Follow Up On Gulf-Related Oil Companies

Steve posed an worthy question that I think deserves to be followed up on in a big way. "Would other Gulf-operating organizations be affected long term or will the moratorium be lifted quickly enough that these other companies could take advantage of BP's now tarnished image?" This is a discussion that is very much worth having going forward and I would like to explore some of the possibilities. 

The companies listed here are Cameron International (CAM), Oceaneering International Inc (OII), Transocean (RIG), Diamond Offshore (DO), and Amerada Hess (HES). Of all of them, CAM and RIG are those most closely related to the particular event, though it appears that CAM has been weathering the storm comparatively well when you look at RIG. RIG, as the owner of the rig (how's that for a great stock symbol by the way), has direct liability issues with the spill just as BP does. CAM is also potentially liable as they actually made the equipment that was supposed to close the well-head and stop this from occurring in the first place. 


Outside of BP, CAM, and RIG, the others might present some possibilities among the oil service companies. Of course, there are also BP's rivals such as ConocoPhillips (COP) and Chevron (CVX). The biggest risk to those two is easy to understand. If the Gulf is shuttered, less oil for them, and there will be greater capital expenditures on exploration and field development elsewhere in the future. If the Gulf is not completely shuttered, both COP and CVX look somewhat promising at this juncture.


Now, as for the variety of oil service companies mentioned here and also in this TheStreet.com article it is important to know exactly how these companies make their money, what their exposure to the Gulf is, etc. In terms of how they make their money, is it more reliant on new field development or is it more of a function of the output of current fields through contracts with the integrated oil companies? I have to confess, I am not too familiar with these arrangements. To boil down my previous knowledge on these companies to a simple statement: I knew they made money when oil went up and made less of it when oil went down. Circumstances such as this add complications and it is worth looking into it. I don't think that the market has priced many of these companies efficiently, particularly those with greater overseas exposure. 


That being said, it is very important in this group that you know how the company makes its money. If it is more a function of global oil prices than new field development, that is worth noting. I simply am not familiar enough with them at this point to say which ones are good plays and which ones are not. I will take a stab at OII to see how reliant they are on the Gulf, what their contracts look like, and whatever else may be interesting. All of these companies have gotten slammed big time and there will be opportunities to be had. The question is where. 

Threading Strategies Together

Several different strategies have been discussed here on Finance Monitor along with numerous individual investments and I thought I would provide some context on how to view the discussions in the context of your own investments. The fundamental goal of this post is to weave several different posts on different subjects together. I will try to provide links so that you can quickly look up the prior discussions.

I guess the proper way to start this conversation was with the prior post on risk reduction in portfolio construction. This is one way of looking at your macro strategy, though there are many potential variations on this broader strategy. Within the core portfolio, either use equity index funds or balanced funds and basically just try to keep your overall allocation right, unless you want to be a little more active here. Then, you can engage in what was discussed on the post on dynamic asset allocation.

To do this, use the SPY and TLT ETFs at a basic level. If you have less than $2,000, I strongly encourage you to only re-balance when interest rates suggest you make a large reallocation from stocks to bonds or bonds to stocks. If you re-balance with every twinge, you'll get eaten alive by commissions. For example, let's say the model changes each month and you re-balance with $7 commissions each time (on both purchase and sale) with a $2,000 balance. You will incur $14 a transaction 12 times for a total of $168 in commissions. That would be 8.4% of your portfolio or greater than your average annual gain. With $20,000, it's 0.84%, which is bad, but not ruinous. If you are so fortunate to get up to $100,000, the fees are very low indeed. The ETF fees for TLT and SPY are also very low. In the case of SPY they are 0.09% per year and 0.15% on TLT.

Is BP a good buy at these levels?

Disclaimer: I am in no way trying to diminish the environmental damages to the Gulf Coast. In fact, I am more than outraged about it. However, remember that on this blog we play the role of cold, Ayn Rand-like, cynical capitalists. 


Whenever there is a company just getting its ass handed to it (that's a technical term) like BP (BP) is, there is always some appeal in possibly nibbling at it. Indeed, BP has gotten absolutely slaughtered over the past several weeks.

Compared to the other integrated oil companies, like Exxon Mobil (XOM) and ConocoPhillips (COP), it has been downright ugly. 


That being said, it is unclear exactly what the damages to BP will be. If the losses will be only in the range of a few billion dollars, then they're very cheap right now. If, on the other hand, they get hit with $40, $50, or $60 billion in damages and punitive fines, then they're not so cheap. Given that this is an election year and politicians love issues like this because they make for great righteous indignation and extreme sweeping measures, it's anyone's guess.


I personally say no to this because I am risk averse and I don't like the size of the unknowns here. There is the possibility that BP is barred from future exploration and development, for example. However, disagreement is what makes a market. What do you all think?