As recently as June 10, London-based J.P. Morgan analyst Fred Lucas told clients that BP (NYSE: BP) is a screaming buy. But current “back of napkins” estimates employed by JPM and others to determine the scale and cost of the disaster are far too low, in my opinion.
Given what we’ve learned in the last month, I suspect that even current “high-end” estimates will look optimistic in hindsight. My own estimates are much higher than everything else I’ve seen. Of course, my numbers are really just guesses, like everyone elses. Naturally, I think my numbers are more accurate. With that out of the way, here is my analysis of the worst-case scenario for BP and the Gulf of Mexico.
J.P. Morgan’s BP analyst is one of the few to venture a guess as to how much oil (total) will be leaked into the Gulf. So I applaud Mr. Lucas for putting the opinion out there, even though I disagree with his current conclusion.
The WSJ reports that the Mr. Lucas’ “worse-case” estimate is 1.9 million barrels leaked into the Gulf, all told. (So does “worse-case” mean worse than the current estimates, or a worst-possible scenario? Could be a typo, could be legalese.)
With official barrel-per-day (BPD) rising from 0 bpd initially, to 1,000, to 5,000, to 12,000, to 19,000, to 30,000, all the way to the latest official estimate of 35,000 to 60,000 barrels per day, it seems unwise to assume the trend of increasing estimates will end at any given time (it should be noted that quotes from the JPM buy rec are from a June 10 interview in the WSJ).
My current worst-case scenario: 20 million barrels leaked into the Gulf, and $560 billion in damages. Let me explain how I arrived at that number.
Update: As I was writing this piece, the official FRTG estimate jumped from 20,000-40,000 to 35,000-60,000.
The group in charge of official estimates, the Flow Rate Technical Group or FRTG, has been hesitant to give exact numbers and opinions of all scientists involved. (update above). I spoke with NOAA officials yesterday, and they would not comment on whether the previous 20k to 40k range was actually the low end of a broader range, rather than a median or consensus estimate. They did mention a new official estimate was out soon, but referred all questions on flow rates to the USGS and FRTG.
0 to 60,000 BPD, Will It Stop Here?
As far back as May 21st, a NYT editorial by independent experts said 100,000 bpd is certainly not out of the question. So it seems logical to include those numbers in a worst-case analysis.
Let’s run a few scenarios using different inputs for barrels/day (BPD) and number of days until the leak stops. Note: 35,000 represents the low range of the latest official estimate. Total barrels leaked will depend on future revisions of how much oil has leaked out over time, as the flow varies.
|BPD||Days||Total Barrels Leaked
|35,000||56 (today)||1.96 million|
Worst-Case Cost Estimates for BP, Based on Valdez Costs
Keep in mind that the Exxon Valdez tanker spilled a relatively small 250,000 barrels of oil into Prince William Sound. That disaster cost Exxon around $7 billion, adjusted for inflation.
The Gulf disaster could end up being 10-80x larger than Valdez in terms of barrels spilled, based on the scenarios outlined in the table above. That would mean 2.5-20 millon barrels spilled close to the Mississipi Delta. It’s an area which is arguably more important, by an order of magnitude, than Prince William Sound, where the Exxon Valdez ran aground. Thinking about the long-term environmental damage is overwhelming.
To summarize: My total economic damage estimate range, based on the Exxon Valdez model multiplied by how much larger this spill/leak, is $70-$560 billion.
The original effort to stop the main wellhead gusher appears to have been abandoned. The focus is now on capturing as much of the leak as possible until a “bottom kill” using relief wells can be attemped.
In his analysis, J.P. Morgan’s Mr. Lucas also assumes that relief wells will succeed by July 4th. Everyone wants these wells to work, but it seems reckless to use July 4 as the base assumption for analysis, especially when you call it worse-case.
Most analysts do not expect relief wells to succeed until August at earliest, with Business Week reporting that efforts could take until Christmas.
We have no idea how much oil is leaking into the Gulf right now. Even after the recent revisions, those estimates could go higher. One big reason for this uncertainty is that current estimates are all based on flow rate from the main leak(s).
Oil Leaking from the Seafloor?
Some evidence is emerging that oil is now leaking directly from the seafloor, not just from the broken wellhead. Consider this video shot from an ROV on the seafloor, reportedly shot from one of two ROVs from the Viking Poseidon.
Keith Olbermann of MSNBC reported on the possibility of oil leaking from the sea floor on his show, which aired June 8th.
It’s not a happy situation. I don’t want the Gulf to suffer or BP to go under. I bought BP shares on May 4th, stopping out for an 8% loss a few days later. So I understand the temptation to value-shop. But facts have emerged over the last month that dramatically change the situation, as I explained here on June 1st.
Unless we start preparing for a true worst case scenario, we will not be ready for the economic, environmental, and financial impacts it could bring.
Note: I am currently short BP and own puts, so please assume this analysis is biased. I do not think it is, but welcome refutations and/or corrections. One might consider the possibility that Wall Street firms who count BP as a client may be unintentionally biased, as well. Do your own research, this is not investment advice. It is the solely the opinion of the author.
Guest Editor, EnergyandCapital.com