Blessed by the Potato

On the topic of BP and the environment: I meant to focus more on the horrible nature of the situation in my last post, on the Chernobyl-like precedent this tragedy might have in the public mind. How things like the deepwater drilling ban might spur us to say, tax oil a bit more to reflect the costs, or encourage better, faster implementation of crude alternatives in our power and transportation systems.

But I got on the investment thinking train, and that seemed to prove popular, so let me just continue briefly here.

First up, I’ve been trying to pay more attention to the story in the media lately. I was a little surprised to see a guest on BNN the day after I put my last post up saying almost word-for-word what I said about this disaster not killing BP outright, so at some point there must be value in the stock. He followed up by advising people to not catch the falling knife though, which is advice I have a particularly tough time following, so it’s good to hear again.

BP has now successfully cut off the top of the riser pipe down there, making for a cleaner hole. That makes it possible for them to siphon some of the oil off of the gusher and up to a surface ship. It also unfortunately allowed more oil in total to be released, which will be really bad if say a hurricane starts to form and the surface ships have to skedaddle. I thought that net-net, it was a positive move, but that may be a close thing, depending on how close to the upper end of the range we were at for the size of the gusher: if they’re collecting ~15k barrels/day, and the cut in the pipe allowed 20% more oil to escape, then that’s a losing move if the size of the leak was over 75 k barrels/day. I actually expected BP’s stock to jump on that news, but it had another horrible day today (down almost 16%). It’s now under $30, which has me making “Om Nom Nom” noises.

One thing their collection operation proves though is that the early estimates of oil flow were way, way too low. The most-reported estimates of the size of the spill are still climbing day by day in the media, but now seem to be plateauing in the lower range of what the image analysis guys were saying (i.e., in the neighbourhood of 50k barrels/day). Not all of that is making it to the surface, and there’s no way to tell yet whether or not that’s a good thing. Obviously it’s harder to skim/clean oil that for whatever reason is remaining dispersed beneath the surface, but maybe we’ll get lucky and it won’t need to be cleaned. OTOH, it may poison marine life for decades to come. No way to say just yet, I think.

Alongside the climbing volume estimates comes the climbing cost estimates, which are now closing in on my back-of-the-envelope $50B figure. At that point, I still have to think that BP is value-priced now at < $30. Some articles today raised the spectre of bankruptcy for BP, which I think is highly unlikely given the facts on the ground right now — as I said before, BP is a very profitable company, and can afford to make good on even large payments if given time (and litigation will likely give them that time). Even a $100B final price tag wouldn’t kill them if they had 5-10 years to pay out, though it would mean that the stock would have more shit left in it to get kicked out. Despite the fact that I’ve been pretty pessimistic on the scale and cost of this disaster so far, I think $100B is probably the upper-end of the range.

That is, assuming that the relief wells being drilled right now are able to stop the leak before the end of August. A 3rd-party drilling expert was interviewed on BNN the other day, and he gave me hope that this would work. Specifically he said that these kill wells have a greater than 90% chance of success, and are very good at being able to find the borehole underground. With two drills going, there’s a very good chance this will stop before the fall.

In the scenario that the kill wells fail (or to compound a tragedy, one of them blows out) then there is unfortunately no salvation for BP. If this thing leaks for the better part of a year like Ixtoc, then the Clean Water Act penalties and other settlement costs could conceivably bankrupt them. I can’t say that it won’t happen for sure, but I discount it as a very remote possibility.

On the matter of the dividend there has been a good deal of commentary. It’s a tough call. On the one hand, they do have enough cash on hand and cashflow being generated to pay for the ongoing costs of the cleanup at the moment, so a dividend cut isn’t strictly necessary. Plus, it’s a “widows and orphan” stock, especially in Britain, so there’s some pressure to continue to pay a dividend (even if a reduced one). On the other, there are the optics, which can cut both ways. They may seem callous to the situation by paying out cash to shareholders in the midst of the crisis (and powerful politicians are calling for them to cut it). To a lawyer in front of a jury though, a cut and the buildup of a reserve fund may just be a target — however much they build up, a court may reason that they should award more in damages to make the award truly punitive. Giving the cash to their limited-liability shareholders may help keep the court awards/settlements down. The dividend is pretty rich, but I’m not sure that eliminating it for a few years should really affect the investment thesis all that much — the uncertainty in the cleanup costs is much higher than that, so I don’t get the news reports saying that the stock declined on rumours of a cut. I think that they can keep it up, but will probably cut (not necessarily to zero though — probably down to 25-50% of what it was), however either way I don’t think it’s a significant enough factor to affect my value price.

