Oil Slickonomics (Part II)

David R. Kotok, Cumberland Advisors

May 10, 2010

In “Oil Slickonomics”, part 1, we set forth three scenarios for the BP disaster. They are “bad,” “worse,” and “ugliest.” Events are now moving from bad to worse.

BP’s attempt to install a large funnel-type device is running into problems. They have shifted the device several hundred yards away from the well as they try to deal with complex technical issues. Meanwhile the damaged well continues to spew at least 200,000 gallons of oil a day.

Within days we will have reached the second level of damages in the Gulf of Mexico. Under our “worse” scenario the total will be in the many tens of billions before this is all over. There are now early reports of “tar balls” washing up on beaches. Damage is now witnessed in Alabama, Louisiana, and Mississippi. NOAA has expanded the no-fishing zone to about “4.5 percent of Gulf of Mexico federal waters.” The original closure boundaries, which took effect Sunday, May 2, encompassed “less than three percent.”

Readers please note that this event is still mostly confined to United States “federal waters,” which are under NOAA jurisdiction. International claims are a more complex financial liability for BP and its partners.

So far, BP has offered US-based fishermen a one-month-pay settlement package. This is being routinely rejected, according to the professional fishermen we have been able to reach. If this spillage continues, as we project under our second and “worse” scenario, and IF it can be limited to that scenario and doesn’t worsen to “ugliest,” the ultimate loss of income to fisherman will continue over many, many months or even years.

According to NOAA, “There are 3.2 million recreational fishermen in the Gulf of Mexico region who took 24 million fishing trips in 2008. Commercial fishermen in the Gulf harvested more than 1 billion pounds of finfish and shellfish in 2008.” BP’s offer of one month’s pay is a pittance when compared with the ultimate damages that will be suffered by the fishing industry.

Some readers have asked about the federal fund that is designed to pay for cleanups of oil spills. It is funded by an eight-cent-per-barrel tax and is wholly inadequate for this type of catastrophic event. In the wake of the BP explosion, three Senators have offered a bill to broaden the scope of the fund and raise the tax.

One May 1, the New York Times reported that, “A count made by the Department of Homeland Security last August found that since 1991, there had been 51 instances in which liability exceeded caps. In most years it was a handful; in 1999 there were 11, because of a typhoon in American Samoa that wrecked eight fishing vessels that spilled oil. Numerically, cargo vessels and fishing vessels are the biggest culprits, but oil tankers and barges cause the most dollar damage. The fund’s single largest expense so far came after a tanker in the Delaware River, the Athos I, spilled tens of thousands of gallons of crude oil in 2004. Money can be sought by the states for expenses like restoration of a damaged wetland or compensation for loss of use of a resource.”

We wondered about the details surrounding the federal fund and asked Jim Lucier of Capitol Alpha Partners for his views. Jim is one very smart analyst, whose firm does superb research on federal political activities and Washington-based intelligence. He is current with the BP spill issue. Jim gave us permission to share his piece on this federal fund. You can find “How the OPA Trust Fund Works” on our website, at http://www.cumber.com/content/Special/HowOPA050410.pdf.

We thank Jim for giving us permission to share it. Please note that Jim is a member of the GIC and will be speaking on the Washington scene at our briefing in Paris on June 18.

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