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BP Bites the Bullet: Analyzing the Full Cost of the Gulf Oil Spill

Companies / Oil Companies May 10, 2010 - 05:56 AM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleJason Simpkins writes: The Exxon Valdez dumped 260,000 barrels of oil off the coast of Alaska, and ExxonMobil Corp. (NYSE: XOM) ended up spending about $4 billion in the wake of that disaster. That means Exxon spent nearly 600 times more on cleanup and litigation than what the oil was actually worth at that time.

So how much will BP PLC's (NYSE ADR: BP) Gulf oil spill, which is significantly greater, set it back?


The fact is, it's still impossible to know exactly how much BP will have to cough up to cleanse itself of this crude fiasco without knowing the full extent of the damage caused. But the picture is getting a little bit clearer each day the cleanup effort wears on.

Ian MacDonald, a professor of oceanography at Florida State University, has calculated the amount of oil spilled in the Gulf by BP based on satellite imagery and established models of oil dispersion. He believes that the quantity is already greater than that dumped in Alaska by the Exxon Valdez, the Washington Post reported.

MacDonald estimated last week that 9 million gallons of oil were already in the water, compared with 10.8 million gallons total in the Valdez disaster.

MacDonald acknowledged that the real amount could be different but also said that any comparison to the Valdez spill is misguided because the coastal gulf is far more economically significant than the sparsely populated coast of Alaska.

The type of oil polluting the Gulf is lighter than the heavy crude spilled by the Exxon Valdez. It evaporates more quickly, is easier to burn, and responds better to the use of dispersants, which break up globs of oil and help them sink. But the sheer magnitude of the spill, and the fact that oil continues to gush from the fractured well, adds to the complexity of this cleanup effort.

The oil clean up effort alone is costing BP about $6 million a day, according to the company.

"Whilst difficult to accurately estimate, the cost to the MC252 owners of the efforts to contain the spill and secure the well is currently estimated to be more than $6 million per day," BP said on Tuesday, referring to the Mississippi Canyon block 252.

The latest plan to stifle the oil leak that's pumping about 5,000 barrels of crude into the Gulf of Mexico each day is to drop a 98-ton, 40-foot iron box down onto the broken well. BP also has launched a drilling operation to permanently seal the leaking well 13,000 feet below the ocean floor. Drilling on the relief well is estimated to take some three months.

Lawsuits & Litigation
BP has announced grants of $25 million for states affected by the spill - Louisiana, Alabama, Florida, and Mississippi - but state officials have made it clear they expect more.

"Well, I can tell you we're going to need a ton more," said Florida Governor Charlie Crist.

A lawsuit "is certainly in the realm of possibility," he said.

More than 50 oil spill lawsuits have been filed against BP, Transocean Ltd. (NYSE: RIG), Cameron International Corp. (NYSE: CAM) and Halliburton Co. (NYSE: HAL). Transocean leased BP the collapsed rig, Cameron supplied the blowout prevention equipment on the well, and Haliburton provided cementing services.

Many more lawsuits are expected to pour in, but those involved hope to resolve such litigation quickly.

About 200 lawyers last week descended on a New Orleans hotel to devise a strategy to consolidate as much of the litigation as possible. They have asked a federal judicial panel in Washington to combine thousands of claims into a single multidistrict case, Daniel Becnel, the lawyer who called the meeting, told Bloomberg.

"We're not going to have a long march to trial,"said Becnel. "This could all be over in 90 days."

Most of the suits have been filed by commercial fishermen, shrimpers, property owners, seafood processors and tourism-related businesses. Analysts are unsure how much economic activity will be lost as a result of the disaster.

ExxonMobil was hit with a storm of litigation after its 1989 spill that cost the company $500 million in damages claims. That number was revised down through legal challenges from $5 billion.

Experts at the Harte Research Institute for Gulf of Mexico Studies in Corpus Christi estimated that as much as $1.6 billion of annual economic activity and services - including effects on tourism, fishing and even less tangible services like the storm protection provided by wetlands - could be at risk.

"And that's really only the tip of the iceberg," David Yoskowitz, who holds the endowed chair for socioeconomics at the institute, told the New York Times. "It's still early in the game, and there's a lot of potential downstream impacts, a lot of multiplier impacts."

At least 10 wildlife preserves in Louisiana and Mississippi - which nurture the region's $1.8 billion seafood industry - are at risk, as are billions of dollars in revenue from outdoor recreation, sport fishing, and beach tourism.

