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The Value Play on BP
Over the years, I have invested so much time wildcatting in the oil patch that I will never be wanting for great steaks at Nick & Sam’s in Dallas, skyboxes at Cowboys games, and personally signed 8 X 10 glossy photographs of George W. Bush. So to get the skinny on the BP mess, I spent the weekend catching up with old friends who live with a permanent oil stain under their fingernails.
Some of the chatter that came back was amazing. BP has discovered the largest and most powerful well in history, and control of it may be outside existing technology. The previous record gusher was Union Oil Co.’s Lakeview well in Maricopa, California, which spewed out a staggering 100,000 barrels a day at its peak in 1910, and created an enormous oil lake in the central part of the state. My grandfather worked there for Standard Oil during the Great Depression, and 2o years later, oil was still everywhere.
Estimates for the BP well now range up to 50% more than that. The pressures at 18,000 feet are so enormous, that drilling two more relief wells might only result in creating two more oil spills. If Obama doesn’t want to take the nuclear option, (click here for my piece at http://www.madhedgefundtrader.com/june_4__2010.html ), then there will be no other alternative but for the spill to continue until the field exhausts itself or becomes capable, possibly some time next year.
This is not the end of the world. Less than 1% of the spilled oil is ending up on the beaches. Watch TV, and that is not 150,000 barrels on the beach in Pensacola, Florida. Most of the crude is being moved parallel to the coast by the current and will eventually end up in the mid-Atlantic, where it will break down or dissipate. Tropical sunlight, salt water, and crude are all highly corrosive, and the three don’t last together long.
Using the high end estimates, and assuming that it takes a year to run out, possibly 36 million barrels will end up in the sea (pressure is declining). This is the same amount of oil that was dumped into the Atlantic during WWII, when 452 tankers were sunk by German U-boats, mostly along the US east coast, and when tar balls on the beach were a daily occurrence. This is on top of the 1.5 million barrels a year that leak into the Gulf through natural seepage, which no one ever notices.
One way or the other, this will end, and Western civilization will survive. And by the way, the crude price rise brought by the spill also marked up the value of BP’s reserves, easily allowing it to cover the cost of the clean up, no matter how big it is. This is how profitable this company is, and why they were so generous with a $20 billion contingency fund.
No sooner did I put out the call the buy the pariah stock at $29, than I hear Whitney Tilson of T2 Partners, one of the giants of the value corner in the hedge fund universe, is doing the same. Whitney has come up with a few more arguments which I haven’t thought of, which I will happily pass on.
For a start, no company has ever made more mistakes than BP, and panic is rife. Great time to buy. BP has the fourth largest revenue of any company in the world after, guess what, three other energy companies, Gazprom (GZPFY.PK), Exxon Mobile (XOM), and Royal Dutch Shell (RDS/A). Pre crisis Q1 operating profit estimates were at a staggering $34 billion, and the net at $22 billion.
While the environmental damage is substantial, it is nowhere near as bad as when 11 million barrels of crude poured into the Persian Gulf during Desert Storm in 1991, which is one sixth the size of the Gulf of Mexico. The spectacular estimates for the federal fine are based on top end flow estimates at the well head. The real number will come in closer to the actual amount landed on the beach, which could 0.1% of the headline figure, or so BP lawyers will argue.
While the cleanup cost may come to $2 billion plus and is payable up front, there may be 20 years of litigation before a payout is ordered for punitive damages. The Exxon Valdez incident in the end only cost $3.5 billion.
The best historical analogy is not asbestos or tobacco, but the 2004 Vioxx disaster at Merck. The stock halved and then more than doubled, once the initial liability was shaved by 90%. It all harks back to my belief that there is way too much fear priced into this stock than the fundamentals justify.
Keep in mind that in these emotionally charged conditions, BP stock is not for widows and orphans, but for those with 24 hour global trading desks, rigorous risk control, and the ability to cross hedge against other oil companies and sectors. I would be scaling in too, and not bet the ranch. This stock will either go to zero, or more likely, double. Better to buy BP ultra high yielding debt, which at this point may bounce as much as the stock, but with a fraction of the downside risk with its senior credit position.
For a fascinating peak on how BP’s management initially responded to the Gulf oil spill, watch this video taken by a secret camera inside their board room, which I obtained from a confidential source on pain of death. Brace yourself. And you wonder how it got so bad. http://www.youtube.com/watch?v=2AAa0gd7ClM .
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two and a half years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.
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BP is more like the asbestos problem than Vioxx. Asbestos was everywhere, and the problem took all companies down with it. This oil has the potential to be everywhere and will also take BP down with it unless they stop the oil gushing and fast. So will this relief well work?
