The BP downgrade cycle

By Felix Salmon
June 16, 2010
Quote of the day comes from Fitch's Jeffrey Woodruff, in the wake of downgrading BP by a whopping six notches, to BBB from AA:

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Quote of the day comes from Fitch’s Jeffrey Woodruff, in the wake of downgrading BP by a whopping six notches, to BBB from AA:

“We think the CDS market is overdone hence our decision to shift rating to BBB,” said Jeffrey Woodruff, senior director in Fitch’s EMEA Energy team and lead analyst for BP.

Inevitably, partly as a result of the downgrade, BP’s CDS gapped out: it seems that rising CDS spreads cause ratings downgrades, and ratings downgrades cause rising CDS spreads, in exactly the kind of death spiral that we all remember far too vividly from a couple of years ago.

In this case, however, I don’t think there’s much systemic risk. Real-money investors are buying BP cash bonds (Pimco’s just snapped up $100 million or so at double-digit interest rates), and BP has solved a lot of potential cashflow problems by suspending its dividend. I think we can leave the ratings agencies and the CDS markets to do whatever it is they feel they need to do: there’s no sign that the nervousness in the CDS market — or even the tone-deafness of BP’s chairman — is doing any damage to BP’s $100 billion market capitalization.

On the other hand, nervousness in the credit market is unpredictably contagious: it can have no effect for months, and then suddenly spill over into stocks and even the broad real economy if everybody starts getting worried about the banking sector again. That could, conceivably, happen if Obama signs a tough financial-reform bill.

Meanwhile, I’d love to hear from any investors in BP what and whether they think about the ethics of their investment. Does there come a point where a moral investor should avoid certain companies entirely? I, for one, wouldn’t feel comfortable buying shares in BP at any price. It just feels, well, slimy.

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Comments
13 comments so far

I bought some shares of BP in my IRA last week. I understand wanting to steer clear of companies that make one feel icky–indeed I think the first mutual fund I ever bought was an SRI fund–but I’ve come around to the belief that the only criterion to consider in choosing a stock is whether you think the shares will sell for more later than they do now. And for BP I certainly think that’s the case–even the wildest estimates for their liability from the spill don’t suggest that the company should be worth fully $90B less than it was in early April, and within a few months when politicians have found something else to express outrage about and BP is no longer leading every evening newscast I fully expect that other investors will value the company more rationally and give me a good exit point.

The main reason I’m not morally conflicted about this is that I don’t see that I’m doing the management of BP any genuine favor by becoming a shareholder–certainly I’m doing it less of a favor than I would be if I were buying its products. At most, by decreasing the supply of their shares I’m making it easier for them to go to the capital markets if they should need funding, but for one thing I don’t think my ownership of 0.000003% of the company will impact that, and for another, for the few months in which I plan to own the shares it seems like we should want BP to have access to capital if they need it so that they can pay claims.

Posted by fedka | Report as abusive

Did you stop buying gas from all the other companies who filed inadequate prevention plans?

As far as buying the stock now from other investors, some people would rather have 31 dollars of my cash, and I would rather have one share of their BP stock. Wouldn’t it be worse to tell them that they’re stuck owning that which they don’t want, or that there is some opprobrium in buying it from them so they should take less?

As far as whether its immoral to own shares in BP, you don’t have any reason to believe that other oil companies are any safer or cleaner just because they failed to have this kind of accident.

It’s ethically counter-productive to say that this exceptional case is the dubious one, and by implication, everything else is probably fine. The practical implication of what you’re suggesting is even more dangerous: if “ethical” people stayed away from owning BP stock, then the company would have an adversely selected group of less ethical shareholders, bringing us all that much closer to another accident.

Posted by AdamB1438 | Report as abusive

seen on the message boards today: “The two best reasons to buy BP: you hate yourself and you hate your money”

Posted by KidDynamite | Report as abusive

It seems the 975 to 1075 bps quotes on BP 1yr CDS are the quotes in Euros. In fact, I was told that the bid/offer is Euros is 937.5/1062.5. From a different source, I was told that bid/offer in USD is 575/675. How reasonable is it that the CDS levels are so different when denominated in different currencies, since there is no systemic risk in BP? Any insights?

Posted by sds-pm | Report as abusive

I bought BP’s 1-yr bonds @ 11% and 2-yr bonds@ 9.5% YTM this morning.

I think the near-term bankruptcy fears in CDS and Bond markets are perhaps overblown. The corporate structure of BP is such that, in the event of massive losses
or claims: BP PLC should be able to let BP Holdings North America go bankrupt and cut its losses at that level. Claiming compensation from the parent company beyond that could be difficult as that will be fought over in London courts which might toss
out a lot of claims filed by Americans.

I do agree with your point that BP common stock is not yet attractive. Even if BP survives, you could be stuck holding it for years that too without a dividend.

