A BANKRUPT BP - WORST THAN LEHMAN?
June 28 - July 04, 2010
The BP crisis in the Gulf of Mexico has rightfully been analysed (mostly) from the ecological perspective. People's lives and livelihoods are in grave danger. But that focus has equally masked something very serious from a financial perspective, in my opinion, that could lead to an acceleration of the crisis brought about by the Lehman implosion.
People are seriously underestimating how much liquidity in the global financial world is dependent on a solvent BP. BP extends credit through trading and finance. They extend the amounts, quality and duration of credit a bank could only dream of. The Gold community should think about the financial muscle behind a company with 100+ years of proven oil and gas reserves. Think about that in comparison with what a bank, with few tangible assets, (truly, not allegedly) possesses (no wonder they all started trading for a living!). Then think about what happens if BP goes under. This is no bank.
With proven reserves and wells in the ground, equity in fields all over the planet, in terms of credit quality and credit provision ñ nothing can match an oil major. God only knows 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 it all are those dreadful OTC derivatives again! 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 ñ 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 (regardless of whether it is deserved), and 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 kickback 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. Now credit has been cut to BP. Counter-parties will not accept their name beyond one year in duration. This is unheard of A giant is on the ropes. If he falls, the very earth may shake as he hits the ground.
As we are beginning to see, the Western pension structure, financial trading and global credit are all intertwined. BP is central to this, as a massive supplier of what many believe(d) to be AAA credit. So while we see banks roll over and die, and sovereign entities begin to falter... 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 from under us. Ecological damage is not just an eco-event on its isolated own. It has been added to the list of man-made disasters jeopardising the world economy. The price tag and resultant knock-on effects of a BP failure could easily be equal to that of a Lehman, if not more. It is surely, at the very least, Enron x10.
All the counterparty risk associated with the current BP situation means the term curve of the global oil trade has likely shut down. Here we have yet another credit-based event causing a lock-up in markets that will now impede trade and commerce. It looks like an exact replication of the 2008 credit market seizure could ensue all over again ñ and it could probably be a lot worse. The world is in a far more delicate state now.
Although never really discussed, 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 market, intellectually lazy and slow to realisation, as it often is, probably has not woken up to it yet ñ but the 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 financial house of cards we live in even more severely. If the implicit danger of the possibilities imbedded in such an event doesn't make an individual now turn towards gold at full speed, it is likely that nothing will.
The article is written by Jim Sinclair for Oilprice.com.