So after looking at it a little closer, my back-of-the-envelope calculation doesn’t seem all that far off to me: BP is likely getting into the buy range now (under $30 for the NYSE ADR), and it might just be a matter of waiting for it to stop being sold in a panic to get in as a long-term value/recovery play. That said, it’s definitely getting detached from the fundamental issues here and trading on emotion in my opinion. It could go nowhere until the relief well connects and kills the leak; it might stay low until a decade from now when the settlement payouts stop and people see the EPS clearly again. It might spring back 15% tomorrow on no news. Some big-name analyst might pan it and it could go no-bid until the vultures start picking it up for pennies. Just no way to say in the short term. That said, the bonds may also be well worth looking at: I haven’t bothered to log into the fixed income side of my broker’s website, but the paper today said that their debt was now yielding 8% — and that was just a 3-year bond! — which plays even better into the “they won’t go bankrupt” thesis (especially if you conclude with “at least not in the next 3 years”).

Another side to the catastrophe that I haven’t seen mentioned yet is the fact that a large portion of the release appears to be methane. As we know from the snickering over cow farts, methane is a very potent greenhouse gas, and here we have a rather substantial release of the stuff going on. I have to wonder if it’s going to be enough to affect the climate records for the next 10-20 years, though I suppose that’s a problem to worry about after the spill is stopped.

One final note on government malfeasance. Some have speculated that the US will simply confiscate BP (or it’s american assets), or create legislation to penalize them post hoc. That is expressly forbidden in the US constitution. However, the US government’s actions during the financial crisis (seizing banks that were not necessarily demonstrably insolvent; arbitrarily making bondholders whole and wiping out common and preferred shareholders without the benefit of a release of their calculation arriving at such a split or orderly liquidation; their continued efforts to keep the GSE’s down with ridiculous interest payments on money that they are forcing them to borrow, which the GSE’s don’t really need — what use capital requirements when possessed and guaranteed by the government?) do not inspire continued faith in the concept of due process.

PS: note that when I say “today”, I mean June 9th (I composed this the evening of June 9th, but held off until June 10th to hit publish).

For the curious, here is my expanded first draft; I should say emphatically that my coauthors on that paper are not responsible for what’s said here, this is all BbtP baby. As you can see, a lot was cut out to fit in the space provided, and to not come off as some guy ranting on a blog. Fortunately, this is the perfect venue for an article that comes off as a guy ranting on a blog! For those who have no idea what this is a first draft to, don’t worry about it, this stands on its own.

In Science (vol 327, p931, 19 Feb 2010) a little article came out describing the difficulties researchers in China were having with their studies of functional magnetic resonance imaging in children specifically to get healthy children to volunteer for a scan to act as controls for their patient group.

Intending to enroll children in the study, university students last December handed out fliers at a primary school. But they came away empty-handed: Parents were worried that MRI scans might harm their children. […] parents are reluctant to expose children to strong magnetic fields.
[…]
After 3 decades in the clinic, MRI is considered safer than x-ray scans and proton emission tomography, says physicist Yihong Yang, chief of the MRI physics section at the National Institute on Drug Abuse in Baltimore, Maryland. The main danger is for people with a pacemaker or other metal in their bodies. “Millions of people have been examined with MRI so far; thus it seems now very unlikely that there would be a side effect,” says Arno Villringer, director of cognitive neurology at the Max Planck Institute for Human Cognitive and Brain Sciences in Leipzig, Germany. […] Recruitment goes more smoothly in the United States, where “many parents will allow their children to take the test…”

There is some balance though:

…that reassurance cuts little ice with many parents—and some scientists. “I would not dare to allow my children to be tested by MRI,” says radiologist Han Hongbin of Peking University Third Hospital. “Nobody can ensure that there is no potential danger,” such as during nonroutine MRI scans that use extremely powerful magnetic fields, he says.

This is a very tricky ethical dilemma, for a number of reasons.

Stating that “millions of people have been examined with MRI so far; thus it seems now very unlikely that there would be a side effect,” is an irresponsible statement to make in the face of empirical evidence to the contrary. We know that there are deterministic effects of the fields used in MRI: strong, rapidly changing gradient fields can stimulate nerves to fire; radiofrequencies can cause heating; strong static fields can create projectiles out of metal objects. There are safety limits and procedures in place to attempt to control these effects in MRI scans, but there may still be stochastic effects present. Indeed, it is well known that at high fields some people may experience nausea/vertigo, or a metallic taste. Several studies have examined the effects of the time-changing fields. These effects are not necessarily negative: Rohan et al. [2004] found that a particular MRI scan could improve mood in bipolar patients, and the undesireable effects are subtle and fairly easily managed. The effects are also not necessarily chronic, but the possibility that more exist that we have not yet discovered must be accounted for, particularly when imaging subjects that will have no medical benefit from the scan.

This becomes a particularly touchy issue when children become involved. There are many processes that affect developing organisms more severely than fully matured ones. Some early research into the effects of electromagnetic fields suggests that this may be the case for something like an MRI as well. The fact that millions of adults have been scanned over the past ~30 years may be cold comfort to a parent volunteering their child.

