Will The Clean Water Act Cripple This Energy Giant?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

BP (NYSE: BP) has pointed out that its $4.5 billion settlement does not resolve what is potentially the largest penalty related to the spill: Fines under the Clean Water Act. BP also acknowledged that it had provided inaccurate information to the public early on about the rate at which oil was gushing from the well and will pay a civil fine of $525 million for misleading investors. While the settlement eliminates the possibility of further criminal charges, it still leaves the company vulnerable to fines for spills under the Clean Water Act depending on the interpretation by the courts. In this article, I will examine how the Clean Water Act could impact BP and what it means for BP investors. 

What Is The Clean Water Act (CWA)?

The Clean Water Act is a U.S. federal law governing water pollution...All waters with a "significant nexus" to "navigable waters" are covered under the CWA. However, the phrase "significant nexus" remains open to judicial interpretation and controversy. So far, analysts and experts calculating potential oil spill liabilities have mostly concentrated on the cost of the clean-up and compensation for economic damages to affected parties. BP owes economic damages, which are capped at $75 million.

What The CWA Means For BP

The potential for civil fines has not received the attention it deserves, and a clause buried deep in the CWA may expose BP and others to civil fines that are not limited to any finite cap. The CWA allows the government to seek civil penalties in court for every drop of oil that spills into U.S. navigable waters. The basic penalty, according to the act, is $1,100 per barrel spilled, but can rise to $4,300 per barrel if a federal court rules the spill resulted from gross negligence. In past oil spills, civil fines have comprised a modest proportion of total liability, but, because of the magnitude of the Gulf spill, the government may seek unprecedented penalties.  While the government would seek to maximize the fines, it has nothing to gain by driving BP into bankruptcy. The U.S. government would likely allow the company to pay over a period of some years to cushion the impact on the company's financial position.

Impact on Third Quarter Financials

BP’s third-quarter replacement cost (RC) profit was $4.68 billion, compared with $5.23 billion in 2011. After adjusting for a net loss from non-operating items of $321 million and net unfavorable for value accounting effects of $162 million (both on a post-tax basis), underlying RC profit for the third quarter was $5.17 billion, compared with $5.46 billion for the same period in 2011.

For the nine months of 2012, RC profit was $9.85 billion, compared with $16.29 billion for the same period in 2012. After adjusting for a net loss from non-operating items, underlying RC profit for the nine months was $13.65 billion, compared with $16.67 billion for the same period of the previous year.

Including the impact of the Gulf of Mexico oil spill, net cash generated for the third quarter and nine months was $6.3 billion and $14.1 billion, respectively, compared with $6.9 billion and $17.1 billion during the same periods in 2011. Excluding amounts related to the Gulf of Mexico oil spill, net cash generated by operating activities for the third quarter and nine months was $6.4 billion and $17.1 billion respectively, compared with $7.8 billion and $22.8 billion for the same periods of the previous year.  

Competition

BP is an attractive income investment with a dividend yield of over 5%. I will compare BP with other dividend paying energy stocks. Total (NYSE: TOT) is financially strong and should be able to weather any problems that come from Europe's woes. Total is in a strong position in the chemicals industry. Total currently has a dividend yield of around 5%, but heavy capital expenditure on projects could limit dividend growth in the short- term. Enersis (NYSE: ENI) has solid relationships with countries that are typically considered difficult to deal with in areas such as Africa and the Middle East. Enersis' yield of 4.5% doesn't fully reflect the risks such as the Italian government ownership. Royal Dutch Shell (NYSE: RDS-A) is a good company and, in spite of the low U.S. natural gas prices, Shell’s size and experience in the liquefied natural gas space makes it a key player.  Natural gas may be a drag now, but it could turn into a key asset in the future. The dividend yield of about 5% is much higher than that of industry heavyweight ExxonMobil (XOM), in spite of their similarities, including the move toward natural gas.

Summary

BP continues to be a strong and profitable company. Any fines relating to the Clean Water Act would be paid over a period of five years to minimize the financial impact. BP's earnings growth is impressive. Despite the past uncertainties due to the oil spill, the consequences are now much clearer and the company should be able to withstand the financial burden. I believe BP will grow its dividend in 2013, which makes it a very attractive income investment. I recommend buying BP for income.


jordobivona has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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