7/13/2010
By Conley Turner, Research Analyst

Crude Oil

The price of the crude appears to have developed another leg of support as oil traders and investors take their cue from the strength in the broader equity markets.  After several weeks of overarching concern by market participants that the economic recovery in the U.S. and the much of the developed nations was faltering, oil prices declined accordingly.  The decline was exacerbated by the Greek debt crisis and its resulting impact on the rest of the European Union.   Furthermore, speculation that China's economic growth may be slowing also proved to be a downside catalyst for the commodity.

Nonetheless, in recent days, a rash of benign data from the government has been the impetus for a turnaround.  Recent weekly data about intermittent drawdown on inventory levels to the possible disruption in supply in the Gulf of Mexico due to adverse weather conditions also provided buoyancy for prices.

However, with the onset of corporate earnings season, the upbeat reports are providing investors with renewed optimism about the economy's prospects.  To this end, the better than expected earnings results posted Alcoa Inc and CSX Corp has set the stage for an upbeat broader market performance.

The expectation at this point is that the improvement in corporate earnings is a reflection of an improving economy.  This in turn is expected to translate into an increase in activity which means an increase in oil demand.

 Industry - 2  Administration - 0

The battle against the drilling moratorium in the Gulf of Mexico imposed by the Obama administration in the wake of the BP oil spill continues.  The latest chapter saw a federal appeals court side with a lower court ruling in lifting the ban. In response the Department of the Interior issued a modified drilling moratorium which it was more specific and targeted.  The administration is betting that the new approach enhances its chances of getting the two previous unfavorable ruling overturned.  Furthermore, the time horizon for this new ban only extends to a November 30 deadline.

The industry has argued that the ban is causing undue hardships to all concerned from the drilling companies down to the onshore communities that support their operations However; the administration in its effort to prevent a repeat of the worst environmental disaster in American history is attempting to raise the bar on seemingly lax industry practices.

While the back and forth volley continues some operators have opted to leave the Gulf region for greener pastures. These areas include off the coasts of Brazil and West Africa.  The most recent of these drillers to do so is Diamond Offshore (DO) which is relocating one of its deepwater rigs to the Republic of Congo. 

Meanwhile, the court battle continues and rig operators are unlikely undertake the risk and expense of resuming operations with that much uncertainty. It is important to note that even when drilling resumes, the operating environment in the Gulf will definitely be more restrictive and expensive for operators.

BP

To say that the past couple of months have been rough for BP and its shareholders is a gross understatement.  The company's numerous failures in capping the intransigent well in the Gulf of Mexico only served to add fodder to severe adverse public sentiment and these factors weighed heavily on the stock price.  As costs associated with the clean up continued to escalate with no end in sight, a sense of nervousness and dread cast a cloud on investor sentiment.  Nonetheless, as it turns out, reports of BP's imminent demise have been greatly exaggerated!

Though the cost of the cleanup is staggering, the company is well positioned to survive this disaster. Though some estimate put the final clean up costs at just over $20 billion, it is important to note the company generated more than this in revenue over the past year alone.  Even with this disaster as an overhang, BP is likely to generate equally as much in 2010. Furthermore, the Company possesses good revenue generating visibility in the Gulf region since it owns more leases in that area that all the other oil companies.

In context, the news surrounding the spill is getting better. A new containment cap has been placed atop the well and is being tested for its efficacy.  If proven to be successful in at least capturing most of the spill, then it will constitute a significant milestone in bringing this disaster to a point of equilibrium.  A final solution will not be in place until the well is permanently sealed via the relief wells. The new cap will also enable containment vessels to quickly and efficiently disconnect from the system and leave the area in the event of an adverse weather pattern such as a hurricane.

Talks are circulating about the Company initiating an asset sale to the tune of $10 billion in order to further bolster its financial position.  Such a move would at least provide some added assurance to the markets.  Shares of BP are worth serious consideration at this point.

Conley Turner
Wall Street Strategies