For some biological effects there may be a long latency time as well, before effects can be observed. Solid tumor formation, for example, may take over a decade to manifest after ionizing radiation exposure. Good, long-term epidemiological studies will be needed in the future, alongside basic experimental studies on animals and cell cultures, to arrive at a good answer to the question of whether there are biological or behavioural effects of MRIs, and what they might be. Indeed, it is well known that there is a slightly increased risk of cancer formation from the ionizing radiation present in an x-ray/CT scan. However, if we were at the same point in ionizing radiation-based imaging as we are with MRI — millions of patients scanned, but little long-term follow-up looking specifically for effects — we might not be able to find that risk! Absence of evidence is not proof of the absence of risk, and it is widely accepted that there are small, but non-zero risks associated with CT. Accordingly, it has been appropriate to adopt the precautionary approach, and apply the dictum of ALARA – as low as reasonably achievable – to ionizing radiation dose.

I’m not in any way trying to be fear-mongering: fuller understanding of the processes is needed to mitigate these potential risks. Gadolinium-DTPA was for a long time used as a contrast agent and was understood to be safe. Recently, it has been determined that it can have severe side-effects in some people. These risks can be managed, for example through kidney function tests to determine who may be at risk. Any behavioural or biological effects of MRIs may likewise be managed in the future once they are better understood.

Hoping that there are no effects, without rigorously pursuing the matter in a scientific manner, will not be beneficial in the long run. More research on the potential biological effects of MRI, especially in children, is needed.

We can’t say for sure yet, and will indeed never be able to say with full confidence that there are no biological effects of the fields used in MRI. At this point we can probably agree that any effects, in adults, are not so severe as to counterbalance the usefulness of MRI as a diagnostic and research tool. As more research is done, we will either uncover what the effects are exactly, or continue to narrow down the maximum effect that we could discover with the population tested. With children, however, the studies have not been done, and our confidence that MRIs have no effect is not particularly strong.

And note that I say this as someone who depends very much on having volunteers step up to get an MRI for research purposes, and as someone who’s had a dozen MRIs himself. For an adult, having an MRI is safer than going for a short cruise in your car, a risk that people take for trivial benefits on a regular basis, so I completely understand when someone steps up to help science (and make a few bucks themselves). For children though, we just don’t know. Ultimately it’s the parents’ decision, but informed consent means that the researchers should try to educate them about both sides: the benefits and research aims as well as the potential, unknown risks.

A study is going to be better scientifically if it uses healthy controls to compare to a patient group (in this case, ADHD), rather than a different patient group (such as epilepsy) where the region of the brain being studied is likely not affected. However, that has to be balanced with the ethical realities of doing research.

I was out helping a friend car shop today when I ran into a fairly sleazy dealer tactic. The guy was actually a pretty good salesman: enthusiastic, knew the car, personable… but then he started hammering out numbers (using the “adjust to a certain monthly budget” method) too fast to follow. He was trying to beat a quote she got from Mazda, which has 0% financing right now, and he said that Kia didn’t (though when we checked the website afterwards, they did). He was going to discount the car to make up for the financing, and was hammering away on the calculator. He turned the calculator around, and said he could do $162. We were like wow, that’s less than half of Mazda’s quote. “Oh, no, that’s bi-weekly, so multiply by 2 to get $324 per month. Pretty good, right?”

Pretty sleazy, actually. There are 26 bi-weekly periods in a year, but only 24 twice-a-month periods. So to get a monthly payment from a bi-weekly one, you have to multiply by 26 and divide by 12, which is 2.167, not just 2X. So he was actually presenting a $351/mo payment, which was more than the Mazda.

I love free stuff (especially food — the grad student cliche is true). It’s like cheap, only better.

However, I turn down a lot of free stuff that I know isn’t actually free: it comes with strings that you have to untangle later, especially free crap I don’t really want. The telemarketers sometimes get confused at this (or are trained to act confused when people reject their offer of free crap), why would I turn down free crap when I can call back within 30 days and wait on hold for an hour and go through 6 automated menus to cancel?

Ellen Roseman this week covers the case of Seema, another newb who fell prey to Extreme Fitness. Their business model is built on the free trial followed by lock-in concept, yet Seema jumped for it, signing up for something she had “NO intention whatsoever” of actually signing onto long term just to take advantage of a free trial. Due to a mix-up of cancellation times, she ended up calling back 4 days too late and they tried to lock her into paying for a full membership. Fortunately, Ellen Roseman rode in to the rescue and helped get her out of the contract.

The lesson? Don’t sign up for crap you have no intention of using, even if it’s (temporarily) free. That goes for gym memberships, magazine subscriptions, Rogers TV upgrades, Bell phone features, credit card insurance, music subscription services, credit reporting services, World of Warcraft accounts… need I go on?

In fact, I think at least a quarter of the consumer activism Ellen works towards could be eliminated if people just followed this one simple rule. TANSTAAFL.

For those that haven’t yet heard about it, head over to the Whatever to read about the Wil Wheaton and the Scalzorc fan fiction contest being run to benefit lupus research. This is going to be quite a challenge, because there is a lot going on in that picture to try to come to terms with in just 2000 words. The only thing wrong with this contest is that you can only enter once.