I’m quite sympathetic to BP’s situation. A broken pipe 5″ in diameter, 5000ft below sea level is tough to fix. Given 70% of future oil is expected to be extracted from Deep Sea, it is almost guaranteed to happen again.

I think they have been a bit too nice in agreeing so quickly to a 20billion escrow account and suspending the entire dividend. I would like to have seen them put up a bit of a fight (at least till a court judgement).

Posted by raghuveern | Report as abusive

Bill Gross said he was happy to get 10% yields on what he just now called an AA credit. An AA has an extremely small chance of going bust.

Folks who really think BP will go broke are not using their thinking caps. If there is any chance of that, BP has a duty to its shareholders and to the Queen to throw its US subsidary under the bus and walk away.

BP is, by sales, as big as the next four British companies combined (HSBC, Vodafone, Tesco and Barclay’s). This is a horrible spill, but Obama and his merry band of thugs are not going to shout this company into oblivion and force the British people into poverty.

We are all still waiting for team Obama to come up with their first idea to help stop this spill.

Posted by DanHess | Report as abusive

Whatever it is that leaves a sinking oil rig last, and rats it may be, they’re not all there any more. This could mean all the more room for bottom feeders. At the same time, that “millions of flies can’t be wrong, so buy BP” argument is rapidly losing viscosity and isn’t liable to adhere forever.

For those on the wrong end of the slick, though, it may seem like it.

Posted by HBC | Report as abusive

As for ethics of investing in BP, this is an interesting question. I bought BP at around 37 recently, and frankly I lose no sleep over the ethics of it. I am someone who refuses to buy Altria for ethical reasons.

Look, oil feeds us all. It transports us all. For the time being, it is about the most important tangible thing in our economy, with viable and scale substitutes far off on the horizon.

For anyone in 2010 to demonize oil companies is silly and hypocritical — even a NYC cyclist must eat, and we all like to fly around.

Tom Friedman nailed this:
http://www.nytimes.com/2010/06/13/opinio n/13friedman.html

BP is the largest and most productive driller in the Gulf, it is not unexpected that a spill should be theirs.

We all pay good money for oil companies to go hell-for-leather for the sake of our needs. While I hope for alternatives, I am glad as heck that oil is feeding our children in the meanwhile.

Posted by DanHess | Report as abusive

I can’t agree, yet, with the demonization of BP. It is not clear to me that they really did anything wrong other than exercise some bad engineering judgement.

And, as others have pointed out, they provide a product we really want.

Sorry to get philosophical, but to one degree or another, every company pollutes intentionally. Every company makes design and operational decisions based on risk/cost/benefit. Rarely are these decisions clearly right or wrong. This event is no different than the explosion of the space shuttle Challenger or the break up of Columbia – terrible accidents cause by the under-appreciation of risk. What are you going to do about it?

Posted by silliness | Report as abusive

“It is not clear to me that they really did anything wrong”

Aside from possessing 750 times the number of safety violations in the US alone than their next closest competitor, right?

It’s time for you to stop talking, “silliness” – that dog won’t hunt. Your pro-BP shtick is inane and flat-out wrong.

“Rarely are these decisions clearly right or wrong”

This statement is incorrect. Industry standards exist for a reason. A correct statement would be: “Rarely are BP’s decisions clearly right.”

“What are you going to do about it?”

In a free market, the court is the check on private industry profits. Get ready to be bankrupted.

Posted by Unsympathetic | Report as abusive

If it weren’t for BP’s production, which is a decent chunk of the global total, oil and food prices would be quite a bit higher.

That would be no big deal for the rich but rotten for the lower income people of the world.

Folks needs to be careful what we wish for. Oil has to come from somewhere and corn stalks or chicken grease are not going to do it.

Gee, how about Iran, everybody? That is also a way to support our other favorite regime, North Korea.

Posted by DanHess | Report as abusive

@unsympathetic: I should stop talking because I refuse to jump to conclusions? OK. By the way, what were those 750 violations? Do you even know? Were they from employees smoking near flammable liquids? Were they from employees not wearing required PPE? Or were they design flaws that ignored obvious hazards? The number means nothing.

I’m not defending BP, I’m criticizing the American tendency to assume that errors in engineering judgement are the same as criminal negelct. Get it?

Posted by silliness | Report as abusive

> Were [BP's safety violations] from employees smoking near flammable liquids? Were they from employees not wearing required PPE? Or were they design flaws that ignored obvious hazards? The number means nothing.

Why would BP be 750 times more likely to be violated for smoking near flammable liquids or employees not wearing required PPE? More importantly, does it even matter?

The number means everything. Assuming BP was not being singled out by regulators as a form of corporate harassment, with a statistic like that it’s probably safe to assume BP was–and is–operating with a significantly more lax attitude towards safety than the industry norm.

Posted by MarkC123 | Report as abusive
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