now looking like only $10bn.  So when BP announced the top kill had failed and effectively they would not be able to stop the flow until the relief well was drilled, the share price took a steep drop on 27th May to account for that but a degree of uncertainty was removed: everybody now knows there is another few weeks of 12,000-19,000 barrels per day going into the sea (BP’s efforts to collect some of that notwithstanding) and the initial worst case cost estimates of $20bn-$30bn are now looking likely.  So the share price dropped steeply, but has since stabilised: people now have a better idea of what the true costs will be.  Unless there is some other serious setback, such as both relief wells managing to snap their drill strings downhole or any other reason preventing their completion, the share price should not fall much lower.  There might be some daft political factor which causes it to drop further – some knee-jerk legislation ordering BP out of the US, or something – but what we know now is enough to stabilise the share price.  And if it does drop much lower out of general fear by risk-averse investors, you can be sure there are a few people who will think the stock is undervalued and will be snapping it up (which seemed to be happening before the top kill attempt failed, probably by people gambling on its working).

So, assuming its current value of $120bn holds steady for a while, is this low enough to attract a take-over bid?  I don’t think so.  Firstly, nobody is going to go near the company until the well is capped, and once the well is capped the share price should rise a little: another area of uncertainty is removed.  Secondly, Tony Hayward is probably a bit busy at the moment and wouldn’t be able to spend much time talking about a take-over and his discussing the finer details of his severance package might just attract some criticism at this time.  By the time the company is in a position to negotiate a take-over bid, the worst of the Macondo disaster will be behind them and the company will be in a stronger position.

But most importantly, who would be in a position to buy them?  There is a short article on the FT blogs discussing this which contains this useful little graphic:

As the FT’s Kate MacKenzie says:

While it might be a technically viable, and attractive, target for some companies, there are enough drawbacks to make it difficult to see who might be seriously interested.

Indeed, and I’d agree with the pros and cons identified in the graphic.

With one exception: PetroChina.  Whilst it might seem obvious that buying a company allows you to acquire expertise and technology, it is usually not so simple.  For what does the expertise actually consist of?  People.  The Macondo accident notwithstanding, BPs expertise in deepwater drilling lies in its employees.  They know how the technology was developed and how it is operated and the philosophies behind their employment and operation.  Most of this information is stored in half a million procedures and manuals on the shelves of the BP offices, but it is the people who know how and when to apply them.  The manuals tell you what to do, it is the people who know how to do it.  Good implementation is as important as the asset itself.  So if you want BP’s expertise, and you want to make use of their technology, you need to ensure you are buying their people.

And how many BP staff want to work for a Chinese company?  Not too many, I’ll bet.  In the event of a PetroChina takeover of BP, most staff would want to head for the exit door.  True, most of them would have no choice but to stay because the industry does not have enough vacant places for a staff the size of BP’s to move elsewhere (and especially not right now).  But the experts who PetroChina would be hoping to acquire?  They’d likely be off like a shot.  The chap who has spent 20 years in the development of deepwater directional drilling, his mate who has 15 years under his belt on seismic mapping of reservoirs, and the brilliant young process engineer who performed so well on the last LNG project?  They’ll be banging on the doors of Exxon and Chevron within twenty minutes of the Chinese taking the keys.

There’s some anecdotal evidence to back this up.  When Gazprom took over the ownership of Sakhalin Energy from Shell in the summer of 2007, both the expatriate staff and the Russians thought it was going to get worse for them, and it did.  It took a year or so to get going, but there was a campaign to squeeze the terms and conditions, especially things like travel and medical, which became a bloodbath when the oil price crash came and Gazprom could not afford the operating costs of the company.  Those who were not fired found their benefits axed, contracts renewed for only a few months each time, salaries effectively cut as the rouble fell, training courses cancelled, overtime forbidden and working practices take a step away from what was the norm under the Shell management systems, changes which were not for the better in any other area but finance.  Almost as soon as this started there was an exodus of those who could get a job elsewhere (which in the climate was not an easy task), and interestingly it was the Russians who were the most unhappy.  They had purposefully applied to a foreign company because they didn’t want to work under Russian management, and their fears were realised once Gazprom started flexing its muscles.  At the time most had no choice to stay, but as the global oil and gas industry slowly picks up, its best employees are now leaving for elsewhere if they haven’t gone already.

Of course, there is no guarantee that PetroChina would start to squeeze the employee terms and conditions currently enjoyed by BP staff in the event of a take-over, but it is likely.  They would also want to start bringing their own management into play, which would cause enormous problems and employee tensions due to cultural differences if nothing else.  The biggest job PetroChina would have on their hands were they to take over BP would be to retain their best staff, but supposing they couldn’t?  Does it really matter?  Well, yes it does.  The US government is going to be very nervous about allowing any oil companies to be drilling in deep water after the Macondo disaster, and the beefed-up regulators are going to be breathing down their necks with every turn of the drill bit.  Even if we disregard the political objections to PetroChina buying BP and operating in US waters, it is highly unlikely they will be able to negotiate a permit having bought somebody else’s license and assets and watching the expertise who made it all happen walk out the door to be replaced by people who have no deepwater drilling experience whatsoever.  And you could extend these concerns with deepwater drilling in US waters to other areas of the global industry, such as the operation of refineries and LNG terminals.

So my prediction is BP will not go bankrupt sooner or later, and will not be subject to a take-over.  Their reputation in the US will probably be ruined for good so you might find them selling off their American operations, but as a company they will survive, be battered and bruised for a few years, but be as strong as they ever were when the next disaster hits – hopefully for them – somebody else.

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11 Responses to The Future of BP

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  2. Tatyana says:

    Tim – to the point and reasonable, as always.

    Re: Chinese style in management: see here. Haven’t had the experience with Chinese in China, but worked with Chinese in America – and can confirm, on my small scale, the observations in teh book/review and the thread.

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  4. dearieme says:

    I was telling a pal that the BP people I’d worked with long ago were nothing like the ogres complained of by the hysterical Yanks. He said that BP had got worse since my time, blaming Lord Browne and his insistence on looking only at the short term, out-sourcing and whatnot. So I googled said Noble Lord: Stanford Business School. So it’s the Yanks’ fault after all.

  5. john b says:

    If I were BP CEO at this point, I’d be looking to sell off my retail operations, probably country-by-country.

    The brand, even outside of the US, will probably lose more custom than it creates among consumers for several years, and retail isn’t a particularly profitable or technically difficult activity (any supermarket management team could run BP retail, with the addition of a grizzled oil storage & transport veteran as COO to ensure hazmat rules are thoroughly followed).

    The deal that Shell’s done in Australia, where all Shell sites are owned and managed by supermarket chain Coles and supplied from Shell refineries would be a good one for BP to replicate with anyone who’ll take it (although minus the franchise deal that keeps the Shell name on the Coles sites).

    On PetroChina: I agree with your concerns, but remember that if PC is willing to pay way above the current market capitalization (or at least, shareholder perceptions of what market capitalization should be once the uncertainty has died down), then BP’s managers can’t take the fact that the deal won’t be good for the combined company into account. Their responsibility is solely to BP shareholders, and if the Chinese are willing to blow vast amounts of cash on a bad deal, that’s PetroChina’s problem alone.

    See: Cadbury/Kraft, where the worse-managed, slower-growth company was willing to pay a large premium for the takeover – and then sidelined the Cadbury managers who’d actually driven the growth, and whose expertise you might have thought they were paying for.

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  8. Tim Newman says:

    John B,

    Agreed on all points.

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