BP plc has launched a strategic plan to help fund Gulf of Mexico (GOM) recovery efforts, which includes a $7.5 billion reduction in dividends and $10 billion worth of asset sales. However, don’t expect BP to sell any of its properties — or its shareholders — short, energy analysts said last week.

Last week was somewhat of a turning point in what BP plans to do — and how it plans to fund — to help the GOM recover. Long-term, BP’s future as a leading U.S. producer is as murky as Gulf waters because the oil spill continues unabated and litigators are lined up around the block.

However, following a meeting with President Obama on Wednesday, the company announced the beginnings of a plan to move forward. The board of directors suspended the company’s dividend, agreed to slash capital spending and said it would sell up to $10 billion of noncore assets over the coming year to fund a $20 billion claims fund and as a $100 million unemployed workers fund.

As a “responsible party arising from the Deepwater Horizon spill,” the board agreed to create the claims fund over the next three and a half years.

Initially, BP is to make payments of $3 billion in the third quarter and $2 billion in the final three months of this year. Those payments would be followed by a payment of $1.25 billion per quarter until a total of $20 billion has been paid.

As the fund is being created, BP agreed to set aside U.S. assets with a value of $20 billion. “The intention is that this level of assets will decline as cash contributions are made to the fund,” the board said.

“The fund will be available to satisfy legitimate claims including natural resource damages and state and local response costs,” said the board. “Fines and penalties will be excluded from the fund and paid separately. Payments from the fund will be made as they are adjudicated, whether by the Independent Claims Facility (ICF)…or by a court, or as agreed by BP.”

The ICF, to be administered by Obama appointee Ken Feinberg, is to adjudicate on all Oil Pollution Act and tort claims, excluding federal and state claims. Any money remaining in the fund once all “legitimate” claims are resolved and paid would revert to BP.

“The fund does not represent a cap on BP liabilities but will be available to satisfy legitimate claims,” said the board. More terms about the claims fund are to be announced as soon as possible.

“Notwithstanding BP’s strong financial and asset position, the current circumstances require the board to be prudent and it has therefore decided to cancel the previously declared first quarter dividend scheduled for payment on June 21, and that no interim dividends will be declared in respect of the second and third quarters of 2010,” the board stated.

A resumption in the dividend payments would be considered in 2011 when results for the fourth quarter of 2010 are issued, which is the time the board said it expects to have a “clearer picture” of the longer term impact of the GOM tragedy.

Given the “current uncertainty over the extent and timing of costs and liabilities relating to the spill,” the board said it was “right and prudent” to take a conservative financial approach.

“BP’s businesses continue to perform well, with cash flows from operations expected to exceed $30 billion in 2010 at current prices and margins before taking into consideration costs related to the Deepwater Horizon spill.

BP’s “gearing level,” considered its actual cost of doing business, “remains at the bottom of its targeted band of 20-30%. In addition, the company has over $10 billion of committed banking facilities.”

To increase available cash resources, the board said it would “implement a significant reduction in organic capital spending and to increase planned divestments to approximately $10 billion” over the next year.

“We appreciated the constructive meeting conducted by the president and his senior advisers and are confident that the agreement announced today will provide greater comfort to the citizens of the Gulf Coast and greater clarity to BP and its shareholders,” said Chairman Carl-Henric Svanberg. “We welcome the administration’s statements acknowledging that BP is a strong company and that the administration has no interest in undermining the financial stability of BP.

“This agreement is a very significant step in clarifying and confirming our commitment to meet our obligations. We regret the cancellation and suspension of the dividends, but we concluded it was in the best interests of the company and its shareholders.”

CEO Tony Hayward, whose future as BP’s chief has begun to stir rumors that he will step down or be fired, said, “From the outset we have said that we fully accepted our obligations as a responsible party. This agreement reaffirms our commitment to do the right thing. The president made it clear and we agree that our top priority is to contain the spill, clean up the oil and mitigate the damage to the Gulf Coast community. We will not rest until the job is done.”

Analysts React

On Friday IHS Herold analysts said BP’s initial plans to cut its dividend and sell assets are a step in the right direction. However, like other analysts pointed out last week, BP’s capital outlay is likely to hamper the company’s long-term growth.

“From a public relations standpoint, news that BP will set up a $20 billion escrow fund helps in rebuilding the company’s image, especially in light of the speed at which the agreement was reached,” said IHS Herold Senior Equity Analyst Matti Teittinen. “In addition, the tone of the interactions between BP and the government had become increasingly confrontational in recent weeks, but this agreement perhaps marks greater cooperation between the two, which could benefit BP down the road.

“However, while the $20 billion figure is really the first concrete number we have seen related to potential liabilities, it is not a cap, and future commitments, including punitive damages and fines, are likely to be in excess of this $20 billion.”

Suspending the dividend is not a surprise, but “it does remove some of the uncertainty in BP shares,” Teittinen said. The $7.5 billion dividend savings, along with reduced organic capital spending levels and a three-fold increase in planned asset sales, “will essentially cover the $20 billion price tag.”

