Last week (03 Oct) oil major BP (BP.) announced it had won a partial reprieve over payouts related to the April 2010 Gulf of Mexico oil spill. The modest share price reaction - up 1.1% on the day - reflects lingering uncertainty over the final bill facing the company for this disaster and the impact it could have on its finances and ability to maintain the dividend.

The US court of appeal has halted compensation payments to businesses which had allegedly been affected by the spill. Having settled with private sector plaintiffs in December 2012 BP had initially expected these claims to total $7.8 billion but warned alongside its second quarter numbers (30 Jul) that ‘fictitious’ claims had taken the total beyond this level and pushed the cumulative charge for items covered under a $20 billion trust fund to $19.7 billion, leaving precious little headroom.

Competing claims

The oil giant added that any claims beyond the $20 billion level would have to come straight off the bottom line and argued the appointed administrator Patrick Juneau was misinterpreting the terms of last year’s settlement in compensating alleged victims. The appeals court has now ordered the lower district court to review the wording of the deal in order to draw up a narrower set of definitions that will exclude unfair claims.

In theory this might be a spur for the market to re-examine the BP investment case - with the shares trading on 7.6 times 2014 consensus forecast earnings per share of 57.2p and offering a prospective yield, based on a 2014 forecast dividend per share of 26.1p, of 5.9%. In practice the ongoing fall-out from the Gulf of Mexico disaster could make these headline numbers misleading.

The £82.6 billion cap has already taken more than $42 billion in charges to cover a range of liabilities following the disaster aboard the Deepwater Horizon drilling rig, which triggered the worst offshore oil spill in US history. The blast killed 11 workers and released an estimated four million barrels of oil into the sea.

The hit taken so far includes $14 billion in spill cleanup costs, $12 billion already paid to Gulf Coast people, businesses and governments in restitution in part through a class-action settlement, $4 billion in criminal settlements and more than $2 billion in environmental restoration and research.

A new phase of the civil trial, the second of three, began at the end of last month (30 Sep) and will help determine how much BP will pay in penalties under the federal Clean Water Act. If it is found to have been grossly negligent then these penalties could run as high as $18 billion, though the company says it believes the total will be closer to $3.5 billion.

The outcome of the first two phases of the trial is expected in early 2014. The third and final phase will begin next year to decide exact penalties for damages. A settlement ahead of this ruling now looks relatively unlikely so uncertainty over the eventual size of the burden is likely to remain until then.

Payout pressure

Ratings agency Moody’s says a number close to BP’s internal estimate of $3.5 billion could be absorbed but has warned a more severe penalty could compromise its credit quality - potentially putting its debt at risk of a downgrade. This would, in turn, increase borrowing costs and put BP’s balance sheet under pressure.

It could also raise question marks about the safety of the company’s dividend. Based on consensus estimates for 2014 the dividend cover ratio at 2.2 looks relatively skinny. If, in the event of a substantial penalty, earnings estimates were to be downgraded then the payout would look even more vulnerable (BP suspended dividends in June 2010 in the immediate aftermath of the spill). In light of this, the decision to continue an $8 billion share buyback programme looks questionable.

Although the valuation appears superficially attractive, the level of uncertainty and therefore reduced quality of BP’s earnings profile means investors should not see judgement as an opportunity.