Will Massive Trial Pressures Derail This Stock?

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Proceedings have started in one of the most significant environmental pollution trials in the history of the U.S., involving BP (NYSE: BP) and the oil spill in the Gulf of Mexico. In this article, I will analyze the early part of the proceedings, as well as details of a rumored settlement and the implications for the company.

The first week of the trial

The first week in one of the largest trials about environmental pollution in U.S. history came to a close after three days of testimony about the causes behind the 2010 BP oil spill in the Gulf of Mexico. Testimony was given from current and former executives of the company. Gulf Coast residents and the U.S. government were pitted against one of the biggest companies in the world, with billions of dollars at stake. The first phase of the civil trial, which will last for three months, will determine liabilities of BP and other companies for the explosion aboard the Deepwater Horizon rig in 2010, in which eleven workers died and millions of gallons of crude was spilt, which could cost the companies involved more than $20 billion in federal fines and settlements.

"This will be the most significant trial ever brought under environmental laws," said David Uhlmann, a University of Michigan environmental law professor and former chief of the Justice Department's Environmental Crimes Section. "The amount of money involved and the significance of the gulf oil spill make this an unprecedented trial." So far, lawyers for the plaintiff have used documents, expert witnesses and the company's executives in an attempt to demonstrate that the British energy giant placed profits above safety and was "grossly negligent." BP has agreed that it should take some of the blame for the incident, but is trying to argue that other companies, such as Transocean (NYSE: RIG), the owner of the rig, and Halliburton (NYSE: HAL), which provided the cement to seal the ill-fated well, are also to blame.

Possible settlement

According to a New York Times article from late February,

As the trial against BP stemming from the 2010 explosion of a drilling rig in the Gulf of Mexico began here Monday morning, the details of a settlement offer by federal and state officials to the oil company to emerge. The plan, worth a total of $16 billion, would limit the fines paid by BP under the Clean Water Act to $6 billion, a proposal that could help reduce its tax liability, one person briefed on the plan said Sunday, speaking on the condition of anonymity. BP would also pay $9 billion in penalties to cover damages to natural resources as well as the cost of restoration, that person said. The remaining $1 billion would be set aside in a fund that could be tapped if unanticipated environmental damages related to the spill developed.

Even if settlement talks take time, the proposal is a breakthrough for several reasons, according to lawyers. It would be the first time that Louisiana, the state worst hit by the spill and standing to receive the largest payout from a settlement, has participated in settlement talks. In addition, the proposal signifies the first time that states and the federal government have agreed on two other crucial issues--namely, a plan for how the settlement money will be split between states and how the settlement would resolve fines and penalties against the company. Naturally BP would prefer to pay penalties rather than fines.  Penalty payments, such as those coming damages to natural resources, would be tax-deductible, while fines, like those payable for violations of the Clean Water Act violations, would not.

The consequences for BP

If the judge were to find BP grossly negligent, the company could be liable for fines of up to $17.6 billion under the Clean Water Act.  However, if the company and its contractors were found to be "negligent," which is a less-severe standard, the fines would only be around $4 billion. The higher fine would also require that the judge accepts the contention of the government that four million barrels of oil spilled into the Gulf, a claim that the company says is exaggerated. The company will also be assessed penalties under a separate federal statute, for environmental damages and remediation costs, and these could range from $5 billion to $20 billion.

The other players in the incident

Transocean has received court approval of its $1 billion settlement with the U.S. for pollution claims arising from the incident. The company owned and operated the Deepwater Horizon oil rig, which burned and sank in April 2010 after BP’s Macondo well exploded. The company must also establish a technology innovation group to concentrate on drilling safety and spend at least $10 million for the effort. Transocean also agreed to plead guilty to one misdemeanor count of violation of the Clean Water Act and to pay $400 million in criminal penalties. For the fourth quarter of 2012, the company's revenue grew by 9% year-over-year.

Net income exceeded the consensus estimates of analysts, though its revenue was slightly below the expectation. Transocean reported net income of $456 million, or $1.26 per share, compared to a loss of $6.17 billion, or $18.76 per share, in the same quarter of the previous year. Excluding one-time items, the EPS for the fourth quarter was $0.91 a share. Analysts had expected $0.82 per share and $2.36 billion in revenue, according to FactSet. Investors should keep a close eye on the company over the next several months. Current investors should hold onto their positions, but new investors should wait until next quarter to buy.

Halliburton is one of the world’s largest providers of services to the energy industry, and employs more than 72,000 people from 140 nationalities who work in approximately 80 countries.  The company announced  that income from continuing operations for the fourth quarter of 2012 was $589 million, amounting to $0.63 per diluted share, compared to net income from continuing operations for the preceding quarter of $608 million, or $0.65 per diluted share. Adjusted income from continuing operations for the preceding quarter was $625 million, or $0.67 per diluted share. Halliburton’s total revenue in the fourth quarter was $7.3 billion, compared to $7.1 billion for the preceding quarter. Total operating income was $981 million for the fourth quarter, compared to $954 million for the third quarter. The company continues to exhibit growth in international regions, particularly in Middle East/Asia and Latin America, where growth compensated for seasonally lower activity levels in North America.  Given the reduced levels of drilling activity in North America, I recommend that investors keep a close eye on this stock and use caution when buying.  

Conclusion

BP is strong financially, and has already made substantial provisions so that it should be able to withstand even an unfavorable outcome from the trial. The stock has been trading around $40, compared to a mean analyst target price of $51. I see 25% upside potential here between now and six months out, and I recommend buying the stock.


StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends Halliburton. The Motley Fool owns shares of Transocean. 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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