Spread Betting on BP Shares
To Buy or to Sell?
Most spread betters love volatility as fast-moving markets will certainly provide more opportunities than ranging ones, so for many a stock London-based oil major stock like BP PLC which is constantly making it to the news is likely to be popular. Certainly, for those who want some excitement in their lives, BP has certainly provided some, and, until the situation is fully understood and completely under control, will probably continue to do so. It provides clear examples of excessive ‘trading the news’ and trading on market sentiment.
Here’s the recent BP share chart, since the 2010 Gulf of Mexico oil spill -:
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The main event that had a disastrous impact on BP’s share price was the explosion on BP’s Deepwater Horizon drilling rig which led to millions of gallons of crude oil pouring into the Gulf of Mexico over the next 87 days or so. The disaster took place in April 2010 and the initial explosion left 11 mean dead and the Deepwater Horizon oil rig subsequently sank. The company’s efforts to stem the oil spill repeatedly failed and days turned into weeks and weeks into months and naturally during this time BP’s stock price was very volatile; losing whenever attempts to stem the oil spill failed and recovering when any sign of good news encouraged investors to take a position in what appeared to be an underpriced stock. Everything has its price and after the initial Macondo explosion on 20 April 2010 BP’s share collapsed from 640p to just 303p (June 2010) in just 8 weeks which factored in a lot of bad news and market sentiment. The spill ended wiping one-third of BP’s market value as the market struggled to value the FTSE 100 firm’s environmental and total legal liabilities and a weaker than usual oil price further pressured the price.
You can see that the volatility and the candlestick lengths were much smaller prior to the spill, on the left edge of the chart. The volatility has increased enormously in recent months as the work to cap the well and clean up has gone through many phases of hope and despair.
The question is whether you want to spread bet such a volatile stock, and the answer is that it is up to your temperament and risk profile. When you spread bet with a stock like BP whose price can vary rapidly and radically, then you open yourself up to large gains, but also large losses. For spread betting, you need something that is going to move in a reasonable period of time, as this stock has, as you do not want to ‘buy-and-hold’ with spreads.
As the costs of the cleanup continued to climb, there were talks of takeovers and mergers and BP even started considering winding down some of its operations to concentrate on upstream activities as opposed to downstream (from the refinery and beyond) where the extent of competitions is likely to pressure margins. At the time of writing BP has stemmed the leakage of oil and the company is stabilising and although no-one knows exactly what will happen to BP shares, and there are several different shades of opinion. Undoubtedly, taking a short position as the extent of the problem became clear was almost a given, and the question became how quickly could you get in, and how long should you hang on. But unexpected announcements have kept the price jumping, making trading BP an exploit which requires constant attention.
BP has continued to arrive at settlements with various counterparties, individuals and businesses relating to the Deepwater disaster and
has been relatively successful at offloading non-performing assets. With the resumption of the dividend, investors are becoming more confident about the ability of the company to meet its outstanding liabilities and put the whole episode behind it.
When news of the $20 billion compensation fund reached the markets in June, BP’s share price took another plunge as the requirement frightened many investors as the spill caused enormous damage to fisheries, tourism industry as well as wildlife habitats – but this ignored the fact that BP is financially sound and could easily payout this bill, especially since the amount is to be spread over 4 years. BP has some 7 billion in the bank and an additional $16 billion in stand-by banking facilities. BP has also sold premium assets in both Vietnam and Venezuela as well as four mature Gulf of Mexico fields, several southern African marketing units, its 60% stake in Argentina’s Pan American Energy and its Pakistani upstream assets has seen the firm raise over $10 billion in the fourth quarter alone. The company has cashflow amounting to some $14 billion per annum (assuming oil remains hovering at the $70-abarrel price range). BP reduced capital spending by 10% and sold $7 billion in assets to Apache. The company also cancelled dividends at the time which put further pressure on the share price south further but one has to consider that this saved BP another $10 billion and BP with all its troubles remained the fourth most profitable company in the world. Since the spill, BP has sold at least some $35 billion in assets as the company attempts to focus on the higher margin crude oil exploration. The latest divestments included the Texas City and Carson refineries. And that $35 billion excludes the latest deal (October 2012) consisting of Russia’s state-run oil giant Rosneft (ROSN:RM) proposed acquisition of BP’s stake in TNK-BP joint venture for a 19.75% holding in the Russian major plus $12.3 billion (£7.7 billion) in cash to BP.
