It’s been over three years since the Deepwater Horizon spill – BP’s Gulf of Mexico disaster – was finally capped. However, the leak continues to hurt the oil giant’s bottom line.
A few weeks ago it was forced to raise the amount of money set aside to pay compensation, for the second time in six months. Overall, it has paid out over $42bn so far.
As well as claims from businesses, it still faces negotiations with various US government agencies. Throw in a ban on business with the US government, and an investor lawsuit, and you can see why shares are still down 30% from their peak.
So why do I think that now is the right time to buy in?
The clouds hanging over BP are starting to clear
One of the big negatives hanging over BP has been uncertainty regarding just how much it would have to shell out in terms of fines and compensation. However, there are signs that the company may be succeeding in its attempts to slow down the rate of new claims.
As part of the post-disaster settlement, BP agreed to set up a $20bn trust fund that would pay compensation directly to those affected. The idea was that independent trustees would make decisions on compensation. This would ensure that the company could not try to save money by delaying legitimate claims. It also meant small firms could get any money owed quickly, reducing the chances of them going under.
That all sounds fair. However, BP now argues that the claims process has gone too far in the other direction, allowing all manner of frivolous claims. One big bone of contention is the amount of compensation paid to those who were indirectly impacted.
This includes service sector industries, such as hotels and restaurants, which were supposedly hit by the impact that the spill had on the tourist industry. In many cases, compensation for ‘business economic loss’ has far exceeded the compensation for property damaged.
Of course, BP has a clear incentive to throw doubt on the process. However, they’ve uncovered some pretty compelling evidence to boost their position. Allegedly, some of those in charge of judging claims were lawyers who were themselves suing BP – an obvious conflict of interest.
As a result, BP has filed a counter-suit, trying to claw back an estimated $1bn that was overpaid. Yet, even if BP doesn’t win, the trust fund has only $300m left in it. This means that remaining claims will have to go through BP. This will allow them to control the pace of payments, and reduce the risk of frivolous claims.
BP is also having some success in getting the two other firms involved in the disaster, Halliburton and Transocean, to share the burden. And the company is also close to cutting a deal with the US Justice Department to resolve the major outstanding charges.
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Breaking out the drill bit again
So the uncertainties over the aftermath should dissipate soon. That leaves us to consider BP’s future.
One thing that the crisis did was to force BP to sell poorly performing or overvalued assets. The company’s exit from Russia has also freed up a large amount of cash. While some of this will go on legal bills and compensation, much of the rest will be returned to shareholders. BP has decided to raise its dividend and buy back up to $8bn worth of shares.
It is also set to increase the amount spent on investment. This is vital. Like mining companies, oil firms need to explore constantly to ensure their long-term survival. If they don’t do this, their reserves of oil dwindle over time, damaging their ability to pay dividends and buy back shares.
In the immediate aftermath of the crash, BP was forced to cut back on new investment. But in the past 18 months, it has resumed major activity. JP Morgan thinks the company is now on course to return to its pre-crisis drilling rate of 15 to 20 new wells each year.
For example, the company has just invested $1bn in two new projects in Alaska. It is also running studies to see whether it would be worth following up with an extra $3bn in the area in the near future.
The best reason to buy BP – it’s cheap
The ending of this legal uncertainty and its return to investment are both major pluses for BP (LSE: BP). But the biggest reason to buy in is also the simplest – it’s cheap. BP trades at just 5.1 times its earnings. It is also valued at only 1% above its net assets. Finally, it has a yield of 5.26%.
This is very attractive compared with its competitors. For instance, Exxon trades at 11.6 times earnings, and 134% over its book value. Even Royal Dutch Shell, a more conservatively valued company, trades on a price/earnings (p/e) of 8.7 and is valued at a 20% premium to its book. Both Exxon and Shell have lower yields of 2.9% and 4.8%.
My colleague Phil Oakley delves into the attractions of BP’s dividend in more detail in the next issue of MoneyWeek magazine, out on Friday. If you’re not already a subscriber, you can get your first three issues free here.
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