BP Spill Size Estimates Keep Growing - Along With Potential Costs

Last week I tried to bracket the cost exposure for BP as a result of the Deepwater Horizon well head blowout and explosion. That attempt proposed a very wide bracket, from $9 billion to $100+ billion. This week the numbers are being suggested to be between $15 billion and $40 billion. These estimates are subject to change depending on how much more oil is spewed into the Gulf of Mexico in the coming months.

The latest numbers above come from a June 7 article in The New York Times by Andrew Ross Sorkin. He bases his report on analysis by Credit Suisse (CS) which has estimated clean-up costs at $23 billion and liability costs at $14 billion or more.

Size of Spill Still Unknown

The uncertainty about the eventual cost is determined by the lack of any credible estimate of the size of the leak. In the past 24 hours the recovery process has been increased to almost 15,000 barrels a day (June 8 report). The same day the underwater video of the oil spilling into the mile deep Gulf still looked a lot like it had in previous days and weeks. It is now evident that the 12,000 to 19,000 barrels a day that were the official estimates recently were grossly too small.

Sunday and Monday statements by BP indicated a volume was being discharged at the rate of at least 33,000 barrels a day. If that is an accurate estimate, then a little less than half of the effluent oil is being captured. That would mean that a reasonable estimate for the discharge for the first 48 days would be at least 25,000 barrels a day.

(The riser cut-off to install the current collection device was estimated to increase the discharge by 20%. The current estimate of 33,000 barrels a day is 20% greater than 27,500. Using 25,000 for the pre-cut riser days is conservative by 10%.)

Can BP Survive?

The question has been raised about possibility of bankruptcy for BP as a result of this incident. Ezra Klein pointed out in The Washington Post that Chapter 11 reorganization for BP has a precedent with such action by Texaco in 1987 when faced with a $1 billion judgment against it in favor of Pennzoil.

There has also been widespread discussion of whether BP will be knocked down to such a low market value that they will become an easy take-over target. I have expressed the opinion that this is only likely if some liability cap can be agreed upon between the acquirer(s) and the U.S. government.

The question of survival of BP will be revisited in the final section of this article.

Submerged Plumes

There is now official recognition of the existence of vast submerged clouds of deep sea oil droplets ("plumes"). The existence of these were denied just ten days ago by BP CEO Tony Hayward. An article by Justin Gillis, Campbell Robertson and John Broder in The New York Times points out that there has not been an official connection of these dispersed oil clouds to the Deepwater Horizon well head. But no one has suggested any other source, either.

Revised Size and Cost Estimates

It now seems likely that 50 million gallons or more of oil has been released into the Gulf of Mexico to this point. This is the amount that would result from the rate of 25,000 barrels per day for 48 days. There are 42 gallons per barrel. The earliest that a relief well can be completed is about 60 days in the future. In 60 days' time, another 40-50 million gallons or more could be released. The possibility that current estimates still may be too low is quite real.

(Calculation: 33,000 produced - 15,000 capture = 18,000 barrels a day discharged into the Gulf. 18,000 barrels/day x 60 days x 42 gallons/barrel = 43.5 million barrels.)

The cost per gallon for the Exxon Valdez spill was approximately $270 per gallon (approximately $3 billion remedial and liability expense for an 11 million gallon spill). There are reasons why this event could have a higher cost:

Inflation.

The higher population density affected.

The greater value of the commercial interests involved (fishing and tourism).

Let's use the $270 per gallon number as a starting point. That would put the current cost at about $14 billion and the 100 million gallon figure at $28 billion. Applying an inflation adjustment (approximately 80% since 1989), the approximate cost for the oil released to date could be $25 billion. For a doubling of oil released before capping, the cost could be $50 billion.

My estimates do not make any adjustment for factors 2. and 3. above, which could drive the costs higher.

Can BP Survive Revisited?

These cost estimates are much larger than the annual earnings for BP (about $21 billion), current assets on their balance sheet ($6.7 billion) and annual dividend payments (approximately $11 billion). Annual earnings and dividends are after taxes, so one needs to add in the taxes paid annually, which have ranged from $8.3 billion to $12.6 billion over the past three years. Taking the average (about $10 billion), the total available from BP operations is about $42 billion per year. When the $6.7 current assets are added, the total is very close to the $50 billion cost estimate.

My conclusion is that, assuming the costs are spread over at least two years, BP easily has the cash flow to handle the expenses likely for this event. Of course, we could still have the following eventualities:

The spill may ultimately be much greater than the 100 million barrels maximum considered here.

The cost of $270 per gallon, even when adjusted for inflation, may be significantly too low.

BP may have reduced revenues because of the efforts expended on the spill diminishing production in other areas.

BP may face criminal charges based on their own internal documents. This would amplify any BP civil liabilities.

If the eventualities above are realized, BP will probably not be able to survive.

Disclosure: No positions.