Morever, the downside to BP as a company is limited, but there is not yet a full realization of this. For instance, USA law specifically prevents damages awards that would put a company out of business. BP’s presence in the USA is greater than the US company Exxon-Mobil, so there is a significant buffer before the monetary awards will really pull it down, and it’s likely that the courts will drag on for years, so inflation will reduce the effective value of any awards. BP shares are beginning to look undervalued when considering conventional indications and rumours of a takeover bid from Exxon-Mobil are reminders that BP holds valuable assets.
Apart from this, service provider Halliburton (NYSE: HAL), blowout-preventer manufacturer Cameron International (NYSE: CAM) and driller Transocean (NYSE: RIG) were the (initially American, but offshore for tax reasons) subcontractors that BP was using, and it is only a matter of time before this provides relief to the pressure on BP – Transocean is already the subject of a class action lawsuit which alleges false and misleading statements and concealing knowledge of serious hazards and thus they may end up have to share part of the costs. It is worth noting here that BP only had a 65% interest in the oil field, with Anadarko Petroleum (NYSE: APC) and Mitsui being part-owners.
In January 2011, an official commission concluded that the spill was caused by careless cost-cutting decisions by BP, Halliburton and Transocean which dramatically increased the risk. The board didn’t point fingers to any one person or party, noting that the mistakes were due to systematic problems. However, in September 2011, federal regulators released a report concluding that BP is the ultimate responsible party for the spill. The report noted that BP breached federal rules, ignoring warnings and made bad decisions during the cementing of the well which lies a mile under the Gulf of Mexico. BP has admitted its fault and accepted responsibility for the costs and damages but it also urged other companies to contribute their share.
To set against this somewhat optimistic position, it is clear that there has been widespread incompetence exhibited by all parties to the tragic accident, and that is something that cannot be eliminated rapidly if it is part of the corporate culture. The imminent $21 billion lawsuit from the USA government is a troubling concern although this case would need to prove serious negligence on the part of BP. In addition, the clean-up costs and damages, fines and lawsuits are likely to be massive and will continue hitting BP for the next few years. The company has been involved in accidents before as well; in 2005 it suffered an explosion at its Texas City oil refinery while in 2006 BP experienced a leak in its oil pipeline in Prudhoe Bay in Alaska. A serious petrol leak in Lancashire in 2001 affecting water supplies is only now being cleaned up, under threat of court action by the council, so there is considerable evidence that the company has endemic problems. On the positive front, news of the incoming CEO Robert Dudley taking over from Tony Hayward is likely to be welcomed as he has already promised changes in BP’s corporate culture and to review its safety strategy. In any case, tread carefully if you spread bet these shares, and set and stick to tight stops to avoid losses.
‘BP stock has been one of the most popular spread betting markets in 2010,’ says Giles Watts, head of equities at City Index. ‘But it was not just the downward move in BP’s share price that pulled spread betters looking for a potential bargain, it was the extreme volatility that attracted them. [BP] remains top of the activity list; being a household name, and a component of so many people’s pensions, interest has remained high as investors watch to see the long-term recovery of a wounded giant.’
Update December 2011: Oil giant BP remains a highly traded stock, but investors may be wary of buying to the company in the wake of its oil spill in the Gulf of Mexico. Although the disaster occured back in early 2010, the repercussions are still being felt, with the stock price presently however around 458p compared with pre-spill highs of 624p. Management still needs to get their act together or BP could end up prey for a competitor that takes advantage of its unfulfilled potential. BP’s stock price still feels the negative effects of the liability surrounding the Deepwater Horizon disaster and uncertainty over its Russian venture, TNK-BP. Of course this doesn’t mean that BP stock can’t be traded 😉
Update March 2012: We have just heard that BP has reached a $7.8 billion settlement with individuals and businesses which had sued BP’s over 2010 April’s Deepwater horizon rig explosion and Gulf of Mexico oil spill. We can say with confidence that BP’s troubles are mostly behind it. Considering BP and the Deepwater Horizon spillage. They survived because they had huge assets. They went from £15bn profit to -£3bn loss and back into profit simply because they had such strong assets. They cut their spending (dividends) and sold a few assets to survive. That’s exactly what high debt countries have to do. The UK and USA also have the advantage of printing as much cash as they want to. That increases assets – and share prices.
