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Halliburton Stock Crash: 4 Key Questions

The latest BP oil spill twist places Halliburton and its cement under the spotlight, leaving investors with a tough call on the oil service company's shares.

NEW YORK (TheStreet) -- Shares of Halliburton (HAL) - Get Halliburton Company Report were flattish in trading on Friday, but that didn't make up for the Thursday stock price crash triggered by the cement-test crisis. On Thursday, the government released a letter from the presidential commission investigating the BP oil spill, a letter that revealed problems with Halliburton's cement used in the BP Macondo well. The Halliburton cement has been at the epicenter of the oil-spill investigation since the beginning of the crisis, so it's no surprise that the cement job has come into focus again. The ongoing level of risk to Halliburton shares is the question for investors.

The knee-jerk reaction was immediate on Thursday, with Halliburton shares falling 10% at one point and with close to 100 million shares traded. On Friday morning, shares were close to flat after opening lower by another 3%, and trading action was again heavy.

>>Halliburton Shares Crash on Cement Test

Halliburton shares fell all the way to $21 earlier in the oil spill crisis, but buoyed by two straight earnings beats, Halliburton shares rebounded. Do the latest revelations from the government mean that there is another leg down in Halliburton shares likely before another leg up? Has the exogenous risk of the oil spill again become a greater pressure point for Halliburton than business fundamentals?

To recap Thursday's events, the government revealed that several tests carried out by Halliburton on its cement support the claim by

BP

(BP) - Get BP Plc Report

that there were several parties at fault for the oil spill, and in particular, BP's claim that it was a "bad cement job," a claim made by former BP CEO Tony Hayward in the BP interim report on the oil spill. Tests conducted before the BP Macondo oil spill showed that cement used by Halliburton were liable to create unstable conditions.

The government also recently completed testing of samples of Halliburton cement taken from the same mixture used for the BP well. Independent testing show unstable conditions in an environment designed to mimic the BP Macondo well.

The presidential commission findings don't rule out multiple causes for the oil spill, though they do indicate that proper cement stability should have prevented the deepwater well blowout.

Halliburton posted a copy of its contract with BP for the Gulf of Mexico to the investor relations page of its web site on Thursday afternoon. The document seemed to make clear that Halliburton was fully indemnified in the case of the oil spill.

Given the intricacies of the Halliburton cement crisis, encompassing legal risks, political risks and risks to business operations, here are four key questions for investors to consider.

Halliburton Key Question No. 4: Is there a fundamental business risk for Halliburton in the latest oil spill twist?

The most obvious case to be made for an ongoing business risk to Halliburton is a combination of political damage and opportunistic plays made by Halliburton competitors in the oil service segment. There are already fears that the new permitting process for deepwater drilling in the Gulf of Mexico will cause long delays in getting projects approved. If that's to be the case, and the view of Halliburton from federal regulators is turning decidedly more negative as a result of the cement test results, investors should rightly fear that Halliburton could face the loss of business.

It's just logical speculation at this point, but think of it this way: if you are a company drilling in the Gulf of Mexico and already worried that your project may not be approved quickly, and Halliburton is a persona non grata with the U.S. government, would you rather that permit being reviewed with the name of Halliburton or the name of

Schlumberger

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(SLB) - Get Schlumberger NV Report

on it?

This is a risk that may never come to bear on Halliburton, but investors were starting to talk about it after Thursday's events.

Halliburton Key Question No. 3: Will BP Challenge Halliburton's Indemnity Clause?

The contract posted by Halliburton on its web site on Thursday afternoon was clear cut in its indemnification. Clauses 19.6 and 19.7 state that Halliburton is not liable for any "blowout" or "uncontrolled well condition" and the terms are irrespective of gross negligence and notwithstanding any breach of duty.

In terms of the language, by providing the contract on its web site Halliburton couldn't have been more open -- some have said that they thought it illegal for Halliburton to go ahead and post the contract. Nevertheless, regardless of the contract language or the quality of Halliburton cement, the key question is whether BP would attempt to challenge what seems to be Halliburton's clear-cut indemnity. Is BP simply looking for an admission of guilt from Halliburton as part of its PR campaign, or does it want to make a legal challenge that would place Halliburton on the hook for a portion of oil spill claims and government pollution act penalties?

For BP, it might be safer to use the government cement-tests results as confirmation that BP was not the only bad actor in the oil spill, and leave it at that without turning it into a fight with Halliburton over financial burdens resulting from the oil spill. If BP makes a challenge to Halliburton's indemnification, it would risk setting a new and costly precedent for exploration and production companies. The Halliburton contract with BP makes clear that it was BP's responsibility to test the cement -- and as the government letter also stated, BP decided to not conduct a key test before cementing.

