“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 .

David R. Kotok, Chairman & Chief Investment Officer, Cumberland Advisors, www.cumber.com

Category: Energy, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

29 Responses to “Oil Slickonomics”

  1. ZackAttack says:

    What this tells me is that we’d probably better be thinking about a world without BP anymore. Also, that you should settle early, because otherwise, they’re going to try to play it out in court for decades.

  2. ZackAttack says:

    Thing is, this looks like a pattern of behavior… Texas City in 2005 was BPs issue, as was the Prudhoe Bay blowout a couple of years ago.

  3. Have you no sympathy for the ‘Drill baby drill’ rednecks?

  4. Chuck Ponzi says:

    Wait a minute…

    I thought we were running out of oil! Someone please explain to me how the earth simply spews forth millions of barrels without so much as a pump to get it out?

    I’m not being facetious, I really want to understand!

    Chuck

  5. callistenes says:

    Wasn’t transocean the operator of the rig?
    Halliburton built it?
    It depends where the failure was (we may never really know).
    There is a fund available for cleanup so BP might get out better than anyone thinks.
    And thus far I believe BP has only claimed responsibility for the cleanup (not collateral damage).

    The Texas City refinery is quite old and since no one seems to want to build new ones, refinery incidents may get more common.

    And the Alaskan pipeline is also 40+ years old although there is no denying that the cutbacks on inspections allowed the leak to happen.

    Actuaries always weigh in on these types of decisions. BP and the environment were burned by “The Formula”, Tyler would be so proud. Doesn’t the Valdez still sail to this day under another name?

  6. Brendan says:

    @Chuck: First off, millions of barrels of oil really isn’t much in the grand scheme of things. So even if we have millions of barrels a year coming out of the ground at wells like this, we’re still running out. It’s used much faster than that. US production has been in decline since the 70′s. All of the ANWR’s few billion barrels are estimated to only be enough oil (if it could be recovered all at once) to supply the US for less than 12 months. The numbers sound big, until you put them in perspective.

    For the most part we don’t “pump” oil anymore. There aren’t the nice shallow reservoirs of crude that the early oil pioneers tapped into anymore. They’ve all been basically emptied, the easy oil has been found and used. Instead we get oil from extreme depths under intense earth and/or sea pressures. It is contained in small labyrinthine caverns and even smaller pores, not in nice contained pockets oozing from the ground. Retrieving oil at these depths is more like popping a zit and letting the skin pressure push the oil out. In this case, my quick calcs suggest the oil in that well is under 1000+ atmospheres of pressure. That’s what’s happening in the Gulf right now. The sea and earth is pushing down on the “zit” squeezing the oil out.

    At other similar wells, when the natural pressure reduces, instead of squeezing the ground to the get the rest out, later they will come in with another well nearby and start injecting sea water into the ground nearby to flush out the remaining oil. This will dilute the oil over time as more and more of what comes out is sea water, but the well will continue to produce for a long time this way, slowly tapering off to the point where it is no longer economical to keep pushing in water to recover small amounts of the oil/water mixture.

    While it’s a bit dated being nearly a decade old, I recommend “Hubbert’s Peak” by Princeton Professor and ex-oilman Kenneth Deffeyes if you want a truly in depth answer to your questions. Except for the last chapter, the book is pretty much devoted to answering the questions of how do we get oil, and why are we running out.

  7. callistenes says:

    Update:
    http://news.yahoo.com/s/ap/20100503/ap_on_bi_ge/us_gulf_oil_spill

    By HOLBROOK MOHR and ALLEN G. BREED, Associated Press Writers – 53 mins ago
    VENICE, La. – BP PLC said Monday that it will pay for all the cleanup costs from a massive oil spill in the Gulf of Mexico that could continue spewing crude for at least another week.
    A fact sheet on the company website says BP takes responsibility for the response to the spill after the offshore drilling rig explosion and will pay compensation for

    “legitimate and objectively verifiable” claims for property damage, personal injury and commercial losses.

    President Barack Obama and several attorneys general have asked the company to explain what that means.
    “We are responsible, not for the accident, but we are responsible for the oil and for dealing with it and cleaning the situation up,” chief executive Tony Hayward said Monday on ABC’s “Good Morning America.” He said the equipment that failed and led to the spill belonged to owner Transocean Ltd., not BP, which operated the rig, the Deepwater Horizon.
    Guy Cantwell, a Transocean spokesman, responded by reading a statement without elaborating.
    “We will await all the facts before drawing conclusions and we will not speculate,” he said.

