BP PLC will have to step up pension plan contributions at a time costs from its Gulf of Mexico oil-rig explosion and the ensuing environmental disaster are draining much of its cash flow, according to an analyst.
BP executives “are spending all the time worrying about the liability in the Gulf, but there is the pension liability they have to worry about, (too),” said Kenneth S. Hackel, president of CT Capital LLC, Norwalk, Conn., and publisher of credittrends.com.
Contrary to Mr. Hackel's view, company and external reports show BP has a relatively strong pension funding level.
BP's funding level was at 98% as of Dec. 31, according to its annual report.
Mr. Hackel estimates the funding level at 90% to 92%.
Mr. Hackel said the company's pension funding position appears strong because of overstated assumptions. He claims it has worsened in the last year because of declines in the equity and real estate markets.
Long term, BP “cannot afford the pension plan,” he said.
“They should terminate it,” he said. “But that is difficult to do. There are unions (that would resist) and in Europe it's not easy to do.”
BP “has to put into its (combined) plan(s) at least $2 billion a year” in contributions, or $1.5 billion a year more than the company now plans for the next three or more years, Mr. Hackel said.
“They aren't generating enough cash to contribute to their pension fund” the amount needed over the next few years, Mr. Hackel said.
London-based BP's worldwide pension plans combined were $572 million underfunded with $28.4 billion in pension assets at the end of last year and $28.9 billion in pension liabilities.
BP paid out almost three times in pension benefits last year than it contributed, Mr. Hackel noted. BP has followed that pattern generally over at least the last five years, he added.
In 2009, BP paid $2.348 billion in pension benefits, while it contributed $804 million, according to a company report he cited. Both that payout and contribution were the highest in at least the last five years for BP, according to the data. In 2008, it contributed $368 million, while paying out $1.898 billion.
According to a BP spokesman, Anthony B. Hayward, group chief executive, sent a statement to pension plan participants in late June, saying “the pension funds are in a very strong financial position. The most recent valuations show a funding level of greater than 100%. The underlying cash generation from our global operations remains very robust. BP's balance sheet remains very solid with a 19% debt/equity ratio at the end of the first quarter 2010. We remain fully committed to the covenant that underpins the funding of the pension funds.”
As of last Dec. 31, BP's U.K. pension plans in aggregate were slightly overfunded, with $22.5 billion in assets and $21.4 billion in liabilities, according to its annual report. Its combined U.S. pension plans were underfunded. with $5.8 billion in assets and $7.5 billion in liabilities, the report said.
Howard Silverblatt, senior index analyst, Standard & Poor's, New York, said BP's worldwide funding level of 98% at year-end 2009 was improved slightly from 97.8% a year earlier, when it had $23.6 billion in pension assets and $24.1 billion in liabilities.
BP “is almost fully funded,” Mr. Silverblatt said. “Compared to most U.S. companies, they are in good shape.” The 344 companies in the S&P 500 with defined benefit plans were only 81.6% funded as of Dec. 31. Only 18 S&P 500 companies had overfunded plans, Mr. Silverblatt said.
BP closed its U.K. defined benefit plans to new hires as of April 1, except for some joining from North Sea operations.
The closing will help ease BP financial obligation to the plans, Mr. Hackel said. “But that doesn't affect my analysis” and the 50 to 60 years of pension payments he says the company will have to make.
Mr. Hackel said he based his estimate of BP's pension funding level on “more realistic” assumptions than the company uses.
BP's assumptions overstate the funding level, while understating costs, Mr. Hackel said. He said most U.S. companies, like BP, use assumptions favorable to them.
BP's assumed long-term investment return is 7.3% for its U.K. pension plans and 8% for its U.S. pension plans, according to its annual report. That's too high, Mr. Hackel said, even though it is lower than the 8% average of S&P 500 companies.
In addition, he said BP's discount rate for liabilities is too high. It is 5.8% for it U.K. plans and 5.4% for its U.S. plans. The rate should reflect termination costs of purchasing long-term, or 10-year, annuity rates, Mr. Hackel said. “I would say it should be about 5%,” he said.