Fishing has been shut down in federal waters from the Mississippi River to the Florida Panhandle, leaving boats idle in the middle of the prime spring season. A special season to allow boats to gather shrimp before it got coated in oil closed last Tuesday.

Analysts estimate that the Louisiana fishing industry could sustain $2.5 billion in losses, while Florida could lose $3 billion in tourism income. The total cost to the region could be $8 billion-$12 billion, according to estimates.

Federal laws enacted after the Exxon spill require the "responsible party" to pay for all the costs associated with the cleanup. And while there is a $75 million cap on economic damages such as lost earnings and damage to local resources, U.S. lawmakers are seeking to raise that cap to $10 billion.

"[BP] says it'll pay for this mess. Baloney," said U.S. Sen. Bill Nelson, D-FL. "They're not going to want to pay anymore than what the law says they have to, which is why we can't let them off the hook"

U.S. Sen. Bill Nelson has filed a bill that would increase oil companies' liability to $10 billion and put them on the hook for lost business revenues.

BP chief executive Tony Hayward - who promised to pay "all legitimate claims" privately balked at committing to paying all claims for economic damage caused by the company's oil spill, said Nelson.

"When I said 'Will you be responsible for the economic damages?' he said, "That's something we'll have to work out in the future,'" Nelson said.

Buy, Sell or Hold?
BP stock plunged more than 15% to an intraday low of about $47 a share on May 3, from about $60 on April 20. However, the stock appears to have bottomed out, as it surged a little more than 4% about May 3 to its current value of $49.06.

That bump was largely the result of a call by some analysts that the company had been oversold by panicked shareholders. Bernstein analyst Neil McMahon wrote in a note to clients that BP's decline seemed "extreme" relative to the potential worst cost scenario of about $12.5 billion.

What's more, is that BP - with a price-to-earnings (P/E) ratio of 7.7 - is trading at a significant discount to other big oil firms. Chevron Corp. (NYSE: CVX) is trading at 11.71 times earnings and Exxon has P/E ratio of 14.50. BP's dividend yield stands at relatively rich 6.86%, as well.

BP has lost roughly $30 billion in market value since April 20.

Still, investors beware: The full extent of the impact the oil spill will have on BP's other operations or its earnings are still largely undetermined. The same can be said for Transocean, whose stock has plunged about 22% since April 20.

Additionally, the prospects for offshore drilling as a whole have been put at risk.

"This will be a financial calamity for many firms, not just BP and its partners and service providers. Their liabilities are immense and must not be underestimated," said David Kotok, chairman and chief investment officer of Cumberland Advisors, which does not own BP shares.

Indeed, the energy sector as a whole has come under selling pressure as well, as traders fret over potential changes to U.S. offshore drilling policy. But that's not all. The price of crude oil has dropped precipitously in the wake of Europe's debt crisis, stumbling to $75.14 a barrel Friday from above $86 a barrel in early April.

If Europe sidesteps a full-fledged debt contagion, and the price of oil rebounds, there's a good chance the sector will bounce back. But it will still have to wrestle with the potential political fallout from a BP backlash.

President Obama lifted a ban on offshore drilling, opening up large portions of the East Coast and Gulf of Mexico to new development. But now the administration appears to be backing off.

"All he has said is that he's not going to continue the moratorium on drilling," White House senior advisor David Axelrod told ABC's "Good Morning America." No domestic drilling in new areas is going to go forward until there is an adequate review of what's happened here and of what is being proposed elsewhere."

That moratorium had been put in place after a disastrous oil spill off the coast of California sparked a public backlash against offshore drilling and drove lawmakers to action.

California Governor Arnold Schwarzenegger has already withdrawn his support for new offshore drilling in his state.

"You turn on the television and see this enormous disaster," said Schwarzenegger. "You say to yourself, 'Why would we want to take on that kind of risk?'"

Still, offshore drilling enjoys widespread support among many lawmakers.

"Depending on how bad the spill proves and how serious the public reaction is, we believe the most likely potential implications are" slower progress approving new leases and a smaller chance of lifting the moratorium on drilling in the eastern Gulf of Mexico, said Goldman Sachs Group Inc. (NYSE: GS) in a research note.

Source : http://moneymorning.com/2010/05/10/gulf-oil-spill-2/

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