Gulf oil disaster will probably end up costing $7 billion

Although it won't end up being as damaging as a natural disaster such as an earthquake, the unfolding oil disaster in the southern US will still be quite costly. Oil companies and others in the oil & gas industry have their own estimates of potential costs but perhaps the best estimates are the ones from the insurance companies (and the analysts covering them.) Since insurance companies are the ones that will pay out most of the damages—the oil companies, drilling companies, and equipment suppliers tend to pay a small fraction of the costs—insurance companies don't have any incentive to overstate or understate the losses. MarketWatch has a story on the costs likely to be borne by the insurance industry:

At first, the industry focused on the rig itself. Transocean Ltd., its owner, has $560 million of insurance covering total loss and wreck removal. Several insurance industry executives have estimated this could be an $800 million to $900 million event.


But a much bigger hit could come from liability claims stemming from the oil spill. That's especially true if lots of oil pollutes the shorelines of Florida and other states around the Gulf of Mexico.

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BP, which is the operator on the lease with a 65% stake, insured itself, rather than buying coverage from insurance companies.

That means the company is responsible for funding clean-up operations in the Gulf of Mexico, according to rating agency Fitch Ratings. The cost of that could reach $2 billion to $3 billion depending on how much oil eventually reaches the shore, the agency estimated this week.

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Neil McMahon, an oil industry analyst at Bernstein Research, estimated that the final cleanup bill could be $7 billion, according to media reports.


Compensation will also have to be paid to other businesses hit by the slick. The cost to the fishing industry in Louisiana could be $2.5 billion, while the Florida tourism industry could lose $3 billion, Bernstein predicted.

Compensation in the billions of dollars may also have to be paid to the families of the 11 rig workers who likely died when the structure exploded and sank.

It's not clear who will be responsible for these costs.

Rig owner Transocean carries $700 million of environmental liability insurance. Cameron, which made the so-called blowout preventer that was fitted to the rig, has a $500 million liability policy.

It looks like BP is self-insured so the insurance industry escapes with a sigh of relief. The insurance companies still have to pay for the loss of life and cost of the lost rig*, but those costs pale in comparison to the economic damage. It's not clear if anyone, other than taxpayers, will be paying for the economic damage. As the article points out, the law limits oil company liability to $75 million, whereas the damage is expected to be at least $7 billion.

The disaster is question also shows how pursuing short-term profits can turn into a disaster when a low-probability event occurs. In this case, the failure of the rig in this manner was a remote possibility; I'm sure many expect rigs to fail on a regular basis, but not in this manner. But society was pursuing short-term profits (apparently the US government doesn't require a remote control shut-off valve, required in oil-producing countries like Norway and Brazil) and it will end up costing the lives of precious sea creatures.



Side Note:

* You can get a feel for how complex and advanced the oil & gas operations are by the cost of the rig. The rig apparently costs around $800 million. That's just to drill a hole, albeit very deep in the ocean. The drill costs more than a full-size electronics factory used to produce thousands of computers a week, costs more than a 100-unit apartment building, and is a bit less than an auto manufacturing factory (I'm just using very rough figures; the numbers depend on specifics such as the size of the factory, the cost of buildings (driven by things such as labour costs), etc.) Not only does the operation involve complicated technologies, it also must witstand harsh weather. The rigs probably can't survive hurricanes and tsunamis but they are supposed to be able to witstand storms.