Oil Slickonomics
(Parts 1 – 3, including update)
Courtesy of David R. Kotok, Chairman & Chief Investment Officer, Cumberland Advisors
Oil Slickonomics – Part 1 (May 2, 2010)
“At its current leak rate of 5,000 barrels of oil per day, the spill could surpass the size of the 1969 Santa Barbara spill by next week. If the leak cannot be contained, it could exceed the size of the 1989 Exxon Valdez oil spill off Alaska by mid June.” Paul Harrison, Environmental Defense Fund
Three scenarios lie ahead. They rank as bad, worse, and ugliest (the latter being catastrophic and unprecedented). There is no “good” here.
The Bad.
Containment chambers are put in place and they catch the outflow from the three ruptures that are currently pouring 200,000 gallons of oil into the Gulf every day. If this works, it will take until June to complete. The chambers are 30-foot-high steel configurations that must be placed on the ocean floor at a depth of one mile. This has never been done before. If early containment is successful, the damages from this accident will be in the tens of billions. The cleanup will take years. The economic impact will be in the five states that have frontal coastline on the Gulf of Mexico: Texas, Louisiana, Mississippi, Alabama, and Florida.
The Worse.
The containment attempts fail and oil spews for months, until a new well can successfully be drilled to a depth of 13000 feet below the 5000-foot-deep ocean floor, and then concrete and mud are injected into the existing ruptured well until it is successfully closed and sealed. Work on this approach is already commencing. Timeframe for success is at least three months. Note the new well will have to come within about 20 feet of the existing point where the original well enters the reservoir at a distance of 3.5 miles from the surface drilling rig. Damages by this time may be measured in the hundreds of billions. Cleanup will take many, many years. Tourism, fishing, all related industries may be fundamentally changed for as much as a generation. Spread to Mexico and other Gulf geography is possible.
The Ugliest.
This spew stoppage takes longer to reach a full closure; the subsequent cleanup may take a decade. The Gulf becomes a damaged sea for a generation. The oil slick leaks beyond the western Florida coast, enters the Gulfstream and reaches the eastern coast of the United States and beyond. Use your imagination for the rest of the damage. Monetary cost is now measured in the many hundreds of billions of dollars.
Some thoughts about markets and impacts.
Usually, the first estimates in any crises are too low. That is true here. 1000 barrels a day is now 5000, and some estimates of spillage are trending higher. No one knows exactly. The containment and boom mechanism is subject to weather cooperation as we can see this weekend. Soon we are entering the hurricane season. The thoughts of a storm stirring up the Gulf, hampering any cleanup or remediation drilling effort and creating a huge 10,000 square mile black stew is frightening to every professional in the business.
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. The first estimate of $12.5 billion is only a starter.
Thousands of small and independent businesses as well as larger public companies in tourism are hurt here. This is not just about the source of half the nation’s shrimp. That is already a casualty. It’s also about the bank loans for the $200,000 shrimp boat and the house the boat owner and/or his employees live in and the fact that this shock piles on a fragile financial system that is trying to recover from a three-year financial crisis. Case study, my fishing guide in the Everglades splits his time between Florida and Louisiana. His May bookings in LA have cancelled. His colleagues lost theirs and their lodge will be empty. They are busy trying to find work in the clean up. For him, his wife and eleven year old daughter, his $600 a day guide fees just went “poof”. When I asked him if he thought he had a legal claim on BP, he said he hadn’t thought about it yet but it gave him pause. As we suggested above, the $12.5 billion loss estimate is only a starter.
Federal deficit spending will certainly rise by tens, and maybe hundreds, of billions as emergency appropriations are directed at larger and larger efforts to clean up this mess. At the same time, federal and state revenues tied to Gulf-region businesses will fall. My colleague John Mousseau will be discussing the impact on state and local government debt in a separate research commentary.
