BP's Legal Drama Could Impact These ETFs

Shares of BP (NYSE:BP), the second-largest European oil company, are down almost three percent on heavy volume as the Justice Department is taking harder stance against the company for its role in the 2010 Gulf of Mexico oil spill. That spill was the largest in U.S. history.

New court documents show the Justice Department's harshest tongue lashing against the British oil giant to date. The Justice Department used verbiage such as "gross negligence" and "willful misconduct," according to Reuters.

BP is in a position where it must prove the gross negligence claims faulty or risk paying up to $21 billion in Clean Water Act damages. That would quadruple BP's civil damages tab, Reuters reported.

The risk to BP and the ETFs that allocate significant weights to the stock is clear. The company was hoping for quick settlement in the $15 billion to $25 billion range to get the overhang of the Macondo well tragedy in its rear-view mirror. With DoJ stepping up the rhetoric, BP will be forced to defend potentially punitive gross negligence claims meaning the spill trial, slated to start in January 2013, could last for far long than BP and its shareholders want it to.

Bottom line: BP's legal woes could adversely affect the following ETFs.

SPDR S&P Energy Sector ETF (NYSE:IPW)

The SPDR S&P Energy Sector ETF is a curious case and not simply because its average daily volume is barely over 1,000 shares. IPW reduced its BP exposure following the 2010 spill, but the stock is now the ETF's largest holding with a weight of 10.2 percent.

Arguably, that is enough to rattle IPW should the legal proceedings drag on for too long or worse, go against BP. On the other hand, if BP suffers, rivals such as Royal Dutch Shell (NYSE: RDS-A) and Total (NYSE:TOT) could benefit. Those stocks combine for over 26 percent of IPW's weight.

iShares MSCI ACWI ex US Energy Sector Index Fund (NYSE:AXEN)

The iShares MSCI ACWI ex US Energy Sector Index Fund is an even more egregious offender than IPW on the volume front. AXEN sees average daily turnover of just 320 shares. So there is a catch-22 with AXEN. The fund's light volume might appear to make it vulnerable to large declines on small volume. On the other hand, AXEN's underlying components are heavily traded, which means this ETF is by no means "illiquid."

The real issue is BP is AXEN's largest holding with an allocation of almost 8.1 percent. In addition, Transocean (NYSE:RIG), the owner of the Deepwater Horizon rig, accounts for almost one percent of AXEN's weight.

Market Vectors Oil Services ETF (NYSE:OIH)

Switzerland-based Transocean, which accounts for more than five percent of OIH's weight, still has Gulf spill financial overhang of its own. Not to mention, DoJ has not been shy about throwing sharp rhetoric Transocean's way, either. Unlike some of the other partners on the Macondo well that have settled with BP, Transocean has not done so. The company has shown it wants its day in court and that increases the dark clouds hanging over the stock.

No stranger to litigation, Transocean is facing a major legal tussle in Brazil, too. Controversial and volatile, Transocean may not be large enough in OIH to rock the ETF in the event of bad legal news. However, if that scenario comes to pass, OIH will be worth watching because some traders could dump Transocean in favor of steadier oil services names such as Schlumberger (NYSE:SLB) and National Oilwell Varco (NYSE:NOV).

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