Oil spill may cost BP far more than $20 billion

The plan by energy giant BP to suspend dividends, sell assets and build a $20-billion fund for oil spill victims highlights the delicate balance of post-disaster economics: How to clean up the mess in the Gulf of Mexico without killing the goose that laid the black-gold egg.

BP faces mounting — and as yet unknowable — costs of containing the oil-spewing well a mile under gulf waters, removing oil from beaches and reimbursing victims. On top of that, the London company and the rest of the international oil industry will have to confront a decidedly more hostile public and the near certainty of increased regulation.

BP cleanup costs: In Thursday’s Business section, a chart of BP’s annual profits that accompanied an article about the company’s costs associated with the gulf oil spill used an incorrect scale. The range of the chart’s scale was shown as $1.0 billion to $2.5 billion; it should have been $10 billion to $25 billion. —

Some experts are beginning to worry about whether BP, or any company, has enough strength to pay the eventual price for one of the worst environmental disasters in U.S. history — a tab that may continue to run for two or three decades.

“One of the problems is that we don’t even know if $20 billion will be enough. This is all on an unprecedented scale,” said Joe Hahn, a professor at Pepperdine University’s Graziadio School of Business and Management who formerly worked as an engineer in the oil industry.

Hahn said the company might face the additional problem of severe fines from its decisions before and after the oil rig exploded.

“Initially, I thought they would be able to survive this, but they are in serious financial trouble. Their future is very questionable right now,” Hahn said.

Since the April 20 explosion of the Deepwater Horizon, BP executives have repeatedly sought to assure a skeptical public that the company has enough financial muscle to fix the problems. On Wednesday, the company took significant steps to shore up its financial position and reassure critics that all legitimate claims will be paid.

The company said it would suspend the dividend paid to shareholders for three quarters, sell $10 billion in U.S. assets and cut about $2 billion a year in capital spending to ensure that there would be enough money available for the task at hand, starting with a $20-billion escrow account to deal with the spill and its aftermath as well as a $100-million fund for oil workers idled by temporary moratorium on deepwater drilling.

In addition, BP pledged to set aside $20 billion in U.S. assets as a kind of collateral for the disaster account, which will be administered by Kenneth Feinberg, who oversaw the Sept. 11, 2001, victims compensation fund.

BP has spent $1.75 billion so far on containment and cleanup efforts, executives said Wednesday, but that pales in comparison to expected company cash flow exceeding $30 billion this year at current oil prices. The company will pay into the reimbursement fund over 3 1/2 years, so the financial hit doesn’t come all at once.

BP Chairman Carl-Henric Svanberg said Wednesday that he was confident “that the agreement announced today will provide greater comfort to the citizens of the Gulf Coast and greater clarity to BP and its shareholders. We welcome the administration’s statements acknowledging that BP is a strong company and that the administration has no interest in undermining the financial stability of BP.”

On Wednesday, BP’s U.S.-traded shares climbed $1.43, or 0.5%, to $31.85 on heavy trading volume. The stock, which has lost nearly half its value since the rig accident, rose because the actions were widely anticipated and investors seemed to appreciate the company’s statements of contrition, analysts said.

BP netted more than $5.6 billion in profit in the quarter ended March 31 and had about $6 billion in cash on hand when the disaster began. Still, its financial position weakens every day that the oil gushes unchecked.

Fadel Gheit, a senior energy analyst for Oppenheimer & Co., said in a note to investors that “the costs of cleanup and compensation are likely to be a record that would bankrupt most companies and that only a few of the super majors could survive. We think BP has the financial capacity to survive this crisis, although excessive punitive damage could put its future at risk.”

Gheit said BP had more than 18 billion barrels of proven oil and natural gas reserves, about 3.9 billion barrels of production. Its refineries are the industry’s most efficient and most profitable, he added. BP had already performed major cost cutting before the incident, eliminating more than 5,000 jobs and reducing its operating costs by more than $4 billion, Gheit said.

It also acquired large new assets in oil fields in Brazil, Azerbaijan and the Gulf of Mexico in a $7-billion deal earlier this year.

Separate from BP’s fate, experts point out, is the prospect that new regulations and better emergency and safety procedures will come with costs that will affect everyone.

“In the short term, it won’t mean a whole lot. The economy is still pretty constricted and supplies are more than adequate,” said Mike Fitzpatrick, vice president for energy at MF Global.

“But over time, it’s going to make deep-water drilling a very hazardous proposition for oil companies and investors. There are going to be additional development costs, more regulations, insurance costs will go up. It will definitely drive up the cost of drilling and the price of oil,” he said.

The Deepwater Horizon accident ultimately will bring about a sea change in deep-water energy exploration, said Bruce Bullock, executive director of the Maguire Energy Institute at Southern Methodist University.

“This incident has become the fatal flaw for deep-water drilling,” Bullock said. “Oil companies are going to have to submit to regulators detailed plans that include frequent emergency drills. If they want to bid on an oil lease, they are going to have a response plan in place.”