We expect that the Federal Reserve will extend the timeframe that we have come to know as the “extended period” in the making of its monetary policy. We do not expect the Fed to raise interest rates at all for the rest of this year, and maybe well into next year. We expect to see the deterioration of the economic statistics for the US to reveal the onset of this oil-slick crisis in May, and the negative impact will intensify during the summer months. A “double-dip” recession probably has been made more likely by this tragedy.
We are at the highest level of cash in our US stock accounts that we have seen in over a year and a half. We expect a market correction will present entry points at lower stock prices. We have exited the financial sectors, including the insurance ETF. We now worry about the banks that are exposed. We do not own the major oil stocks now. Some of them face enormous liability payments.
In addition, the offshore-drilling energy sector will face much-increased and more costly regulation. Deepwater and all offshore drilling in the US has been set back for a generation, just as Three Mile Island set back nuclear power development for decades. No politician can win an election now with a permissive view on drilling. Sarah Palin’s “Drill, baby, drill” now condemns her to political marginalization. Off shore drilling has lurched to the top of the political agenda in this November’s election cycle.
Readers may be interested in following events on the NOAA website: http://response.restoration.noaa.gov .
Oil Slickonomics – Part 2 (May 10, 2010)
In “Oil Slickonomics”, part 1, http://www.cumber.com/commentary.aspx?file=050210.asp , we set forth three scenarios for the BP disaster. They are “bad,” “worse,” and “ugliest.” Events are now moving from bad to worse.
BP’s attempt to install a large funnel-type device is running into problems. They have shifted the device several hundred yards away from the well as they try to deal with complex technical issues. Meanwhile the damaged well continues to spew at least 200,000 gallons of oil a day.
Within days we will have reached the second level of damages in the Gulf of Mexico. Under our “worse” scenario the total will be in the many tens of billions before this is all over. There are now early reports of “tar balls” washing up on beaches. Damage is now witnessed in Alabama, Louisiana, and Mississippi. NOAA has expanded the no-fishing zone to about “4.5 percent of Gulf of Mexico federal waters.” The original closure boundaries, which took effect Sunday, May 2, encompassed “less than three percent.”
Readers please note that this event is still mostly confined to United States “federal waters,” which are under NOAA jurisdiction. International claims are a more complex financial liability for BP and its partners.
So far, BP has offered US-based fishermen a one-month-pay settlement package. This is being routinely rejected, according to the professional fishermen we have been able to reach. If this spillage continues, as we project under our second and “worse” scenario, and IF it can be limited to that scenario and doesn’t worsen to “ugliest,” the ultimate loss of income to fisherman will continue over many, many months or even years.
According to NOAA, “There are 3.2 million recreational fishermen in the Gulf of Mexico region who took 24 million fishing trips in 2008. Commercial fishermen in the Gulf harvested more than 1 billion pounds of finfish and shellfish in 2008.” BP’s offer of one month’s pay is a pittance when compared with the ultimate damages that will be suffered by the fishing industry.
Some readers have asked about the federal fund that is designed to pay for cleanups of oil spills. It is funded by an eight-cent-per-barrel tax and is wholly inadequate for this type of catastrophic event. In the wake of the BP explosion, three Senators have offered a bill to broaden the scope of the fund and raise the tax.
One May 1, the New York Times reported that, “A count made by the Department of Homeland Security last August found that since 1991, there had been 51 instances in which liability exceeded caps. In most years it was a handful; in 1999 there were 11, because of a typhoon in American Samoa that wrecked eight fishing vessels that spilled oil. Numerically, cargo vessels and fishing vessels are the biggest culprits, but oil tankers and barges cause the most dollar damage. The fund’s single largest expense so far came after a tanker in the Delaware River, the Athos I, spilled tens of thousands of gallons of crude oil in 2004. Money can be sought by the states for expenses like restoration of a damaged wetland or compensation for loss of use of a resource.”
