Oil and Gas Exploration Springs a Leak

By Van Horn, George | The RMA Journal, October 2010 | Go to article overview

Oil and Gas Exploration Springs a Leak


Van Horn, George, The RMA Journal


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For much of the past decade, rising oil prices helped invigorate the domestic oil and gas exploration industry and the regional and local economies that support it. In a serious twist of fate, the recent failure of one Gulf Coast offshore drilling rig cast an environmental cloud over the industry and its suppliers as well as many of the local businesses reliant on Gulf Coast waters.

This article maps out the impact of the Deepwater Horizon oil spill across the industries and d geographies most likely to be affected. While the final damages may take months or even years to I measure, this mapping process will provide the framework for banks and other creditors seeking to incorporate a single industry event into their own stress-testing and credit portfolio analysis.

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The mapping process described here can be applied to any number of unpredictable or extreme events that might occur with little warning yet have a significant impact. Key to the mapping process is the identification of distinct conditions affecting national versus local industries and businesses.

Overview

At the national level, most naturally occurring disasters--such as floods, hurricanes, tornados, fires, and earthquakes--do not have a significant impact on economic performance. The economic shockwaves of such disasters are quickly dissipated across a wide array of national industries and unaffected geographic markets.

Unfortunately, the most significant effects of natural disasters are often felt by the local industries and the markets in which they operate. Although the impact can be moderated with the help of federal and state governments as well as private insurance and aid, the financial strain on local businesses can be crippling.

The events associated with the Deepwater Horizon accident, however, are somewhat unique and pose both short-and long-term challenges for national and local markets. The U.S. economy's reliance on oil--and, increasingly, foreign sources of oil--will reenergize federal policy debates on acceptable energy development and the regulations and costs associated with operating domestic oil and natural gas wells. Perhaps equally important, the environmental threat posed by the Gulf Coast oil spill expands the "local" impact while interjecting new uncertainties regarding the timing and duration of coastal waterway restoration.

To give the Gulf Coast oil spill some context, Figure 1 shows the annual value of damages caused by natural disasters over the past 30 years. With the exception of Hurricane Katrina in 2005 (the costliest U.S. disaster on record), disasters typically approach $40 to $60 billion in the value of their damage (in 2007 constant dollars) and occur approximately every four years.

By mid-June, BP had agreed to set aside $20 billion to satisfy damage claims associated with the spill. But because BP owns approximately 75% of the well, the initial damage costs will likely exceed $25 billion. Although this initial agreement does not cap the potential expenditures by BP (or other parties involved with operating the well), it does provide a starting point for benchmarking the size of the event.

Combining various costs for damage and cleanup, experts have estimated that total costs for Deepwater Horizon will approach $40 billion. By historical standards, these costs are comparable to those for a wide range of hurricane and drought/heat wave events.

Gulf Coast Industries

The U.S. Gulf Coast spans only five states (Texas, Louisiana, Mississippi, Alabama, and Florida), yet the size of each state's economy and its sensitivity to specific industries varies quite a bit. Table 2 illustrates the aggregate size of the industries considered the most sensitive to the Deepwater Horizon accident.

The specific industries included in Table 2 will be further defined in subsequent portions of this article. …

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