Tuesday, June 22, 2010

Is there a Lehman Bros disaster looming in the Gulf?

I have been following an interesting discussion on another blog and it raises a fascinating point.

What are the ramifications of the BP crisis in the Gulf of Mexico from a financial perspective?

This is a line of thought that suggests the events in the Gulf could lead to an acceleration of the crisis brought about by the Lehman implosion.

Apparently a significant amount of liquidity in the global financial world is dependent on a solvent BP. BP extends credit – lots of it - through trading and finance.

So much, in fact, that the amounts, quality and duration of credit is on such a scale that a regular bank could only dream of. The financial muscle behind a company with 100+ years of proven oil and gas reserves dwarfs that with a bank (with few tangible assets) possesses.

What happens if BP goes under?

With proven reserves and wells in the ground, equity in fields all over the planet, nothing can match a major oil company in terms of credit quality and credit provision.

How many assets around the planet are dependent on credit and finance extended from BP? It is likely to dwarf any banking entity in multiples.

And at the heart of all that credit is a rat's nest of over-the-counter derivatives.

As a blogger posted, "Banks try and lean on major oil companies because they have exactly the kind of credit-worthiness that they themselves lack. In fact, major oil companies, conversely, spend large amounts of time both denying Banks credit and trying to get Bank risk off of their books in their trading operations. Oil companies have always mistrusted bank creditworthiness and have largely considered the banking industry a bad financial joke. Banks plead with oil companies to let them trade beyond one year in duration. Banks even used to do losing trades with oil companies simply to get them on their trading register... a foot in the door so that they could subsequently beg for an extension in credit size and duration. For the banks, all trading was based on what the early derivatives giant, Bankers Trust, named their trading system: RAROC – or, Risk Adjusted Return on Credit. Trading is a function of credit bequeathed, mixed with the risk of the (trading) position. As trading and credit are intertwined, we might do well to remember what might happen to global liquidity and markets if BP suffers what many believe to be its deserved fate of bankruptcy. The Intercontinental Exchange (ICE) has already been and will be further undermined by BP’s distress. They are one of the only 'hard asset' entities backing up this so-called exchange."

If BP does go bust (or even if it is just badly wounded) and the US entity is allowed to fail, the long-term OTC derivatives in the oil, refined products and natural gas markets that get nullified could be catastrophic.

These will kick-back into the banking system. BP is the primary player on the long-end of the energy curve. How exposed are Goldman sub J. Aron, Morgan Stanley and JPM? Probably hugely.

Credit has been cut to BP. Counter-parties will not accept their name beyond one year in duration. This is unheard of.

If BP falls, the very earth may shake as it hits the ground.

Mark Carney spoke this week on the perilous condition of the world financial markets.

And in the midsts of founding banks and faltering sovereign entities, we now have a major oil company on the verge of going under.

Another leg of the global economic “chair” is being viciously kicked out.

What will be the effects of a BP failure? Many speculate that it could easily be equal to that of a Lehman, if not more because the world is highly reliant on BPs provision of long-term credit to many core industries. Who makes good on all the outstanding paper that so many smaller oil, gas and electricity companies, airlines, shipping companies, local bus, railway and transportation networks that rely on BPs creditworthiness and performance for?

It doesn’t take a genius to figure out how this could all unwind. If BP has to be bailed-out, like a bank, the system will have to print even more unimaginable amounts of money.

The fact of the matter is that a BP crisis could unleash damage similar to the banking crisis. A BP failure through bankruptcy could make Lehman look small in comparison, and shake the world wide financial house of cards even more severely.


Email: village_whisperer@live.ca

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  1. Even if the entanglement of BP is as great as described by the blogger, it's "failure" would unlikely cause much disturbance as it would be bought out by some other predatory entity (Gazprom?). In fact, it is probably a good idea for BP to sell itself MINUS it's liabilities linked to the GoM disaster. On the other hand, BP has about 7bln of cash reserves on hand and some assets of questionable value. So I still fail to see what is the big deal here.

    In fact some hedge funds are shorting those dinosaurs due to the lack of any new resource explorations.

    (in fact, recent report by US military, by far the largest consumer of oil, suggest extreme shortages of the stuff by 2013.) I'm sure this and a bunch of other reports have been already integrated by the markets and as such, the reliance on oil co's as credit hubs is diminishing.


  2. Tony Hayward sold some of his shares and paid off his house in UK. If he was smart, he transferred the title to his wife or put in his son's name.

    Goldman Sachs sold their shares three weeks before the well blew.

    It would seem everyone knew about it before hand according to one of the survivor's of the blast.

    I am not a believer in conspiracy theories but this makes me wonder. A takeover bid or just greed?
    Canadian Government is mapping potential oil and gas reserves in the Arctic right now.
    According to Stats Can, Canada exports 71% GDP to the US. This will affect us.
    We are as much as the US, a oil/gas dependent society.

  3. No conspiracy theory there. US regulator knew about problems with the Maconda well (cracked well foundation etc) well before the disaster. Just the usual human f**up and negligence.

    P.S. GS is still stuck with over 50% of BP shares I believe.