We wondered about the details surrounding the federal fund and asked Jim Lucier of Capitol Alpha Partners for his views. Jim is one very smart analyst, whose firm does superb research on federal political activities and Washington-based intelligence. He is current with the BP spill issue. Jim gave us permission to share his piece on this federal fund. You can find “How the OPA Trust Fund Works” on our website, at http://www.cumber.com/content/Special/HowOPA050410.pdf.
We thank Jim for giving us permission to share it. Please note that Jim is a member of the GIC and will be speaking on the Washington scene at our briefing in Paris on June 18.
Oil Slickonomics – Part 3 (May 13, 2010)
“We have breaking news on the oil spill in the Gulf. There’s new information that it could be much worse than believed.”
Anderson Cooper, 10 PM, May 13, 2010, CNN
CNN breaking news tonight reports that the estimate of 5000 barrels a day spilling from the BP well in the Gulf of Mexico may be very low. A Purdue University professor has used sophisticated scientific analysis to estimate the flow visible in the now-famous video, and has revised the estimate to 70,000 barrels a day, with a margin of error of plus or minus 20 percent. That is the equivalent of an Exxon Valdez spill every four days. Another way to put it is that about 20 million gallons a week or some 60 million gallons have polluted the Gulf since this started.
The new estimate helps explain the large size of the slick, as estimated by NOAA. It also leads us to move to our second case among the three scenarios we have discussed in part 1 and part 2 of this series. See www.cumber.com for the other parts of the series. We were already at “bad.” Now we may be at “worse” if tonight’s effort by BP is unsuccessful. We should know within 48 hours.
According to Anderson Cooper, other experts who have responded to the new estimate have now called on the federal government to intervene massively and to stop leaving this issue to the oil company. They allege BP is purposefully covering up or excluding information and keeping professionals from participating in a coordinated national effort to deal with this catastrophe.
We have no way to know what is going on inside BP. We do know that the reports continue to be alarming.
Tonight there is another attempt by BP to use another method to stop the flow. BP says that we shouldn’t deal with measuring and that we should focus on stopping the spewing of oil. They are partially correct.
Of course the stoppage must come first. But measuring is a way to determine the responses needed to minimize the damage and clean up the mess. And this is a very big mess. BP’s liabilities are growing exponentially, as are those of its suppliers and partners who are involved.
In addition there is now risk to shipping lanes, because ships and barges cannot safely navigate through oil spills and slicks. The fire hazard has also greatly intensified. There are insurance requirements to prevent the transiting of ships. In sum, it is not wise to sail through a dangerous stretch of oil-contaminated ocean.
We have seen some firms make investment recommendations favorable to BP and the others involved. They claim the existing loss of market cap makes them cheap. We think that an unknown and growing liability is enough to dissuade us from attempting to bottom fish. You could catch a falling knife. We are not positioned in the ETFs that have heavy weights of these companies.
The other issue has to do with the 30,000 wells in the Gulf. They too must be cognizant of the risk of operating with an oil slick underneath them that is spread widely on the surface. Fire hazard again emerges as one of the considerations. We are told by petroleum engineers that these rigs may have to be evacuated if the slick reaches the sort of proportions to be dangerous to them. This is true for both drilling rigs and production platforms.
This situation in the Gulf has gone from bad to worse. It still may be contained. BP’s efforts to capture the gushing oil with the funnel-type device they are attempting to use tonight may still work. We certainly hope so.
Meanwhile the combined federal and oil company effort has now widened to over 500 vessels and 13,000 people. 1.5 million miles of boom and containment-type barriers have been installed, and more are coming. Coastal cities in Florida are making emergency plans. We have evidence of oil spill damage in three states: Mississippi, Louisiana, and Alabama.
Like Yogi Berra said: “It ain’t over till it’s over.”
Slickonomics – Part 3 Updated (May 14, 2010)
What happens when one writes in a hurry and late at night in response to breaking news? Simply put: one makes mistakes. The good news is that I have friends who look out for me and who are kind enough to add their expertise.
