First published in the The Independent on Sunday, 20 June 2010

As BP reels from its toughest week yet since the sinking of the Deepwater Horizon, investors warn the longer term outlook for the embattled supermajor is likely to worsen.

Even as the share price bounced towards the end of last week – in relief at a softening of President Obama’s “boot-on-neck” rhetoric, after the company agreed to pay $20 billion into an escrow account to fund compensation claims – shareholders point out that BP’s liabilities remain unquantifiable and could hobble its oil production for years to come.

BP officials may struggle to imagine things could get much worse, after a week in which chief executive Tony Hayward received the congressional equivalent of a public flogging; damning email evidence suggesting its staff had repeatedly cut corners on safety at the ‘nightmare well’; and the company was forced to scrap its dividend for the rest of the year. But even though the share price has almost halved since disaster struck on 20 April, experts say the longer term impact on the company could be even more serious.

There was relief in the markets that the agreement to pay $20bn into the independently controlled account over three years had bought some breathing space for BP. But $20 billion is probably the floor of the company’s exposure; the fund is only intended to cover compensation claims. Cleanup costs could add $8bn this year, and fines another $20bn, depending on the eventual size of the slick – and estimates continue to escalate.

President Obama has also made clear he expects the company to pick up the wage bill for workers laid off as a result of the US moratorium on offshore drilling – despite the fact his ban suggests safety problems in the Gulf of Mexico are industry-wide not company specific – and this makes BP’s liabilities effectively open-ended. “It would be reckless to assume $20bn is all BP has to worry about”, says Neil Woodford, the highly rated fund manager of Invesco Perpetual.

There is little doubt BP, which made $14bn profit last year, is good for the money – but not without squeezing its exploration and production activities. To pay for the compensation the company plans to cut its capital expenditure by $2bn this year, and raise $10 through asset sales, as well as saving $8bn by scrapping the dividend. If disaster costs rise, and BP continues to keep its borrowings low, it may be forced to cut investment further, and even sell off prized deepwater oil fields – one of the few remaining areas of potential production growth.

As a result, BP’s output may be shrinking just at the time – around the middle of this decade – when many forecasts predict global production will peak and the oil price spike dramatically. “If BP’s investment is squeezed now, it will affect their production over the next five years”, says Steve Robertson, director of energy consultants Douglas-Westwood.

Mr Woodford, who sold a massive 1% stake in BP last year on the grounds the company was shelling out too much in dividends and not investing enough in exploration and production, sees no reason to buy the company’s shares now, despite their recent collapse. “BP’s growth aspirations will have to be significantly reigned back, and it may well be a much smaller business in future”.

The Deepwater Horizon disaster is also likely to squeeze the oil production of other companies in the Gulf of Mexico, as a result of the moratorium on deepwater drilling imposed by the Administration. Douglas-Westwood estimate that if the moratorium lasts two years, output in 2015 could be 400,000 barrels per day – or 25% – lower than otherwise, further cutting supply at about the same time the consultancy expects global production to peak.

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