On the BP Gulf Oil Spill - Research Paper Example

?Research Paper on the BP Gulf Oil Spill Contents Chapter 4 2 Chapter 2 7 3 Chapter 3 14 4 Chapter 4 16 5 Chapter 5 18 References 20 Appendices 22 1 Chapter 1 1.1 Introduction An oil spill is the accidental release of liquid petroleum hydrocarbon into the marine areas due to human negligence and is one of the major causes of sea water pollution. Despite the improved technologies to prevent crude oil spills in the marine environment the accidents continue to occur. The recent case of a large oil spill is the 2010 Deepwater Horizon incident in the Gulf of Mexico for which several companies were responsible to varying degrees and BP was the most prominent party to the incident. The worst oil spill U.S. faced before this Gulf Oil Spill was Exxon Valdez in 1989 in Alaska (Ramseur & Ramseur, 2011, p.1). On April 20, 2010, the oil drilling rig at Deepwater Horizon of BP was near completion when the uncontained release of oil and natural gas caused explosion resulting in the largest oil spill in U.S. waters and killing 11 people and injuring 15. Nearly 200 million gallons of oil was released into the sea over approximately 84 days. However the oil leak was discovered four days after the explosion when BP sent a team of experts to cover the source of leakage. This incident has charged BP with the clean-up costs, economic and natural resources’ damage costs, Clean Water Act (CWA) penalties etc probably leading to approximately $41 billion (Ramseur & Ramseur, 2011, p.1). The initial estimate of the oil spill was 1000 barrels per day which was later revised at up to 60,000 barrels per day (Hiles, 2011, pp.13). By the first week of May BP began the drilling of deep water intercept well half a mile from the leaking oil well. The attempt was to intercept the existing wellbore at around 16000 feet below the sea surface. The process was estimated to take 90 days. The oil slick was discovered to be drifting towards the Florida and Alabama coasts. Not to burn the oil was a decision made between polluted air and endangered sea life. Various measures were taken by the US Government and BP to contain the damage. The case gained worldwide attention and criticism of the policies and measures regarding the prevention of oil spills and protection of marine ecosystem. 1.2 Nature of the Issue The demand for energy has constantly grown leading gigantic efforts and big investments by the energy companies to locate new oil supplies. The Deepwater Horizon was a $365m offshore drilling unit where massive amount of oil was spilled due to two subsequent explosions in the summer of 2010. The incident affected the ecological environment of the Mexican Gulf and has directly harmed the Gulf fishing industry. The demand of the Gulf seafood has probably decreased due to changes in consumers’ perception about the spill (Upton, 2011, p.3). Many of the factors which are believed to have contributed to the BP disaster are technological and regulatory failures. Evidence suggests that the spill was an outcome of lack of proper oversight during the transition of rig oil from exploration to production. In the wake of such disastrous and rare event, federal law-makers have unsuccessfully tried to address the causes and enact policies to guide the economic and environmental recovery of the Gulf region. President Obama issued a moratorium on the planned offshore drilling at the time of the incident. The moratorium banned the deepwater drilling activities in the Gulf region allowing only the existing production to continue. Many have criticized the Federal Government for taking such step without analyzing the exact cause of incident. However this step has served neither to address the principal cause of the accident nor aided in economic rehabilitation of the Gulf economy. It has been estimated that the loss of economic activity in US and Gulf of Mexico region is likely to be total lost output of $2769m and 12046 lost jobs (Appendix 1) (Mason, 2010, p.1). In this paper an in-depth research has been done to find out how the domestic and international factors have contributed to the issue of BP Oil Spill and the impact this has had on the economy of the U.S. and its neighboring countries. Based on the research the change strategies on economic policies in response to changed market conditions are developed and recommended. 1.3 Research Question The BP oil spill is related to many inter-connected factors such as environmental, economic, social as well as political. These factors will be analyzed with the economic concepts of negative externalities and the cost-benefit analysis of the clean-up efforts by the government and corporations. In order to reach any conclusion and formulate any change strategy on economic policies, it is necessary to specify certain research questions which are given below: 1. What are the domestic and international issues related to the BP Oil Spill that have affected the Gulf economies and the corporations involved? 2. What are the alternatives for businesses and Governments to effectively respond to such strategic issues? The first question seeks to examine the factors that have affected BP and the Government policies after the oil spill. This is done in light of the economics theories such as Theory of Externalities and Cost-Benefit analysis of the oils spill. The second question is based on the analysis from first question and seeks to find the change strategies to implement economic policy modifications in response to the market conditions. 1.4 Research Objective The research objective is a statement defining the purpose of the research which needs to be accomplished by the researcher. To find the valid outcome of this research and to answer the above stated research questions, it is essential to develop a set of objectives, which are: To describe the economic and financial issues in the public or private sector related to the BP Oil Spill. To identify the domestic and international factors which have contributed to the economic and financial issues To apply the financial performance of BP to the evaluation of the oil spill. To discuss the long-term consequences of the oil spill incident if not addressed effectively. To formulate the change strategy in response to the oil spill. 