May 05, 2010
How much damage does the market think the oil spill has done?
Econbrowser is pleased to host this guest contribution from UCSD Ph.D. candidate Ben Fissel, who shares a quick estimate of the economic damage from the Gulf oil spill.
by Ben Fissel
At this point it's really hard to tell how much the sinking of Deepwater Horizon and the ensuing oil spill will cost BP. There are a number of factors still in play, such as "when will the spill be capped?" or "how much of the oil will hit shore?" If the leak continues to spew oil unabated for three months, the damage and corresponding cost to BP could be huge. If the winds shift, minimizing the amount of oil that hits shore, then the costs to BP won't be that bad. Until there is some resolution of these and other questions, there is a large amount of uncertainty regarding how this will affect BP's profitability.
What we can assess with much more confidence is the market's expectation of the costs. Stock prices give us a yardstick for the markets perception of a company's long run profitability. When an event, such as this oil spill, impacts a company it will also impact its long run profitability. The divergence of the stock price from what we would have expected had the event never happened is a measure of the net present value of the cost incurred by the oil spill. Event study analysis gives us a framework to answer just this question.
BP prices since Jan. 1st have been plotted below in Figures 1 and 2. The black line gives the real prices and the red line shows the model estimate of what would have happened if the spill had not occurred. Table 1 lists the prices and returns over the event window for both the real time series and the estimate. Event studies use other factors in the market to estimate what BP's stock price would have been. A list of these factors can be found on Table 4. The event window spans 7 trading days April 26th - May 4th and is centered on April 29th. A 10-day event window buffer was used to separate the estimated model from the event window. The 250 trading days prior to the event window and buffer were used to estimate the model.
The t-statistic of the cumulative abnormal returns over the event window is -6.33 indicating that the event clearly had an impact that drove BP's share price outside its normal range of variation. The adjusted closing price of BP on May 4, 2010 was $51.20 whereas had the oil spill not happened I've estimated the price would have been $58.11. This amounts to a net loss of $6.91 per share. BP has 3.13 billion shares outstanding amounting to a net loss in $21.62 billion. This loss reflects the market's expectation of the net present value of the loss in profitability of BP as a result of the oil spill, otherwise interpreted as the cost to BP of the oil spill. This cost may come from a number of sources besides simply cleanup. For example, the loss in customers, punitive damages, or possible loss of BP's ability to profit from this or other potential offshore projects may be other ways the oil spill will hurt BP. This high cost estimate is most consistent with the scenario where BP doesn't cap the major leakage of oil for a substantial amount of time. Clearly, not only for the sake of the environment but also for the sake of BP's bottom line, they are going to want to cap this oil spill and clean it up quickly.
Note: All the data have been obtained from http://finance.yahoo.com
Posted by James Hamilton at May 5, 2010 09:08 PMdigg this | reddit
Add to that $2 bn off the market cap of Cameron and another $6 bn off the cap of TransOcean. With BP, altogether the cost is $30 bn. That's too much, I think, but it's hard to tell where impact will be felt exactly.
It looks like the market has over-reacted the event. And I would not be surprized if BP successfully captured most of the leak.
Posted by: Steven Kopits at May 5, 2010 09:43 PM
Posted by: aaron at May 6, 2010 07:45 AM
Or, is the cost to these companies correct and other companies will benefit?
Posted by: aaron at May 6, 2010 07:46 AM
Cameron competitors, to take an example, are also down.
FMC (a client) is down 9%, a loss of about $850 million compared to pre-spill.
Dril-Quip (friends), another competitor, is down from $70 to $57, a hit of $0.5 bn to their market cap.
Both of these are fine companies, if you like the sector but don't want to play the companies involved.
Posted by: Steven Kopits at May 6, 2010 08:50 AM
Interesting news stories related to the spill:
Biggest impact could be in the arctic
Firsthand account of the disaster
BP plugs first leak
Posted by: Steven Kopits at May 6, 2010 08:54 AM
Excellent stuff Steve. I wish I had cash.