Let me first correct one glaring error. In last night’s “Oil Slickonomics – Part 3,” I noted that 1.5 million miles of boom have been deployed. That was not correct. Such a number is “impossible” and I thank my dear friend and LSU professor Loren Scott for correcting me. The figure should be in feet and not miles. Loren notes that there are 2000 miles of American beaches on the Gulf of Mexico between the bottom of Texas and the tip of Florida. We could protect them many times over with a million miles of boom. We cannot protect them all with a million feet of boom.
I asked Loren for his take on the crisis. He emailed the following, which is very instructive and supportive of the views we have taken. Loren is a world-recognized expert in the oil area and in the Gulf. He wrote:
“My biggest concern for the country is that the slick will move to the West. If it does there are two serious issues. The first is that that is where the great majority of the producing platforms are and most of the few active drilling rigs. If the slick gets under those platforms—as you pointed out—will the MMS or Coast Guard require those platforms to be abandoned for security reasons (fire)? Some can be remotely operated, but not forever. Even if they can remain manned, there is a huge fleet of supply boats operating around the clock supplying those platforms with potable water, food, supplies, etc. Will the Coast Guard allow those supply boats to motor through the slick to make their deliveries? If the answer is no, then the platforms will have to be abandoned. About 31% of our domestic oil supply will be shut off. You can imagine the impact on fuel prices. Dunce senators who argue we should shut down offshore exploration have no idea how harmful such a move would be.
“The second serious issue concerns another key facility to the west, the Louisiana Offshore Oil Port. LOOP is the only super port in the US and is the only place where very large crude carriers can offload their oil. Will the LOOP be closed if it is surrounded by the slick? There goes another 10% of our nation’s oil supply. Combine that with issue #1 above, and the impact on fuel prices is scary.
“Much has been made about the impact on the seafood industry. This is not politically correct of me, but seafood is really a minor player in most of these coastal economies. Louisiana is #2 in the nation in fisheries (second to Alaska). However, the landed value of our fisheries in 2008 was: shrimp – $130.6 mm, crab – $32 mm, oysters – $38.8 mm, and menhaden – $45.8 mm. That’s about $247.2 mm in total. I did a study on the value of recreational saltwater fishing in Louisiana about 3 years ago. Including both direct and indirect effects, it created about $528 mm in business sales in the state. It is also important to note that much of this work is not full-time. It only occurs during "seasons," and in the case of oysters, many people come in from out of country to harvest their beds. All these numbers pale compared to the impact of the oil and gas industry. Those supply boats and platforms are operating 24/7 and involve much higher wages than fishing. We are talking about billions here.
“I also keep up with some of the coastal MSAs from Mississippi to the FL panhandle for a group of banks. I really do not think the slick will impact the Mississippi tourism business much at all. People do not go to the Mississippi coastal area to get in the water. The sand is not as white and the water is not as clear, because it is so close to the mouth of the Mississippi River, so there is still a silt effect there. People come to the Mississippi Coast for the casinos, primarily. Unless there is some ‘odor’ effect as the slick comes ashore, that state should not be hurt all that much.
“Once you get to the eastern side of Mobile Bay, the whole equation changes radically. That is where the beaches are beautifully white and the water is clear. People come there to get in the water. For most of these communities their entire economy is based on tourism and the military. Just the prospect of the slick coming onshore is hurting bookings from Gulf Shores, Alabama to all along the western coast of Florida. The good news is that this should be a short-run problem. Sandy beaches can be cleaned up. New sand can be brought in. If this thing goes to the West—where Louisiana has no sandy, or even identifiable coast—and gets into Louisiana’s marshes, that is another more difficult cleanup altogether.
“Finally, a comment about the size of the spill. There is a great deal of uncertainty about how big it is. The number being repeated is 5,000 barrels or 210,000 gallons. This seems like a huge number. However, envision a relatively shallow, Olympic-sized swimming pool like you saw during the Summer Olympics. That pool contains 660,000 gallons of water. The Gulf is huge. That many gallons being spilled is not horrific. Why is the slick so large? Answer: because it is only about a millimeter thick. I am not pointing this out to minimize the size of this problem. It is a legitimate catastrophe, but we still need to keep things in perspective.”