Update November 2012: Can we finally say that the Macondo disaster is history? BP has at last reached a $4.5 billion settlement with the USA government over its Deepwater Horizon oil rig spill. The sum includes $1.3 in criminal fines for withholding important pertinent information – as well as payments to a number of government depts. The settlement doesn’t include civil claims including those that fall under the Clean Water Act, private civil claims or state claims for economic damages that still need to be ruled. But at least the shares have started to experience a decent recovery and the company has re-started dividends.
Update November 2013: The £billion cap company is still haunted by its past; with the Deepwater Horizon drilling rig now having cost BP more than $42 billion in various charges and liabilities; $14 billion in cleaning the spill, $12 billion paid to compensate Gulf Coast people, settlement with business people and government over a class-action lawsuit, $4 billion in settlements involving criminal cases and more than $2 billion to restore the environment and research. A major civil case is still ongoing. The civil train started on 30th September 2012 and this will help establish how much BP will have to pay in penalties under the federal Clean Water Act. Gross negligence could put the company in the hook for up to $18 billion although the company believes this will be around $3.5 billion.
BP: Spread Betting Trading Example and Practicalities
To place a bet on a FTSE listed share, you normally have to put up 5% or 10% as margin collateral i.e. 5% of the amount you would normally spend buying the equivalent market exposure on shares. As such, placing a £10 (1,000p) spread bet per penny movement in a stock price will net or lose 1,000 times the amount if they held one stock. i.e. a £10 spreadbet is equivalent to holding 1,000 shares (to get the equivalent always add two zeros to your stake). Buying 1,000 BP shares at 442 pence would normally cost you £4420 so you would need to deposit just £442 – 10% of £4420 – for a £10-a-point bet on BP.
So what do private traders and investors find so enticing about spread betting? Probably it is the fact of not having to pay direct commissions or brokerage fees; instead a spread trader pays the ‘spread’. For instance, if you wanted to acquire BP stock, you could buy them from a broker at £4.42 (at the time of writing). Alternatively, you could use a spreadbet to buy a future expiring in June for £4.46 or say, September for £4.48 (the dates representing the dates when the contract is settled). One can see here that the longer the bet lifetime, the more you pay in bid-offer spread (which is the provider’s profit and normally amounts to the equivalent of 1% to 2%). Add to that the low cost of financing positions for short holding periods and you can see why so many traders love the trading medium.
Note that BP is quoted in pennies, thus if you wanted to get £4,460 of exposure, you could place a bet for £10 per point on the June 2013 contract. The spread trading quote is 446 pence. If we multiply this (446) by £10 we get £4,460 (since the £10 is per point i.e. penny movement in the underlying stock price). You may only need to put down 10% of the actual £4,460 market position for the spread betting provider to permit you to open this trade which seems great at first inspection. However, one one has to keep in mind that should the share move in the opposite direction to your trade, you’d be expected to put in more money so that your trade always maintains that 10% margin.
Let’s now take the case of a rolling daily contract. For example, if the BP bid-offer spread at a spread betting provider such as Capital Spreads is 422-423, you could go long BP at £20 a point at 423. Suppose that BP’s share price rises and the new quote is 450-452. You could close your position by selling the spread at the new bid price of 450. Your profit would amount to the difference between the opening offer price of 423, and the closing bid price of 450. That’s 27 points at £20 each which would net a £540 profit.
Trailing Stops
In our example instead of closing the trade by selling at 432p we could have left the trade running and linked it to a trailing stop instead. Trailing stops serve to lock in gains as the market moves in the direction of your trade. For instance in our BP example, if the trade moved in a favourable direction and the price rose to 450, we could have linked this to a trailing stop at 440, with an instruction to trail the price upwards at a distance of 10 points. So if BP rises to 480p, and then started dropping back to 460p, our stop would take us out at 470p, locking in a profit of 47 points. Note that stops aren’t infallible but they are a good hedge against total account wipe-out.
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