Longer term, said the analyst, the lower capital spending at BP will put the company “at an operational disadvantage relative to its peers. As a result, we may see BP exploring a range of strategic alternatives to raise further capital to fund growth.”

The three major credit ratings agencies last week cut BP’s ratings in response to the ongoing problems. Fitch Ratings was first, cutting BP’s credit rating last Tuesday by six notches to “BBB.” Standard & Poor’s Ratings Services followed on Thursday with a cut to “A/A-1.” And Moody’s Investors Service on Friday downgraded the long-term debt securities to “A2.”

“The downgrade of BP’s long-term ratings reflects the worsening impact expected from the oil pouring into the Gulf of Mexico from BP’s subsea Macondo well,” said Moody’s. The “updated assessment is that the spill will have a sustained negative impact on the group’s free cash flow generation and overall financial profile for a number of years.”

S&P credit analyst Simon Redmond said the downgrade “reflects our opinion of the challenges and uncertainties that BP continues to face…These challenges and uncertainties include the difficulties BP is experiencing in containing the spill as well as the ultimate extent of the pollution, the consequences for BP of ongoing official investigations, and the implications of these investigations for the magnitude and timing of further cash payments by BP.

“BP is now subject to intense political pressure in the U.S., its largest market. We see these factors as fundamental issues differentiating BP from its peers.”

According to a report last week by Reuters, Bank of America Merrill Lynch (BofA) told its traders to stop entering into new oil trades with BP that extend beyond June 2011.

“The order to the bank’s traders came from a high-level executive and was made Monday [June 14],” Reuters reported. “It told traders not to engage in trade with BP for contracts beyond one year from this month.” BofA is not considered a major oil trader, and as Reuters pointed out, it’s not one of BP’s main counterparties.

“The majority of those, we hear, are still trading as usual with the firm,” Financial Times (FT) said on Wednesday. “If anything, they’re keen to explore insurance options in the CDS [credit default swap] market to protect their deals, rather than limit trades completely.”

Analysts at TheStreet.com said Wednesday if the BofA action is true, “it would be the first definitive indication that the market doesn’t just think BP has short-term trouble, but that it may not be around until June 2011.” The analysts at TheStreet.com called the situation “ironic for two reasons…

“First, BP is a great example of how the derivatives reform legislation stands to impact not just Wall Street firms, but the various companies they do business with” (see related story). “BP had $19.6 billion worth of fuel-hedging derivatives on its balance sheet at the end of the first quarter. Those contracts help it hedge against risks that the price of oil, natural gas or other refined products will go haywire.

“Meanwhile, everything for BP seems to be going haywire, and Bank of America — which may not be its only derivatives broker-dealer, but is probably a major one — is saying that it will no longer offer the firm protection beyond next June…”

An “even more ironic point,” said the analysts, is that the “most vilified type of derivative — credit default swaps — was created in the midst of the last catastrophic oil-leak disaster. JPMorgan Chase came up with the instrument after extending a loan to ExxonMobil in the aftermath of its Exxon Valdez spill in Alaska.”

No one has yet been able to pinpoint the damage to BP’s finances from the GOM leak. However, in a note to clients last week, BofA said an indication of the costs may be inferred from the current flow rates originating from the Macondo well.

“Based on new scientific analysis from well data, the U.S. authorities now estimate the Macondo well flowrate at 35,000-60,000 b/d (from the previous 12,000-40,000 b/d). Flow rates are the single largest factor in determining the potential cost of the spill and the new estimates are materially higher than the 19,000 b/d midpoint used in our published base case cost estimate of US$28 billion,” which the banking firm published on June 10.

“We estimate that each 10,000 b/d increase in flow rate adds some 10% to our base case estimate,” BofA stated. “As a result, the new flow rate could push cost estimates to US$35-60 billion. Assuming, for example, that BP were to pay 65% of this cost, this could equate to a potential $50-100 per/share economic impact on BP.”

BP is the largest leaseholder in the U.S. GOM and also the biggest natural gas marketer in North America. In the past three years the U.S. upstream assets have generated up to 28% of BP’s total net income, and the GOM assets have contributed 10% of BP’s output, according to analysts.

Analysts now are pondering what “noncore” assets BP may put on the market. A “logical” first step would be to sell its “low growth European and U.S. downstream operations,” FT reported. However, those assets could bring “very few buyers.”

“In the U.S., so the argument goes, the BP brand is sufficiently toxic to ward off any suitors for its petrol stations. Its North American network of pipelines could prove attractive, but would add relatively little to the $10 billion total. Which leaves upstream operations as the most likely focus of any sales.”

BP “has an array of juicy positions many of its rivals would dribble over,” said FT. “The most liquid of these would be its U.S. shale gas assets, which contribute to the company’s position as the second biggest U.S. gas producer.” Most likely would be sale of “capital intensive but profit-light areas such as renewables — which Tony Hayward said in 2008 was ‘worth between $5 billion and $7 billion.'”

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