BP’s second kitchen-sinking can’t mask comeback

November 2, 2010

It will be a long time before BP is back to business as usual following the Gulf of Mexico disaster. The UK oil and gas major has just upped its estimate of costs by $7.7 billion to $39.9 billion, in what investors must hope is the second kitchen-sinking exercise following the disaster—albeit the first under new chief executive Bob Dudley. But the hit can’t mask what looks like the makings of BP’s recovery.

The upward revision to the spill cost was twice as big as some analysts had expected—BP blamed delays in capping its leaking well—but the shares still rose on the news. That isn’t so strange. The Gulf of Mexico disaster has already wiped some $60 billion from BP’s market value, while global markets are little changed from when the Macondo well blew out in April. After tax, the hit falls to $27 billion. That number is still probably a best guess. A gross negligence charge for BP would send the bill skyrocketing. Equally, the costs could fall if BP’s partners in the stricken well end up assuming their 35 percent share of the liability.

Excluding spill costs and other one-offs, underlying quarterly profits were up 18 percent to $5.5 billion, well ahead of forecasts. A lower effective tax rate helped, but refining margins were also higher. Still, BP still lags rivals. Production fell 4 percent in the quarter, against a 5 percent rise at Shell. It will slide further as BP continues to sell assets to fund the spill bill.

Meanwhile, the balance sheet looks strong. Net debt rose slightly in the quarter to $26.4 billion, leaving gearing at 23 percent. Adjusting for cash deposits received on disposals not completed by the quarter end, gearing would have been only 19 percent, according to Collins Stewart estimates. As BP acknowledges, the strength of its cash flow will permit an increase in capital expenditure next year. Depending on how the gross negligence question is resolved, the dividend could be reinstated in 2011, too.

Dudley has his work cut out to rebuild BP’s reputation and safety culture in the wake of the Macondo crisis. Still, it’s easy to see how he could preside over an improvement from here.

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