Debt Market Hammers BP, Partners For Second Day

The cost of insuring debt issued by BP PLC (BP, BP.LN) and its partners in the Deepwater Horizon disaster jumped dramatically Wednesday, and the price of their bonds dropped as analysts began to estimate the cost of the accident, the worst oil spill in U.S. history.

At one point, parties selling insurance--in the form of credit default swaps--on nonpayment of debt issued by Transocean Inc. (RIG), which owned and operated the drilling rig on behalf of BP, were demanding extra payments at the outset of the insurance contracts. The phenomenon, called "trading upfront," is a rare event for an investment-grade company.

Declines in the debt markets were for the most part in contrast to the reaction of the stock market, suggesting bond investors, with their lower risk tolerance, have a dimmer view of how the disaster will affect BP and its partners. BP shares, for example, rose 3.1% even as risk premiums on its bonds were growing by as much as 1.7 percentage points. Risk premiums--the added return investors demand to own the bonds instead of super-safe Treasurys--move inversely to the value of the underlying credit.

"Where there is uncertainty ... and no clear-cut measure of how or when it could get resolved, investors head for the hills," said Susan Jansen, head of U.S. credit research at Nomura Securities International in New York. "Bond investors are looking back at long-term litigation scenarios they have seen for tobacco liability and asbestos, and understanding it may be years before they really understand what the final costs are."

Early reckonings of those costs from Credit Suisse and Tudor, Pickering, Holt & Co. Securities were not encouraging. Credit Suisse put the tally at $15 billion to $23 billion, not including a separate $14 billion of claims from the tourism industry and fisheries. Tudor Pickering put the tally even higher: $35 billion to $40 billion.

BP is on the hook for 65% of the damage, while the rest is split among its partners in the project: Anadarko Petroleum Corp. (APC) at 25% and Mitsui & Co. (MITSY, 8031.TO) at 10%. Transocean doesn't own a stake in the oil field, but it is likely to be a key part of any lawsuits.

"Transocean will certainly field a large number of lawsuits and will incur significant legal fees over a number of years to come, but should ultimately be cleared of clean-up and related economic damage liability," said Brian Gibbons, senior oil and gas analyst at CreditSights in New York. "There is massive uncertainty that will remain an overhang on the stock and bonds for some time to come. Credit investors don't have the risk tolerance to wait this out."

The risk premium, or spread, on BP Capital Markets' 5.255% bonds due in 2013 was quoted at 447 basis points--4.47 percentage points over comparable Treasurys--which was 1.97 percentage points wider than Tuesday. The spread on Anadarko's 7.625% bonds due 2014 were quoted at 4.87 percentage points, wider by 1.98 percentage points.

The spread on Transocean's 5.25% bonds due 2013 were quoted at 6.23 percentage points late Wednesday, according to MarketAxess; that was 1.93 percentage points wider than the day before.

Credit default swaps protecting the holder against non-payment on Transocean debt were quoted at 3.5 points, according to broker Phoenix Partners, before falling back to 465 basis points without any upfront fees. The price with upfront fees would have cost a protection buyer $500,000 per year over a five-year period to insure $10 million of Transocean debt, plus a one-time upfront payment of $350,000; the regular quoted price would cost $465,000 per year for $10 million notional of protection.

Transocean has invoked a 19th century law, the Shipowner's Limitation of Liability Act of 1851, in an effort to limit its liability to just under $27 million. The U.S. Justice Department on Tuesday told a federal court in Houston that the law should not apply to claims made by the U.S. government or the states.

At the same time, Attorney General Eric Holder said the Justice Department had opened civil and criminal investigations into the accident.

Despite all this, some analysts and others said they believed the reaction in the credit markets was exaggerated.

Jaimin Patel, a credit analyst at Societe Generale, said the volatility seen in oil and gas stocks associated with the disaster was directly tied to negative headlines, in the same way that the companies' positions improved when it first appeared that BP's so-called 'top kill' solution might work. "Today was something of a reversal of that," he said.

The companies involved, BP, Transocean, Anadarko, oil services provider Halliburton Co. (HAL), and to a lesser extent Cameron International Corp. (CAM), which made the blowout preventer, are all traditional, investment-grade names. So the reaction to Transocean in particular, a strong BBB name, was surprising.

-By Katy Burne, Dow Jones Newswires; 212-416-3084; katy.burne@dowjones.com

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