John Wright, whom is a renowned expert world, is in charge of the drilling effort and has been successful in all 40 of his previous efforts to intercept leaking wells.(http://www.examiner.com/x-36925-Clay-County-Environmental-News-Examiner~...)
There are questions about the damaged well’s condition, particularly near the point where the interception would take place, and whether it could affect the kill procedure.“No human being alive can know the answers,” said the technician, who spoke on condition of anonymity because he was not authorized to comment on the work. (http://www.nytimes.com/2010/06/29/us/29wells.html?src=mv)
My favorite comment is this: Woods Hole Oceanographic Institution special operations director David Gallo warned that the chances of failure remained high. "Not that many relief wells have been dug underwater - and none at this depth," he said. "It's like hitting a thread with the tip of a needle, and if you don't get it right that relief well will blow out. We think the pressure may be too high for anything to work." (http://www.theaustralian.com.au/news/world/bp-relief-well-nearing-target...)
And say what you like about Simmons, he's been right every time, put his money where his mouth is, and said the casing's blown out and there's no way the relief well will work. (http://www.businessinsider.com/matthew-simmons-on-oil-hurricane-2010-6)
On the other side we had MHFT and BP:
"While such a failure is considered highly unlikely, the contingency plan is the latest sign that with this most vexing of engineering challenges — snuffing a gusher 5,000 feet down in the gulf — nothing is a sure thing. Kent Wells, a BP senior vice president in charge of subsea containment and capping efforts, said Monday that the first relief well was “progressing very well” and on target to intercept the runaway well more than three miles below the surface of the gulf." (http://www.nytimes.com/2010/06/29/us/29wells.html?src=mv)
You decide. DISCLOSURE: I'm short BP.
You might want to be holding a few shares when the relief well is finished in August...
A couple of other thoughts on BP trades, both based on volatility. I'd appreciate hearing opinions and/or the flaws in my logic:
1. The first is a basic BP option straddle. Buy relatively near term calls at strike price equal to whatever BP is trading at ($27 or so). At the same time also buy the same $ amount of puts at same strike price. Obviously the hope is a significant move in either direction. The obvious problem with this strategy is that a certain amount of volatility is already baked into the option prices themselves so volatility in actuality has to be greater than is anticipated by the market to make any money. So the house has an advantage over me basically. October expiration is a logical timeframe because either the relief wells are successful and the leak stops or they aren’t and it’s big problems for BP.
2. The second strategy is similar to the Capital One trade detailed in the book “the Big Short”. The idea is to buy long term options (Jan. 2012 in this case) that are way out of the money both long and short (so maybe $5 puts and $60 calls). It’s essentially based on the idea that black-scholes misprices way out of the money options in black swan scenarios because it doesn’t account for the “fat tails”. In a case like BP where no one really knows WTF is going to happen, the theory is that it underprices the ends of the spectrum, because it doesn’t account for the probability that BP at a $10 price is basically the same probability as at $20, for example. The prices of the options don’t reflect this, however (the $20 is much more expensive), thus the actual probability curve is much flatter than the price curve (which is bell-shaped), which give the player a theoretical advantage over the house insofar as the OTM options are actually underpriced compared to their probability.
I'd be a bit cautious on the expectations for recovery of the share price. If they kill the well tomorrow, there will be oil washing up for the next six months, at least. It will only add fuel to the Trial Lawyers claims for a large chunk of this whale.
MadeHedgeFundGuru: You already submitted this didn't you? Why the double posting?
In some ways this is actually a semi-intelligent post (for once from madhedgefundtrader -- a first), but in other ways the hubris of ignorance fairly gushes forth like a new oil gusher!
"Most of the crude is being moved parallel to the coast by the current and will eventually end up in the mid-Atlantic, where it will break down or dissipate. Tropical sunlight, salt water, and crude are all highly corrosive, and the three don’t last together long."
I'm glad you are sooo expert in the geophysical sciences and chem. engineering....unfortunately, there remains a process known as oxygen depletion, and since the oxygen atmospheric content now appears to be falling even more quickly than the carbon dioxide content is rising, and this neverending gusher, brought to us by BP, will further this physical reality trend, the end of civilization is highly, highly debatable.
And neither your opinion, nor lack of science knowledge, will have any effect on the matter.
But I do agree with your assertion of this being a mega-oil find, and mega-methane as well!
not with 10' pole.....I bought at 39 and mid change and sold at 38 and high change. This was when the cap was lowered. Would have been dramatic if the plume was reduced to zero. Wait till Flipper and Shamu start washing up on the beaches. BP is in a heap big trouble.
You recommended MDR at 23.5. Now at 22.9.
Where is that $50 Billion in financing and asset sales they said were imminent? Are they having trouble getting demand at an interest rate that won't cause panic by existing bagholders?
