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By Jeremy Glaser | 06-02-2010 12:49 PM

Potential Outcomes for BP Shares

Morningstar's Eric Chenoweth on the factors driving BP's difficult and uncertain containment efforts, stock fair value, and dividend security, plus an alternative for current BP shareholders.

Securities mentioned in this video
XOM Exxon Mobil Corp

Jeremy Glaser: I am Jeremy Glaser with As the Gulf oil spill crisis escalates, the uncertainty surrounding BP stock continues to increase. I'm here with Associate Director, Eric Chenoweth, to discuss potential outcomes for BP shares. Eric, thanks for talking with me today.

Eric Chenoweth: Thanks for having me.

Glaser: So, first off, can you give us an update on where BP is in trying to contain the spill, and if you think some of the current actions that they're taking are actually going to be successful or not?

Chenoweth: Sure. Last week, we finished off the 'top kill' effort and it was unsuccessful. The company is really going through a couple of, kind of, long shot procedures now; current one being cutting the riser, trying to place a new cap on top of the current blow out preventer. We'll see how that goes. It's not a high probability chance that will fix it right away.

Some of the more likely candidates are further down the road. The relief wells, there are two currently drilling, and they're well under that process. There's still a chance that those won't be a 100% successful, which I think is important to understand, which is why they are drilling two, and hopefully they don't have to drill a third and a fourth one, but it's a very, very technically challenging process.

Glaser: Do you think that BP has been somewhat overestimating the chance of success of some of these operations?

Chenoweth: I think, we got a little ahead of ourselves last week with the top kill. This was something that has been used in shallower waters and other places successfully, but it was kind of an unprecedented attempt at these depths. And when they came out with I believe a 60% to 70% chance of success that seemed a bit high for something that was such a new attempt.

Glaser: You mentioned that the relief wells, the first one probably coming online in August might not work. If you saw that didn't work either, what would be the potential for liabilities for BP?

Chenoweth: First off, if it doesn't work, this could be very challenging. We have the hurricane season coming up, which could also disrupt additional relief wells getting drilled, so it could step it out, and we could be talking about this at the end of the year, which I would think would be very much a worst case scenario.

Last week, we updated our cost estimates, and our high case at the time was assuming a 180 days of spill, so that would obviously be a bit longer. Under that scenario, we thought the total oil spill cost will be about $60 billion. So that's our high, high case. Our mean case is about $31 billion. BP is on the hook for 65% of that, so just keep that in mind when you're thinking about those numbers. Those are big numbers. Obviously, it'd be bigger if we went to the end of the year.

The other challenge too I think is that you got to stack that up relative to how BP's shares have sold off, and since the beginning of the spill, they've sold off close to $70 billion to $80 billion. Last I checked, it changes very quickly, but in the markets, obviously sold off as well. So you could, kind of haircut that down to maybe a 40-ish type number, if you want to try to isolate the event sell-off.

So obviously the market thinks this is a bigger deal than even some of the estimates we have come up with, or other analysts you hear in the press have come up with. So, it's raised questions I think with us to about what could we be missing, or is it there really that much more fear in the market than what we can point our fingers at, but you stack that $70 billion up against a $40 billion-ish BP share of our worst case scenario.

Glaser: So, how much have you adjusted the fair value for BP so far?

Chenoweth: We've adjusted it $5 per share down, which is closer to, kind of, a little bit above our low-case estimate. Our low case, if we thought everything went right from here, would be about a $4 billion hit. That's looking quite light compared to what the market thinks at this stage, and we've actually ratcheted a bit down more than that.

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