Oil Slickonomics – Part 3

David R. Kotok, Cumberland Advisors
May 13, 2010

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“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

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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 existing drilling rigs 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.”

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