More Pain For BP, Rising Cleanup Costs and Increasing Oil Spill Rates Into Gulf Waters

Last Updated Jun 17, 2010 7:02 PM EDT

BP's siphoning success with a second containment system doesn't backstop the U.K.-based oil major's growing financial exposure. Government scientists increased -- for a fifth time -- the estimated daily flow rate of oil spilling into the Gulf of Mexico from the Deepwater Horizon blowout.

BP announced yesterday that oil and gas is now flowing through a second containment system attached to the Deepwater Horizon rig's failed blow-out preventer (BOP).The new siphoning system -- carrying oil and gas through a manifold and hoses to the mobile drilling vessel Q4000 on the surface -- will suck up between 5,000 and 10,000 barrels of oil per day. Throw in recovery efforts already underway on the converted-rigger Discover Enterprise, connected to the wellhead by a fixed riser pipe that goes down to the containment cap, and combined total processing capacity could hit, on average, 28,000 barrels (1.17 million gallons) per day by June 24, according to U.S. Coast Guard Admiral Thad Allen, the federal government's incident commander.

Unfortunately, drawing on new data and improved methodologies, U.S. scientists overshadowed BP's one good day when they raised high-end estimate of oil flowing from the ruptured Macondo well by more than 50 percent this week. The spill rate of oil is now estimated between 35,000 and 60,000 barrels per day (1.47 million gallons to 2.5 million gallons), said Energy Secretary Steven Chu.

That the U.S. government dramatically revised spill flow rates came as no surprise to independent experts and us "little people" (BP chairman Carl-Henric Svanberg's affectionate nickname for the American citizenry) -- the massive plume of oil bubbling out of the ruptured Macondo discover well on live underwater video feeds being the first clue. The video feeds suggested the Lower Marine Riser Package (LMRP) cap attached to the ruptured riser piping stub protruding from the wellhead (on June 3) was slow to capture much of the oil leak -- and for good reason:
  • three vents had to be kept open to prevent inflows of freezing seawater from clogging the cap, causing a dangerous pressure build-up and likely container blow out! However, BP has acknowledged, too, it had to keep the vents open until topside processing capacity aboard the Discovery Enterprise could be ramped up.
As of June 10, one vent remained open because of concerns over cap stability and performance at this untested depth (5,000 feet), said Admiral Allen.

Feverish preparations are underway to bring in bigger storage tankers and install a more permanent and flexible containment system employing floating risers. BP chief executive Tony Hayward said in his testimony before a House subcommittee that BP anticipates collection capacity climbing to 50,000 barrels a day by end of the month, and capture rates increasing to 60,000-80,000 barrels per day in mid-July.

In my opinion, these aggressive capture rates could prove too ambitious -- and dangerous -- however, given increasing risks associated with large numbers of people working in a confined space filled with flammable gases and hydrocarbons (in numbers uncomfortably higher than industry practices).

Looking to get ahead of the unrelenting anger on Capitol Hill and across America, BP's board agreed to suspend its annual dividend and create a $20B claims fund. The company's pledge to waive the $75M liability cap legally afforded to it for cleanup costs under the Oil Pollution Act of 1990 could prove an empty gesture, and expose it to ballooning recover cost claims. Terms of the escrow account also specifically excludes fines and penalties as recorded monies spent from the fund.

Was BP strong-armed by President Barack Obama? A goodwill gesture that makes the president appear stronger to the U.S. public could go a long way in affording the U.K.-based oil major some tacit ("wink-wink") southside-Chicago style protection from falling branches ("pruned") from the litigation tree, such as the Endangered Species Act and Migratory Bird Treaty Act:
  • under the Clean Water Act (aka, Federal Water Pollution Control Act), BP could be assessed putative civil damages of either $37,500 per-day or $1,100 per-barrel, according to data retrieved from an environmental legal primer (courtesy of Fortune magazine). If Attorney General Eric Holder opts to pursue more "hold up" monies through these revenue-generating venues, watch out BP.
As of Thursday morning, BP's Macondo well disaster had spewed between 66 million and 120 million gallons of oil into the Gulf of Mexico, according to published federal figures. Not surprisingly, Wall Street is rushing to recalculate BP's financial exposure.

Credit Suisse Group was one of the first to push the envelope, calculating total cost estimates of $36 billion (which assumed top daily flow rate of 19,000 barrels per day). Now comes Raymond James analyst Pavel Molchanov -- "seeing and raising" Credit Suisse, gambling on his prediction that total cost to BP will top $63 billion. Molchanov derived his outlandish total cost using inflation-adjusted comparisons from Exxon-Valdez per-barrel spill costs and an estimate of 5.3 million barrels of spillage into Gulf waters.

Expect BP bankruptcy talks to resurface if other Wall Street analysts follow Molchanov's lead. Nonetheless, with billions in annual cash flow, BP can still survive Molchanov's worst-case exposure, assuming the containment contingency plans work, and slow the spillage. In addition, incremental payments staggered over a number of years, would mitigatestrains to near-term operating cash needs.

Hayward admitted in testimony today that it has no other containment option that can plug the leak, top-down. All eyes, most of all BP, turn now to the two relief wells being dug to intercept the leaking well. By mid-August, it is expected that the two relief wells being dug will be at the proper depth and proximity to the ill-fated Macondo well for BP to pump heavy fluid and then cement into the main well - plugging it.
We pray for the people of the Gulf, and we pray that a hand may guide us through the storm towards a greater day, said President Obama in his televised "oil spill" speech to the American public from the Oval Office.
The fact that BP is drilling two relief well gives the effort to finally seal the flow of oil a high probability of success (up to 98%), says Roger Anderson, an oil geophysicist interviewed by Scientific American last week. Lots of big and "little people" in America and the United Kingdom are praying with President Obama and BP executives that Anderson's forecast is correct.

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  • David Phillips

    David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

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