BP and the Efficiency of Markets

The efficient market hypothesis suggests that current stock market prices incorporate all of the information known about a company at the current time. There are three different forms of the hypothesis; the weak form that incorporates all information about current stock prices, the semi-strong form that incorporates all public information, then the strong form that incorporates all public and private information.

To illustrate how the efficient market hypothesis works we can examine the effect of the Deepwater Horizon and disaster on the price of British Petroleum shares. The Deepwater Horizon sank on April 22, 2010 and at that time British Petroleum estimated the leakage at 5000 barrels per day. On April 19th BP shares were trading at $58.50 on the New York Stock Exchange. Ten days after the sinking, BP shares had fallen to $51.70. The market did not believe that the leaker was 5000 barrels per day. With roughly 3.1 billion shares outstanding the market had effectively cut just over $21 billion from BP’s market value.

By the beginning of June when all other attempts to the leak had failed and BP finally cut the pipe BPs market price had fallen to less than $37 a share. At that time estimates of the leakage had risen to 95,000 barrels per day.

Today shares are trading in the $30 range and despite their best efforts estimates of the leakage are still 60,000 barrels per day. It would appear that the markets new on April 22 roughly how large the damage was and began to incorporate that information into the stock price even though official estimates at the time were far less severe. We may not yet know the full extent of the financial damage caused by the oil spill but the market is putting an estimate well in excess of BPs 12 billion dollar cash reserve. British Petroleum is facing a suspension of its dividend and the potential for issuance of debt to pay what is now estimated at cleanup cost and liability payments in excess of $20 billion.

Anecdotal evidence suggests markets knew right away that the BP oils bill was far larger than initially reported giving some credence to the strong form of the efficient market hypothesis.

Click here for an April 29th NY Times article suggesting damage in the “hundreds of millions”

Click here for a June 15th Reuters article estimating oil flow after the cap was installed.

Click here for a June 16th Associated Press article indicating BP is setting aside $20 billion for relief