Oil Slick and Economics

We’ve been watching the Oil Slick and feeling sick… and not just because of the Ecological picture.  We are also concerned what this means for the ECONOMY which is on a tight robe as it is! Many of the Economist we follow suggest that only charging $.09 per gallon in Federal Tax is ridiculous, and some suggest that it should be as high as $9!  Okay, so if the TAX is $9 a gallon – that means gas is well over $12 a gallon – think that’s going to affect the economy?  YES! What about UnEmployment? We are currently running at a rate of 1 in 10 American’s without work.  That being said, having the largest Fishing Industry and Resort Activity in the Gulf Of Mexico out of work is going to make those numbers even WORSE! Here’s what The Cumberland Report suggests:

“Top Kill Fails” screamed the headline as Americans awoke to the news on Sunday morning. For many in the five-state Gulf of Mexico (GOM) region and for many others around the US, this holiday weekend started out with the feeling that the nation had just been kicked hard in the stomach.  The truth is that it has.

In our series entitled “Oil Slickonomics” (www.cumber.com) we have offered three scenarios: “bad, worse and ugliest.” With the failure to cap the well, we have now clearly gone from bad to worse.  Whether or not the ugliest scenario can be averted remains to be seen. To get to this third outcome the oil slick will have to reach the Gulfstream and start to threaten the Atlantic Ocean and the East Coast of the United States.  To date there is no evidence of that event, but the risk continues to rise every day as the oil slick enlarges in the GOM.  Presently the oil seems to be confined to a large eddy in the GOM and has not entered the Loop Current, according to NOAA; however the latest offshore trajectory forecast suggests it is dangerously close.  A half-dozen research ships are tracking the oil plumes in the GOM.

Flow estimates were originally 1000 barrels daily.  They were increased to 5000 and are now estimated at 12,000 to 19,000 barrels a day.  For perspective we must now consider that between 20 and 40 million gallons of oil have spewed into the GOM and the rate continues between 500,000 and 800,000 gallons a day. Dispersant usage is intensified and fully resumed.  Remember that dispersants are a tradeoff.  They help break down the oil while adding their own form of toxicity instead.  There is no precedent in history for the amount of dispersants being used in the GOM.

Right now about 25% of the Gulf’s federal waters (60,000 square miles) are off limits for fishing industry use.  A moratorium is now in place for deepwater drilling in all US waters. Offshore drilling has stopped. If the top kill had succeeded, there would have been an attempt made to lift the moratorium on existing leases and on shallow-water activity.  With the top kill’s failure, the likely outcome is an extension of the moratorium.  We expect that moratorium extensions will be sequentially continued until the well is finally sealed and until the November elections are concluded, whichever comes later.

Force majeure clauses in contracts are being invoked in disputes between oil companies and drilling rig operators. The pricing of rigs is now highly volatile and unpredictable.  It is fair to say that the oil exploration and service industry is in turmoil.  We expect that to continue throughout the next few months and until the relief well is firmly in place and the leak has stopped.  Then there will be the round of new regulations and massive litigation, with its revelations about alleged negligence and mismanagement.  Anyone expecting quick resolution of these issues is going to be disappointed.

At some point there may be initiatives by the US government to impose fines and penalties on BP and its partners. The WSJ (May 28) reports these fines could be as high as $4300 per barrel if gross negligence is proven or admitted.  In addition there is the prospect of criminal penalties in the billions.  These could be in addition to BP’s liabilities for the full cleanup and for damages.  We continue to estimate the total gross cost of this incident to eventually be measured in the tens of billions.

The oil and gas industry in the GOM has permanently changed because of this event.  One can relate this to Three Mile Island (TMI) and its profound impact on the nuclear power industry. It took more than thirty years to overcome the psychological and political damage done by TMI, and there was no actual nuclear leakage.  We estimate that Deepwater Horizon may end up larger in national impact than the nuclear event decades ago.

It is important to understand the scope of the Gulf of Mexico in US and global energy terms.  GOM “accounts for 12% of the world’s active jack-up rigs and 16% of active floating rigs. In 2009 the Gulf accounted for 19% of the operating revenues of the nine largest US-listed offshore drilling contractors.  The Gulf’s share of global capital spending on subsea production equipment was 20% in 2009.  Slightly less than 2% of world crude oil production came from the Gulf last year.  Of total US crude oil and natural gas production in 2009, 30% and 13% (respectively) came from the Gulf.”  (Source: Citi)  There is no way to currently assess what the implications of the Gulf events will be for offshore oil-drilling activity elsewhere in the world.

Our expectation is that the oil business is about to enter a period of intense scrutiny and regulation worldwide.  It will confront higher cost structures and much more inspection and regulation. This will eventually be reflected in higher oil prices.  These strategic cost changes will pile on the geopolitical risks associated with oil.  The current news from the Middle East is an example of cause with the outcome being a higher oil price.

The GOM events have given a boost to onshore crude drilling activity and alternate energy sector expansion. These and domestic natural gas will have some positive impact over time.  Any expectations of immediate results in those areas are problematic and limited.

In sum, five states are experiencing or are going to experience negative economic impacts on their fisheries, oil and gas, and tourism industries that will arise from this worst oil catastrophe in American history.  This is larger than Katrina and larger than Exxon Valdez. They are poor metaphors in economic terms.  We expect to see the initial results in rising initial unemployment claims that may be observed in non-seasonally adjusted reports from the Statistical Metropolitan Areas bordering the GOM.  We already see it anecdotally.  How much this impacts national economic reports and aggregates is still unknown.  That should become clearer in July, as June monthly survey data is released.