BP (LON:BP.) - Cost of Deepwater Horizon rig spill uncertain

A bad oil spill is a dreadful thing and the fire and sinking of the Deepwater Horizon rig in the Gulf of Mexico is a horrible event. The tragic loss of life as a result of the rig explosion has rocked the oil and gas industry and has savaged the share price of BP (LON:BP.) knocking US$23.8 billion off the company’s market capitalisation.

Initially BP estimated that 5,000 barrels of crude per day was leaking from the well, some estimates now say 25,000 barrels. The oil slick covers over 600 square miles and has reached the mouth of the Mississippi River, and spread along the Louisiana shoreline. The oil slick spread faster than expected and is causing an environmental disaster.

The last major oil catastrophe was in 1989 involving Exxon when the Valdez hit Prince William Sound’s Bligh Reef. Some 250,000 barrels of oil spilled into the sea creating an oil slick covering 3,400 square kilometres. The Valdez spill was an environmental nightmare. Exxon reportedly paid US$2 billion in clean-up costs and a further US$1 billion to settle civil and criminal charges. Initially punitive damages of US$5 billion were claimed against Exxon. However, court actions took many years and in 2008 a US Supreme Court reduced punitive damages to US$507.5 million. At the time of the ruling the punitive damages were only 12 hours of revenue.

Exxon recovered a lot of its expenses for clean-up and legal from insurance policies. No two cases can be the same and in the case of the Valdez the master of the vessel was under the influence of alcohol at the time and perhaps for this reason a navigation watch was not in place.

At this point nobody knows exactly what caused the explosion that engulfed and sunk Deepwater Horizon. It is known that the rig was not fitted with an acoustic switch which is something the crew can try to activate to shut down the well. Apparently these safety devices are not required in US waters but they are required in other jurisdictions.

The second largest maker of oilfield equipment in the US is Cameron International Corporation. This company provided the “blow out preventers” for Deepwater Horizon. Cameron International reportedly has an insurance policy covering the company for up to US$500 million in the case of a claim or claims made against it.  Legal proceedings and the blame game are underway in the US but it will take many years to settle matters.

If the rate of leakage has increased from 5,000 to 25,000 barrels per day, the spill will overtake Valdez within days. BP has said that it will take at least a month to try and fit a deepwater cap in an attempt to stop the flow and in the meantime is trying other innovations to control the surface slick.

It seems that the cost to Exxon for the Valdez incident was around US$3.5 billion less what was recouped from insurance claims.  On the assumption that inflation doubles prices in around ten years, it would not be unreasonable to expect the total cost to BP to be in the vicinity of US$15 billion depending on punitive damages if there are any. There are clearly other parties that are in the firing line to pay up, so it is unclear what the cost to BP will be.