Posted by: aaron at May 6, 2010 10:51 AM
Shouldn't the rig owner (transocean sedco I think) be liable for damages? Or does the lease contain a clause that releases the rig owner from liability?
I read somewhere that BP self insures but it still seems like they are not at fault if the problem was mechanical and not human error.
Posted by: tj at May 6, 2010 11:08 AM
Stocks are down also because of the situation in Greece; thus, shares of BP are could be down not only because of the Gulf of Mexico incident [probably the primary reason, but not the only one], but also because of other factors [like Greece and Eurozone generally].
How does one disentangle such effects?
Posted by: Manfred at May 6, 2010 11:41 AM
Off topic: Is that green smiley face a trailing indicator? We'll know next week..
Posted by: KevinM at May 6, 2010 12:53 PM
Manfred: That's why the calculation looks at BP stock relative to the others listed in Table 2.
KevinM: That green face is neutral, not smiling.
Posted by: JDH at May 6, 2010 01:16 PM
I would guess that BP's market capitalization will suffer a reputation penalty going forward. I haven't looked but I bet all companies with any leverage to offshore drilling in the USA just took a hit not explained by the swooning oil price. I believe that oil companies exploring off Africa, Asia and South America may benefit in relative terms. The tragedy is generally bullish for oil prices.
Posted by: GNP at May 6, 2010 03:54 PM
I think your probably right, for better or for worse the fate of future offshore drilling in the US has taken a big hit by the spill.
It almost certainly won't be happening in California now.
Although it was probably never going to be big here.
I think the article posted by Steven Kopits has it right. The biggest impact will be in the arctic.
Posted by: BenF at May 6, 2010 09:50 PM
While applying the loss to total shares outstanding does show the paper loss it does not actually show "market's expectation of the net present value of the loss in profitability of BP as a result of the oil spill." Many of those shares never changed hands meaning that the holders exercised faith in BP and have the "expectation" that BP stock will be higher in the future.
I have no problem with your calculation of the loss of $6.91/share, but I do question the total valuation. Perhaps the net of daily gain/loss on trades would be a better number.
Posted by: RicardoZ at May 7, 2010 06:18 AM
The calculation is based on the notion that the price of the asset is equal to the discounted flow of returns to the investor holding the asset. The costs and lost revenue resulting from the oil spill directly impact future profit and hence the investors return. This is true for each share.
If many people felt the price of BP would be higher in the future then people would be buying thereby driving the price up. Some people probably think the price should be higher others think it should be lower. The observed market price represents a meeting of these two parties and in this sense an agreement on the firms future value/profitability.
Posted by: BenF at May 7, 2010 10:58 AM
the spill affects not just the economy but the environment......
Posted by: velvetranch at May 8, 2010 01:35 AM
A year or so ago, we discussed whether there is/is not sufficient oil in US territory, including offshore, to sustain our present consumption. The answer, of course, is that there is-- just not at a price that anyone would care to pay, especially if fully costed.
The oil industry is already heavily subsidized through tax credits. If it had to pay for the damage its products cause, it would be even less competitive.
I remember one of the posters breezily saying that he lived in Florida right by a BP pipeline and had no concerns whatsoever. Here's hoping that he and all those who are responsible for the dangerous complacency about the environmental damage caused by oil have it wash up on *their* shores, just for the obviously needed lesson.
Drill, baby, drill!
Posted by: Charles at May 9, 2010 01:57 PM
velvetranch: You're right!
Prof Hamilton: The net present value of the cost in that paper corresponds to the private cost to BP, not the social cost, such as the negative externalities of the environmental impact.
Perhaps, the title of the paper "How much damage does the market think the oil spill has done?" should be changed to "How much damage does the market think the oil spill has done to BP?" (frankly, I care much less about the latter).
Posted by: RA2000 at May 9, 2010 07:24 PM