2 Chapter 2 2.1 Literature Review This research paper’s conceptual framework has been formed on the basis of two major theories which are relevant to the issue being analyzed. First the theory of externalities which examines the oil spill has generated any positive and/or negative externalities. The second economic theory is the cost-benefit analysis of the oil spill. The conceptual framework includes the relevant previous studies on the Oil Spills. The major issues related to the topic are also presented. 2.1.1 Theory of Externalities An externality occurs when the costs and benefits of a good spread to those individuals who are not directly involved in producing the good and consuming it. Externality can be negative as well as positive. The production of a good which causes pollution is an example of negative externality. Negative externalities have a negative effect on the well being of other individuals i.e. these are the costs to others. A positive externality provides the benefit of the activity to others (Taylor & Weerapana, 2007, p.430). Example of positive externality is the benefit of a beekeeper neighbor to the orchard whose bee pollinates his flowers, which benefits both. The externalities bring inefficiencies in the markets. In a negative externality, the market produces a quantity which exceeds the equilibrium production level. The example of this is a firm might be involved in using fossil fuels which cause air pollution instead of using clean fuels such as solar power. This is due to the fact that the firms do not take into account the costs of externalities when calculating the costs of production. Therefore the actual cost will be higher than the cost perceived by the firm which leads to overproduction. This leads to inefficiency. In a positive externality, the activity of one individual makes the other individual better off by increasing the benefits and reducing costs. For example, if a person acquires education, he will be in a better position due to his increased earnings and the whole society will benefit from his education as an educated citizen makes a better society and passes on his knowledge to the next generations. The incident of BP oil spill occurred in the Gulf of Mexico where thousands of gallons of oil got spilled over sea surface and caused huge damage to the coastlines. The leaking oil well was 5 miles offshore and a mile under sea. This is understood to be a case of negative externality. The costs of such externality determined are: Damage to marine life Damage to the Gulf fishing industry Damage to the Gulf economies Damage to US exports and employment Ruined tourist-based business Damage to the local individuals who inhale toxic fumes and consume contaminated food Another major problem with the oil spill incident was the government intervention which forced BP to drill five miles off the coast and extract oil from one mile deep well. So when the incident occurred, it became difficult to control the situation which had been easy if the rig oil extraction had been in the shallow waters or on land (Boyes & Melvin, 2011, p.167). The after effects of the oil spill resulted not just in damage only but became a profit making business for law firms as the class-action lawsuits against BP was more than 150. William A. McEachern in his book “Microeconomics” has raised doubts if the BP oil spill was a negative externality. He argues that if the incident had been an externality then there would have been least impact on the suppliers and drilling company Transocean (responsible for drilling in Deepwater Horizon) which however is not the case. The regulators who squarely blamed BP and Transocean for the oil spill had been lax before the accident. BP established a $20 billion fund to compensate the affected parties. The legal system, government, media and stock markets have directly held BP responsible for the incident which has ensured that the otherwise external costs have become internalized (McEachern, 2010, p.385-386). 2.1.2 Cost-Benefit Analysis of the Clean-up Cost-benefit analysis is the analysis of costs incurred and benefits derived from providing the goods and services before making any decision. Economic efficiency entails that benefits outweigh costs. The costs and benefits are towards the society and therefore known as social costs and social benefits. The cost-benefit analysis is widely used by governments in policy making. It is the way where the utilitarian concept of social policy is included in policy making. In such a context an environmental policy or a government policy is said to be efficient if the greatest net social benefit is derived from it. The concept of cost-benefit analysis arose when BP set up a compensation fund of $20 billion for the cleanup of the oil spill and compensate the affected parties. By May, 2011 the company had compensated for around $4 billion. The U.S. Department of Justice charged BP and other corporations with violations of federal safety and operational requirements at the accident site. It seeks to recover the economic costs, removal costs, civil penalties and environmental damages pursuant to Clean Water Act and Oil Pollution Act (Hagerty & Ramseur, 2011, p.9). Assuming that not all the victims will be compensated for such incident the probability, that the benefit of oil production in the Gulf region higher than the costs of compensation is high. Fairness is not always guaranteed by efficiency. As BP is one of the largest oil and natural gas Production Company in the world after Shell and Exxon Mobil, The benefits of oil production outweighs the costs incurred during such incident. 2.1.3 Economic Policies of Government The oils spill followed by the strict government controls raised many issues such as the role of offshore petroleum production in the U.S. energy markets, implications of increased controls or ban on deepwater drilling, U.S. energy prices and import patterns of oil and natural gas. Another issue which was raised is whether the current policies provide appropriate incentives to producers and consumers to take full responsibility of such risks during offshore drilling activities. An analysis of restrictions placed on the offshore drilling activities for six months estimated that decreased investment in oil and gas production can cause substantial loss in wages, employment and production output. The other impacts include the loss of revenue for the government in the form of taxes (Appendix 1). The introduction of the higher safety procedures in the industry means that the costs will increase substantially for the companies engaged in deepwater drilling. These costs are likely to be shifted towards consumers in the form of higher prices. Such high prices ensure that the oil and natural gas usage has