  8. Quincy Webster says:

    TOD coverage from the engineers, oil guys, and rockheads: http://www.theoildrum.com/node/6424

    Where you would find this story list:

    4. Progress on the Gulf oil leak and comments on cementing and well completion by Heading Out (Dave Summers) – May 3
    http://www.theoildrum.com/node/6427

    Background technical information on cementing pipes and well completion, plus discussion of how these seem to be an issue in the Deepwater Horizon blowout.

    3. Tech Talk: Revisiting Oil Well Pressures and Blowout Preventers after BP’s Gulf of Mexico Oil Spill by Heading Out (Dave Summers) – May 2
    http://www.theoildrum.com/node/6421

    Post by a recently retired university professor, describing some of the “ins” and “outs” of oil well pressure and blowout preventers. In the second half of the post, Heading Out talks about how this relates to some recent questions that have been raised with respect to how the current blowout took place, and what can be done to stop the leaking.

    2. BP’s Thunder Horse to Under-Perform in the Wake of the Deepwater Horizon Blowout? -Guest post by Seismobob (Glenn Morton) – April 30
    http://www.theoildrum.com/node/6415

    One question of interest is, “If we do all this deepwater drilling, is it really possible to get a reasonable quantity of oil out?” Hopefully, we will be able to run a number of posts trying to examine this question. The April 30 post was the first such post. Based on the analysis Seismobob did, it appears that at least in this example, production is not going nearly as well as planned–suggesting that deepwater oil reserves may be overstated, and costs of production may be much higher than oil companies have planned on.

    1. The Gulf of Mexico Deepwater Horizon Oil Spill: Some Background and What It Means by Gail the Actuary (Gail Tverberg) – April 28
    http://www.theoildrum.com/node/6407

    Excerpt: It seems to me that the great depth and attendant pressures, and the learning curve that goes working within these new parameters, probably contributed to the initial leak, and is contributing to the difficulties that are now occurring in stopping the leak. This particular well was not an important one–one source said it had economic importance only because of its proximity to a platform which was already in the area. The issues are more the possible environmental damage and the political fallout that could come from the accident. Unfortunately, most of the “easy oil” is gone. The oil that remains all has some challenges–but the fact of the matter is that the world economy cannot run without oil. So there are no easy answers.

  9. Chuck Ponzi says:

    @Brendan.

    thanks, So, how is it that environmental groups (I’m generalizing here based off of my limited understanding). Have a serious problem with this, but also with seemingly cleaner options like nuclear?

  10. manaconda says:

    This is stupid. An oil rig blewup and because of this the world is ending, correct?

    BP said it would pay for the cleanup, but the reimbursement is limited.

    “But reimbursement may be one of the largest battles to come, given that federal law sets a limit of $75 million on BP’s liability for damages, apart from the cleanup costs.”

    Also:

    “There is a federal fund, generated from a tax on oil, that may cover as much as $1 billion in damages.”

    source: http://www.nytimes.com/2010/05/04/us/04spill.html?pagewanted=2

    BP is way oversold.

  11. [...] Oil Slickonomics – from David Kotok of Cumberland Advisors [...]

  12. [...] Ugh Three scenarios lie ahead.  They rank as bad, worse, and ugliest (the latter being catastrophic and unprecedented).  There is no “good” here. [...]

  13. constantnormal says:

    @manaconda

    I’m afraid I don’t understand your post … you point out that BP is stating up front that it will pay for the cleanup costs, and that the most they can be held liable for in damages — APART FROM THE CLEANUP COSTS — is $75M, so that leaves us essentially with the cleanup costs. Even after adding in the billion-dollar federal fund to help defray cleanup costs, how much do you think it will take to clean ginormous amounts of oil from the surface and bottom of the Gulf, and from all the miles and miles of coastline?

    Let’s look at a typical square mile of Gulf. How much to remove the oil from the surface of that square mile? And how much to remove it from the bottom, where it destroys the ecosystem and obliterates the seafood and fishing industries? Go ahead, make a guess. I have no idea (no more than you, at least), but I’m thinking that it’s going to be quite a few hundreds of thousands of dollars to clean that square mile of the Gulf.

    But for the sake of keeping things simple, let’s say that it only takes a hundred grand to clean the surface and bottom of a square mile of the Gulf of oil. (I don’t count waiting for several centuries and letting Mother Nature cleanse it for me as part of the picture here) There are over 579,000 square miles in the Gulf to be cleaned. At my (optimistic, I think) estimate of $100K per square mile, we are talking over $57B that BP has generously offered to pick up the tab on. And remember, that’s not including the coastal cleanups, and has excluded the sure-to-be-politically-popular private class action lawsuits for damages by industries that have been ruined (tourism, cruise ships, fishing, beachfront real estate, …).