We thank Loren for his assistance.
Let’s go to NOAA, which is the main source of the data I use, although interviews with petroleum engineers, fishing professionals, and government officials and other experts are among the other sources that play a part.
NOAA reports and updates daily. Yesterday they listed as follows.
“Response to date
- Total response vessels: 526
- Containment boom deployed: over 1.1 million feet
- Containment boom available: over 300,000 feet
- Sorbent boom deployed: over 320,000 feet
- Sorbent boom available: over 850,000 feet
- Boom deployed: over 1.4 million feet (regular plus sorbent and fire boom)
- Boom available: over 1 million feet (regular plus sorbent and fire boom)
- Oily water recovered: more than 5 million gallons
- Dispersant used: over 475,000 gallons
- Dispersant available: more than 215,000 gallons
- Overall personnel responding: more than 13,000”
Also, let me clarify for readers that the 70,000-barrel-a-day rate of spew is not my estimate. It is from a professor at Purdue. The issue of spill size will now be examined by a congressional committee. Also note BP has said repeatedly that they are not certain of the amount of oil being discharged in the Gulf. I had seen estimates as high as 25,000 barrels a day but did not use them as long as the 5000 daily rate was generally accepted.
The 70,000 estimate is enormous by any reference standard. The experts who computed it say their margin of error is 20%. Whatever the actual number, if it is anywhere near correct, the amount of crude oil is much higher than originally estimated.
Stratecon’s Jay Simkin notes that large spills and flow rates have references and that the 50,000 or 70,000 daily barrels rate is quite high. Jay cites some historical references of very large spills as examples of their rarity.
Jay’s comments follow:
“The 70,000 barrels/day estimate is likely wrong. Here’s why: Kuwait’s Burgan field — second-largest globally – has some of the most productive wells. Even so, flow rates do not exceed 50,000 b/d.
“In Brazil’s new Tupi field, an ultimate per-well flow rate of 30,000 b/d is expected. The Carioca field, also offshore of Brazil, is guesstimated to have wells that will flow at 50,000 b/d, at least for a while.
“For the Gulf of Mexico well to flow at 70,000 b/d means the field is a super-giant. There’s no evidence to show this is so.
“Further, medium grades of crude oil (mid-30s, API) aren’t very flammable. The volatile fractions evaporate rapidly, especially in the Gulf’s late spring heat. The residual oil might burn if napalmed, but likely would not burn for very long.
“Witnesseth: were it possible to burn off the oil that would have been done, to keep the slick from spreading.
“Having a crude oil slick around drill rigs is messy, but not a huge safety danger. If the oil slick were highly flammable, it would not be possible to send into it the ships with equipment to try to secure the runaway well.”
Jay may or may not be right on the fire hazard, but the evidence is that insurers do not want ships to go through oil slicks, and they may soon be re-rating the Gulf as policies allow for these changes. Our point is that there are no good outcomes here.
Lastly, Andy (last name withheld) chastised me for being fully invested while writing about this mess in the Gulf. He liked the cash raising in April and wondered why we reversed ourselves. He attributed the cash raise to the rising risk in the Gulf.
That is a very fair question.
We are back in markets because we believe the G4 central banks are now all in synch on easing. Look at the world’s currency inventory and one sees that the dollar, pound, yen, and euro are all likely to have very low policy interest rates for the rest of this year. They are experiencing no inflation and have an increasing threat of deflation. Furthermore, it is important to average the four currencies and weight them by the total debt denominated in each. That is how global finance functions. Almost 90% of it is in these four currencies, according to the BIS. Given that, we can expect the average of the four currencys’ global short-term policy rates to be between zero and 1% for at least one or two years and maybe longer. That is why are bullish in the face of bad news, whether it originates in an oil slick or in Europe.
We thank Andy for his email, Jay for his comments, and certainly Loren for his help.
All errors are mine.