If BP pushes the issue of Halliburton's indemnity, it will raise the specter of regulators mandating an independent third-party to conduct drilling tests, increasing time and costs for all exploration and development companies. "BP needs to be careful of the unintended consequences," said Sterne Agee analyst David Havens. "A challenge to Halliburton's indemnity clause and the costs for the entire oil exploration business may go up. The cost of every well goes up."

Halliburton Key Question No. 2: Why is the focus on Halliburton again as opposed to BP's decision to skip critical tests before going ahead with the cement job?

The fact of the matter is that the Halliburton cement slurry has been at the epicenter of investigation from the beginning, and investors knew it would remain an issue once BP released its interim report on the oil spill pointing the finger at Halliburton.

What was not highlighted in the headlines on Thursday was the last page of government letter, where the author says that in recognition of fact that cementing is an intricate process, there are failures and that's why tests are done, and BP opted not to do a critical test.

Halliburton didn't skip over this detail from the government letter in its statement on Thursday afternoon.

Quoting from the government letter, Halliburton stated, "The Commission letter concludes by summarizing a widely known industry fact regarding cementing:

"Cementing wells is a complex endeavor and industry experts inform us that cementing failures are not uncommon even in the best of circumstances. Because it may be anticipated that a particular cement job may be faulty, the oil industry has developed tests, such as the negative pressure test and cement evaluation logs, to identify cementing failures. It has also developed methods to remedy deficient cement jobs."

Halliburton goes on to make the argument that it "believes that had BP conducted a cement bond log test, or had BP and others properly interpreted a negative-pressure test, these tests would have revealed any problems with Halliburton's cement. A cement bond log test is the only means available to evaluate the integrity of the cement bond. BP, as the well owner and operator, decided not to run a cement bond log test even though the appropriate personnel and equipment were on the rig and available to run that test. BP personnel have publicly testified they intended to conduct the cement bond log test at a later date and to perform any necessary remedial work at that time.

"The negative-pressure test evaluates the integrity of the production casing to provide a barrier to the reservoir. A successful test is realized when an applied differential pressure is released and no flow is observed from the system. BP has admitted in its Deepwater Horizon Investigation Report (the "BP Report") that the negative tests were not successful and that the results of those tests were misinterpreted by its own and Transocean's employees on the rig. Had they accurately interpreted the negative tests, remedial action, if necessary, would have been possible."

So the argument really hasn't changed from Halliburton's perspective, and even the government conceded in its letter that the onus can be easily placed back on BP for failing to conduct the proper tests.

Halliburton Key Question No. 1: Is Halliburton a 'sell'?

The answer to this question can't be easily resolved because it depends on the legal risk that Halliburton tangible cash flow could become vulnerable to oil spill claims. At the rate that the government has been paying out claims to oil spill victims, there is estimated to be a total of $6 billion in final claims paid -- the government has already paid out $1.5 billion. The $6 billion estimate is based on the average payment made to claimants in the first $1.5 billion of claims paid, and the fact that there are 175,000 claims in the pipeline. There are also the billions of dollars in potential government fines under the Clean Water Act, and class-action lawsuits for parties that choose not to use the government claims process as their final remedy against BP and any other parties for damages. To the extent Halliburton's tangible cash flow could be going out the door, investors may not want to own that risk, but the risk itself is at this point of a legal nature and as such unquantifiable.

Is the latest twist in the BP oil spill saga overdone in terms of the Halliburton selloff, making Halliburton shares a buy, or do Halliburton shares have to be placed at a temporary hold on due to the inability to quantify risk -- i.e. the shoot first and ask questions later approach sometimes taken with stocks facing exogenous, as opposed to fundamental risks?

When Halliburton went from $34 to $27 after the oil spill first occurred, and then down to $21 as cement became an issue, the well was still spewing oil into the Gulf, and there was no limit to the liability potential. Now, at least, the financial price tag can be quantified, even if the inherent risk in Halliburton shares is higher. Short investors were given an unexpected gift on Thursday and probably took the chance to exit Halliburton shares. Halliburton shares could rebound on the business fundamentals back up to the $33 to $34 range, but investors who have already been burned three times in the past four months may not want to stick their neck out too far with Halliburton.

"I support Halliburton shares here, but if you can be buying insurance on Halliburton through the options markets, I would be doing that too," said Sterne Agee analyst David Havens.

-- Written by Eric Rosenbaum from New York.

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