    So you say, WAIT! You’re talking about oil covering the entire Gulf! It’s not that bad!!

    No, not yet. But look at how far it has spread in less than a week. We’re talking months before it is stopped.

    I think BP stockholders have some concerns here. But you go ahead and buy it while it’s depressed.

  14. constantnormal says:

    @Chuck 4:26 pm

    I dunno why the environmental groups have concerns, not being a member myself, but I have concerns of the costs of anything that slants the table on expenses, by pushing the more expensive stuff off into the future and then conveniently neglecting to pay for those costs.

    In the case of nuclear, it is the disposal of nuclear waste that has a lifetime far longer than human beings have existed on this planet (I have a plan to deal with that in a cost effective and safe manner — it’s to bury it in a plate subduction zone and allow it to be recycled beneath the crust, which keeps it out of harm’s way for the requisite hundreds of thousands of years for the radiation to dies down, making good use of that radiant energy in the meantime, but that plan seems unlikely to be approved or even considered in the near future).

    In the area of burning fossil fuels or energy or creating manufactured goods from them (plastics), it is the spewing of waste products into the environment where I live (waste products being plastic in the ocean and landfills, and CO2 into the air), that do not degrade and get recycled back into the larger scheme of things, at least not at a rate comparable to the rate at which we are putting them there.

    In the area of finance, it is people borrowing from the future in order to improve their present, while not simultaneously adding enough to the future to give their grandchildren a chance for the same experience.

    Pretty much all of these things could be ameliorated by reducing the population of the planet by 4-6 billion yapping noisemakers who do not see things my way. That would lower the rate of our production of waste to the point that the natural environment could recycle it for me. But nobody wants to go that route either.

    So yeah, I have serious problems with a lotta stuff. But I’m not an environmentalist. I just like to keep the books balanced, nice and tidy like. I do notice that a lot of those 4-6 billion excess people have trouble doing simple arithmetic (including about 90+% of Bananamericans). I think we could optimize things, and give evolution a helping hand, by letting them exit the scene first.

  15. alfred e says:

    Just another point about animus juicing or stinging the market. Play.

    IT’S NOT ABOUT THE LEAK. IT’S ABOUT THE PLAY. Another trader reaps a $100M bonus.

    What’s more important is that accidents like this happen on an increasing basis because meritocracy is dead.

    Want to be well reward for using your brains to avoid this?

    Why bother. The money’s on Wall Street. And lying, cheating and stealing is well accepted.

  16. WolfStreet says:

    @Peter “With the cheap cost of money that Greece will borrow money for the next 3 yrs” 5% interest rate, you call that cheap?…
    I believe that’s nothing near cheap given Greece current situation.

  17. WolfStreet says:

    WTF? sry I was aiming @http://www.ritholtz.com/blog/2010/05/short-term-relief-for-greece-but-at-large-cost/

    Don’t even how my browser landed me here.

  18. [...] Big Picture looks at the economic fall-out for the US: Federal deficit spending will certainly rise by tens, and maybe hundreds, of billions [...]

  19. [...] unknowns. A good decision works in all the scenarios, a very weak decision only in one, and so on. The Big Picture blog has a wonderful article, called Oil Slickonomics, in which three up-to-date prospective scenarios [...]

  20. wngoju says:

    “Sarah Palin’s “Drill, baby, drill” now condemns her to political marginalization.” Er… if Palin had no identifiable connection with reality before, why it the world does Kotok think she’s finished? – and, therefore, one might question everything Kotok says… Just intoning the words “X; therefore Y” does not make the intonation a syllogism.

  21. [...] – Some oil slickonomics. [...]

  22. [...] contain the leak until June. By then the economic damages all around the Gulf are likely to be in the tens of billions of dollars, while the physical mess will take years to clean up. The effects on ecosystems and endangered [...]

  23. [...] Climateer – “Oil Slickonomics” by David Kotok. Note, you can watch the BP spill unfold at NOAA and [...]

  24. [...] end of the scale is David Kotok of Cumberland Advisors, who postulated a sort of macro-economic armageddon could [...]

  25. GCF51 says:

    Hello… Ever feel helpless – millions of people with ideas – how do you get your idea to someone that can make it count.

    Use a huge tanker as a water/oil gravity separator. Skim the oil off the surface of the ocean, pump into a tanker let the oil and water separate in the tanker and then pump the water off the bottom of the tanker.

    Really…. how does tanker unload without coming out of the water and laying on its side — They pump seawater in as ballast. What part of the picture don’t I understand….

  26. [...] far we are still going from “bad” to “worse,” as outlined in our series on Oil Slickonomics. It’s not in the Loop Current, [...]