BP Credit Protection Costs Flip As Investors Fret

25th Jun 2010 19:41

By Katy Burne Of DOW JONES NEWSWIRES NEW YORK (Dow Jones)--Prices in the credit default swaps market suggest investors believe BP PLC (BP, BP.LN) faces a greater chance of defaulting within one year than in five. The cost of protecting debt issued by the oil giant for one year was quoted at 725 basis points Friday by Markit. That means it would cost $725,000 to insure $10 million of debt over the next 12 months. But the cost of protection over five years was quoted at 575 basis points, or $575,000 annually--about 20% less. The cost of both one- and five-year protection, using derivatives known as credit default swaps, were up sharply from Monday. The cost of one-year swaps rose 15% over that period, while five-year swaps climbed more than 17%. Normally, protection costs more over longer terms because it is more difficult to anticipate events farther into the future. In the rare instances where shorter-term protection is pricier, traders say the CDS curve is inverted. BP bonds are behaving similarly. BP bonds maturing in 2014 have a risk premium, or spread, of 6.79 percentage points over the yield on five-year Treasury securities, according to MarketAxess. But BP bonds maturing in 2019 have a spread of only 4.72 percentage points over 10-year Treasuries. The 2014 bonds were yielding 8.757% Friday afternoon, while the 2019 bonds were yielding only 7.810%. The sour investor outlook behind these anomalies is based on suggestions that BP, which has agreed to cover all costs of the massive Gulf of Mexico oil spill caused after an explosion at the Deepwater Horizon rig in April, needs to raise a lot of cash very soon--a suggestion BP disputes. Nomura Securities energy analysts in London, for example, issued a note Friday saying the company's best course of action for capital raising would be selling equity. "We think funding of [circa] $10 billion would offer the credit market the security it needs," they wrote, adding, "A backing from sovereign wealth [or a] strategic investor would enhance credibility." In another report to investors, CreditSights, an independent credit-analysis firm, wrote that BP was "reported" to be looking at raising $40 billion, of which $30 billion is purported to comprise new debt--$10 billion in new long-term bonds and $20 billion in short-term collateralized bank loans. CreditSights added the bonds would likely have a coupon of around 7.5% and the loans an interest rate of 3.5% over Libor. CreditSights didn't provide the rationale behind its assumptions, but some investors said they didn't think the price it cited will be enough. "I would go higher than that," said Peter Vutz, head of credit at Dwight Asset Management. "I find it tough to see that they could place a good amount [of debt] with a 7.5% coupon. There might be some brave souls out there, but I think they are pushing the envelope." Robert Wine, a spokesman for BP, told Dow Jones Newswires that his company has "very strong cash flows," $5 billion in cash on hand, and access to $5 billion in bank lines and a further $5 billion in standby facilities. BP has already set aside $7.5 billion after suspending its shareholder dividend for the rest of the year. It plans to fund a $20 billion escrow account negotiated with the U.S. government for claims relating to the spill over the next 14 quarters. A further $10 billion could be generated through asset sales, the company said, and reducing capital expenditure by 10% could save $3 billion. "I know of no fundamental reason why there should be a default at BP, near-term or otherwise," Phil Adams, an analyst at another independent research firm, Gimme Credit, wrote in an email. "Aside from the (admittedly large) problem in the Gulf, their business is apparently performing well. I truly believe that BP can handle $1 billion of expenses per month for a very long time and remain solvent, regardless of whether or not it recovers a portion of the costs from its well partners." There is trouble brewing, however, in the form of a tropical weather in the Caribbean that has the potential to delay the oil spill clean-up effort. BP shares fell to a 14-year low Friday, when the company said the cost of the clean-up had grown to $2.35 billion. -By Katy Burne, Dow Jones Newswires; 212-416-3084; [email protected] (END) Dow Jones Newswires June 25, 2010 14:41 ET (18:41 GMT)