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BP Article

BP Article

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Published by zerohedge

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Published by: zerohedge on Jul 01, 2010
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12/16/2010

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1
GORDON T LONG
SULTANS OF SWAP:
BP Potentially More Devastating than Lehman! 
As horrific as the gulf environmental catastrophe is, an evenmore intractable and cataclysmic disaster may be looming.The yet unknowable costs associated with clean-up, litigationand compensation damages due to arguably the world¶s worstenvironmental tragedy, may be in the process of triggering acredit event by British Petroleum (BP) that will be equallydevastating to global over-the-counter (OTC) derivatives. Thepotential contagion may eventually show that Lehman Bros.and Bear Stearns were simply early warning signals of thedevastation lurking and continuing to grow unchecked in the$615T OTC Derivatives market.What is yet unknowable is what the reality is of BP¶s off-balance sheet obligations and leverage positions. How manySpecial Purpose Entities (SPEs) is it operating? Remember,during the Enron debacle Andrew Fastow, the Enron CFO,asserted in testimony nearly 10 years ago that GE had 2500 such entities already in existence. BP has even morephysical assets than Enron and GE. Furthermore, no one knows the true size of BP¶s OTC derivative contracts suchas Interest Rate Swaps and Currency Swaps. Only the major international banks have visibility to what thecollateral obligations associated with these instruments are, their credit trigger events and who the counter partiesare. They are obviously not talking, but as I will explain, they are aggressively repositioning trillions of dollars inglobal currency, swap, derivative, options, debtand equity portfolios.Once again, as we saw with Lehman Bros and BearStearns we have no visibility to the murky world of off balance sheet, off shore and unregulated OTCcontracts, where BP¶s financial risk is presentlybeing determined. At a time when understandinga corporation¶s risk position is critically important,investors are in the dark. When markets areuncertain, bad things are certain to follow. Thenew financial regulations under the Dodd-Franklegislation does absolutely nothing to address this.This was the central issue in truly understandingand corralling TBTF risk. It has not been addressedand the markets will likely make the tax payer payfor this regulatory failure once again.
Massive BP Risk lay in the $615T OTC Market that only the major international banks have any visibility to«. and they are not talking!
 
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GORDON T LONG
THE LEVERAGE ASSOCIATED WITH ³AAA´ ASSETS
I could not have stated it any clearer than JimSinclair at jsmineset.com: ³People are seriouslyunderestimating how much liquidity in the globalfinancial world is dependent on a solvent BP. BPextends credit ± through trading and finance. Theyextend the amounts, quality and duration of credit abank could only dream of. You should think about thefinancial muscle behind a company with 100+ yearsof proven oil and gas reserves. Think about that incomparison to a bank with few tangible assets. Thenthink about what happens if BP goes under. This is nobank. With proven reserves and wells in the ground,equity in fields all over the planet, in terms of creditquality and credit provision ± nothing can match anoil major. God only knows how many assets aroundthe planet are dependent on credit and financeextended from BP. It is likely to dwarf any bankingentity in multiples«. The price tag and resultant knock-on effects of a BP failure could easily be equal to that of aLehman, if not more. It is surely, at the very least, Enron x10.´ From a historical context, some may not be aware that the infamous House of Rothschild at the height of theirbanking powermoved into Energy & Oil. Also, John D. Rockefellerquickly realizedhis globally expanding Standard Oil was more a bank, consolidating his financial empire under a banking structure which resulted in the ChaseManhattan Bank (the basis of Citigroup). As long as an energy giant can manage its cash flows throughout thevolatility of price fluctuations, it becomes a money and credit generating machine. It can borrow with AAA yieldsanywhere on the curve and lend to less credit worthy entities at attractive spreads. These lending differentials helpfuel the $430T Interest Rate Swap OTC market. BP has been able to spin off $20B of earnings for the last 5 yearsand $15B in cash last year.
 
All of this suddenly comes to an end if its credit rating is significantly impaired. Butwhat could possibly cause this to happen? It would take a black swan event. An outlier. A fat tail.Sound familiar? Heard this discussion before?The Gulf Oil Disaster may be the fat tail to end all fat tails and shows the exposure behind the entire risk models of the vast majority of derivatives algorithm models. To suggest that BP would need to take impairments north of $20B would have seemed out of the realm of possibilities less than 90 days ago. Now, if it is contained to only$20B, it would be considered a blessing. Fitch dropped BP¶s credit rating an unprecedented 6 notches onJune 15
th
 from AA to BBB which followed June 3rd's AA+ to AA cut. This is what happens when a fat tail occurs and it hasonly just begun.
CONTAGION HAS BEGUN
Though few are talking openly, it doesn¶t mean large amounts of money aren¶t aggressively repositioning. Thisrepositioning is effectively de-leveraging and is consequentially a liquidity drain. This comes as US M3 has gone
 
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GORDON T LONG
negative and M2, M1 are rapidly declining. BP is going toface a massive liquidity crunch which has all theearmarks of triggering an already tenuous and worseninginternational liquidity situation.I found the charts (right) publishedby Credit DerivativesResearchto be very telling of the abrupt shift that hasoccurred. Their charts show that the April 21
st
Macondowell explosion has triggered a significant inflection in therisk, counterparty and high yield areas. A comparisonwith Government and High Grade Debt has a differentprofile (see end of this report for the charts) whichreflects the European banking concerns associated withthe southern European economies (PIIGS). It isimportant to differentiate these as separate drivers. Bothcome as the percentage of corporate bonds considered indistress is at the highest in six months - a sign investorsexpect the economy to slow and defaults to rise. Thisspells deleveraging.
WHAT WE KNOW ABOUT BP DERIVATIVES:
 1 - CSO (Credit Synthetic Obligations)A study byMoody¶soutlines that a BP bankruptcy wouldimpair 117 Collateralized Synthetic Obligations (CSOs),which would lead to pervasive losses by a broad range of holders. The 117 effected is a startling 18% of the totalCSOs outstanding, which is an indication of the scope and impact of BP financing globally. For those that rememberthe 2008 financial debacle, you will recall its epicenter was the collapse of Collateralized Debt Obligations (CDO)associated with mortgages and Credit Default Swaps (CDS) of financial companies impacted. CSOs are even moreleveraged and toxic.

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