What about the 90% of the well that was to be collected per Obummer?
A bunch of disinformation... I am voting for more shoes to drop before this is all over. Obamam and Thad are complicit in BP's disinformation campaign. So much for transparency. Disappointing...
Another POS article from the Mad Shitter. BP America is headed to bankruptcy court. The parent company will sacrifice the subsidiary to save itself. It's all been worked out with the White House.
Ok, he (the mad hatter) called for averaging down at $44-46 (no I'm not making this up)
27.59 +0.57 (2.11%) Jun 28 1:03pm ETHow's that working out?
If existing laws are enforced, BP might want to change its first initial to RI.
According to the law, BP owes a fine of $4300 per barrel spilled. If your number is correct re the total spill (36 million), BP will be writing the EPA a check for about $155 billion.
You begin with a little humor, and then segue into fantasy-land.
No disrespect, but you do know what all this means? Business as usual.
Laws being enforced? Law is discretionary these days, and the largest procurer to the Pentagon ain't in fear of any law.
Hence my opening caveat. That being said, I'm giving this a 33% probability of at least being tabled (which would send BP into Chapter 11 to protect itself). Why? Because this is an election year, and the 4th of July is coming. At a time when the average American is at his or her patriotic best, TV will be showing segments about crying 8 year old kids whose Moms won't let them go in the water on Florida's beaches. The populace will see this and want blood. Anyone up for election had better pander to this.
Buy at 29? You must love it at 27? I appreciate the hopeful nature of your post - hey we all gotta make a buck, but this mess is nowhere near from any reasonable conclusion. There is a big gulf out there with alot of oil on the surface and below. Oil is starting to, will continue to and increasingly hit more beaches. Job loss from this is in it's early stages and will get worse (save the the army of clean-up crews with perhaps permanent employment). How's that BP bond deal coming along? BP is toast, but don't frown average down.
what I wanna know is ... how many dinasours does it take to produce 100M+ barrels of OIL and how did so many dinasours got to 18000 feet under ground.
Havent you seen "Land of the Lost" or "Journey to the center of the earth"? Not only are there dead ones, but live ones too!
It only takes 2, if they have backhoes.
Buying BP?
MIght as well flip a coin as a strategy. WWGD What would Goldman Do?
If they can tank it some more then broker deals on the reserve assets, it would make them billions.
Don't piss against the big dogs and always carry your umbrella.
I agree that it really depends on how they decide to do the fines, which seems kind of black box to me at this point. If I were to throw out a guess I'd say that Exxon might eventually buy BP of America at a haircut price, which would ultimately positively affect the share prices of both companies.
Shows the power of the "oil cartel" the mass media has gone very quiet on the oil spill in the gulf lately. Is it all over?
The Vioxx example is a poor analogy. First of all, Vioxx was an amazingly good anti-inflammatory/analgesic. And it really was safer on the stomach than its competitors. Second, it remains unclear whether it killed anyone. So MRK paid out to make the suits go away. (Tho FWIW I believe MRK did promote it inappropriately and that it did raise blood pressure)
I can't speak w any certitude about whether BP was negligent, but unlike Vioxx, it is clear that there is harm here. Lots of harm.
Finally, MRK stock has traded in a broad range since it fell from Vioxx. One could have bought it cheaper in 2008/9 than its low point post-Vioxx. And unlike BP, MRK never cut its dividend AND Vioxx was not headline story #1 day after day, embarrassing Pres Bush, who had 1 million more important things going on. AND even had it been, Bush was pro-industry, whereas this Pres is a fervent opponent of fossil fuel in his heart of hearts, it would appear. So the political dynamics are tres different as well.
Sorry, this physician can't agree w the MHFT on this one.
I simply don't believe that your assessment of the well and reserves are correct. The logs are available and show about a 65' pay and we know the BHP was about 12,500 psi. It also has a very high gas / oil ratio. This well would seem to be about what BP announced of the find with reserves in the 150 mm barrel range. Nice, but nothing spectacular.
Obviously it is a tragic screw up with the final cement job. Signals were there that it had a problem and they were overlooked. People on the Gulf and the rest of the country are pretty worked up over it, and that is pretty darned understandable. As to the long term effects, they might not be a tragic as the extremists forecast. See this assessment of the Ixtoc event:
Ixtoc: The Gulf's other massive oil spill no longer apparenthttp://www.mcclatchydc.com/2010/06/12/95793/ixtoc-the-gulfs-other-massive.html#ixzz0sA7Vqe00
What about the Yen trades we all were nearly wiped out in?
Think you that MHFT is the GS of this space? Calling all EU traders...um suckers...um marks....umm...yeah....buy more marks!
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