Tickers in this Article: BP, XOM, CVX, NYSE:RDS-A, NYSE:RDS-B
The Gulf of Mexico oil spill will no doubt cost BP (NYSE:BP) billions in cleanup and other costs, but the market seems to be discounting too much damage to a company that has immense financial resources at its disposal.

BP is one of the largest oil and gas companies in the world, with reported production of 3.998 million barrels of oil equivalent (BOE) per day in 2009, just slightly higher than Exxon Mobil (NYSE:XOM) at 3.932 million BOE per day. Royal Dutch Shell (RDS.A, RDS.B) and Chevron (NYSE:CVX), come in third and fourth with production of 3.152 million and 2.7 million BOE per day, respectively.

Cash Flows
This level of production obviously throws off large amounts of cash. In 2009, BP reported cash flow from operations of $27.7 billion. Of course this doesn't equal free cash flow, but it does give an indication of the scale of the company.

This cash flow from operations, however, was based on recession level realized prices for oil, liquids and natural gas in 2009. The company's average price realized was only $56.26 per barrel for oil and liquids, and $3.25 per Mcf for natural gas.

In 2008, the company realized an average price of $90.20 per barrel for oil and liquids, and $6 per Mcf for natural gas. BP reported cash flow from operations of $38 billion in 2008 based on these prices.

Many observers are looking for oil prices to head back above $100 per barrel as the economy recovers, and this extra cash would accrue to BP, and be used to pay any claims from the oil spill.

Balance Sheet
BP has a strong balance sheet to help it withstand the cost of the spill. BP also has cash and cash equivalents of $6.8 billion as of March 31, 2010, that it can use to pay claims. This is lower now, since the company has paid out more than $1 billion in claims so far, due to the accident.

BP is also under levered relative to its size and cash flows. The company had net debt of $25.1 billion as of March 31, giving it a debt to equity ratio of 19%. BP not only has borrowing capacity, but also has real producing oil and gas assets to use as collateral rather than empty office buildings with an uncertain value like many other borrowers.

Discretionary Items
BP has stated that its free cash flow is break even based on $60 per barrel oil. However, this is a little deceptive, since BP has many discretionary cash expenditures that it can cut back on if cash is needed to pay claims or legal damages. The company paid $10.5 billion in dividends in 2009, and is under no legal obligation to pay any dividends to its shareholders.

BP spent $20 billion on capital expenditures in 2009, and budgeted another $20 billion in 2010. In a worst case scenario, BP could spend only maintenance related capital expenditures, and free up cash needed for claims and costs related to the spill.

This is not a sound long-term strategy for an oil and gas company, as constant investment in exploration and production projects are needed just to keep production flat. However, given the choice between cutting discretionary capital expenditures and bankruptcy, BP could take this route and free up more cash.

The Bottom Line
There is no way to estimate what BP's liability will be, and that has obviously led to the current melt down in the stock price. If we use the Exxon Valdez oil spill as a guide, Exxon Mobil has paid out $4.3 billion to settle claims related to this oil spill since 1989. Exxon Mobil agreed to a civil settlement with the federal government and Alaska in 1991, and agreed to pay $900 million over ten years, with a further $100 million added if late damage is found.

Although the BP oil spill is definitely larger and more serious than the Exxon Valdez, BP seems to have the cash flows and balance sheet to withstand the costs, and will also benefit from the number of years hat will pass before litigation is settled. (For more on BP, check out Is The Oil Spill Over-Dumping BP Shares?)

comments powered by Disqus

Trading Center