environmental costs and this will provide incentives for conservation of resources. However the scale of markets where such changes are expected is very small, the mentioned changes on world oil prices will be very small. Therefore minor changes in prices do not correspond to the impression that the industry will not adopt safer drilling procedures. However the regulations designed poorly could unnecessarily hamper the deepwater drilling without considerable safety improvement (Brown, 2010, p.10-11). In 2011, the Congress members have raised several issues regarding the Deepwater Horizon incident which include: Regulations for outer-continental shelf oil exploration activities The 1990 Oil Pollution Act liability and compensation framework Technological challenges associated with deepwater activities Response activities and decision-making (Hagerty & Ramseur, 2011, p.2). Regulatory Framework: The Clean Water Act (CWA) and Oil Pollution Act (OPA) are primary federal statutes which govern the federal response to these kinds of incidents and authorize the President to direct and monitor all federal, state and local activities during oil spill. The NCP contains the regulatory and operative requirements by the federal government in response to oil spills. The coast guard is responsible for worker safety and systems at the surface level offshore drilling units like Deepwater Horizon. The stakeholders have raised issues during contingencies regarding the relationship between responsible party and federal government and confusion in the role of local and state governments during oil spill response. Prevention and Containment Measures for Deepwater Oil Spills: To intersect the blown out well a relief well is drilled in the same manner as the exploratory well. The Gulf Oil Spill has shown that to drill a relief well can take months and if such wells are drilled concurrently alongside the exploratory well then it may shorten the time to contain the oil spill. Many Congress members have expressed interest in establishing policy for relief wells. However this is likely to increase the costs for the corporations involved in drilling. The use of dispersants which break up the oil into small oil droplets which can mix with water column has raised concerns regarding its short and long-term environmental consequences. Liability & compensation Framework: As per the liability and compensation framework given by OPA, the liability of a party responsible for oil spill is limited, with some exceptions. These exceptions’ applicability is not yet determined for BP. In Deepwater Horizon incident, BP is liable for all the cleanup costs and liability for other damages is capped at $75 million (Hagerty & Ramseur, 2011, p.7). BP long with Obama administration set up the Gulf Coast Claims Facility (GCCF) to process the claims and BP has made incremental payments to finance GCCF which will eventually sum up to $20 billion. Although GCCF has made considerable sum of payments it still has received doubts about its effectiveness in compensating the affected parties. Tax Issues: The losses incurred by BP have resulted in the tax benefits. However the payments received by the victims are subject to income taxes unless specifically excluded by the law. Factors which impact the exclusion of the payment from the taxable income are Whether the payment is received by BP or the Government. Whether compensated entity is an individual or business. Nature of income if the compensation is for the lost wages or for the property damage. The payments made to compensate for the lost income are taxable to recipient. Factors influencing future Government Policies: A lot of oil has been removed from the Gulf region but a substantial amount of oil still remains in the region. The fate of remaining oil is inconclusive and the problem will increase with the passage of time. A pertinent issue has been raised about the scope of the oil spill cleanup and its restoration whether the Gulf is to be returned to its pre-spill condition or a more comprehensive restoration attempt should be carried out. The findings and recommendations of several Government investigations such as National Commission on BP Oil Spill are likely influence government actions in future. 2.1.4 Financial Implication of the Oil Spill BP had initially anticipated the costs of spill to be around $40 billion including the costs of compensation and clean up. However it incurred around $41 billion as spillage expenses only indicated the actual costs to be much higher than estimated. The company reported net loss of $3.3 billion for the year 2010. The company had managed effectively during the 2008 economic crisis. The higher costs incurred for the oils spill also means that it will have the tax benefits of around $1.5 million and in subsequent years (Trefis Team, 2011). The other side of this aspect is the loss of public revenue. The GCCF, on behalf of BP, has continued to compensate parties affected by the oil spill. By May 2011, the GCCF has paid over $4 billion in compensation to individuals and businesses (Hagerty & Ramseur, 2011, p.4). The price movement of BP has been shown in Appendix 2. It shows the sliding of BP stock from April 2010 till July 2010 which can be understood because of the Deepwater Horizon accident. The company’s movement with S&P 500 index has been shown in Appendix 3 which shows similar results. The stock has moved downwards during the oil spill and after that recovered and moved along the index. From Appendix 4, the company has third highest EPS growth quarter-on-quarter. The company’s fundamentals are strong and it will be able to compensate the victims of the accident. 3 Chapter 3 3.1 Research Methodology The research methodology is a system of collecting data for research projects. It is the most important aspect of research. The validity of a research paper is determined by proper selection of appropriate research methods. The research framework should be properly aligned with the research topic. For studying the possible relationships between different variables, exploratory research is useful. If the researcher has a limited experience and needs to critically analyze the collection of literatures then literature survey can be used (Panneerselvam, 2004, p.6). The research method should be based on the nature of the research question and the research objectives. Generally the research is carried out using primary data or secondary data or both. The primary data is collected by the researcher and obtained from direct sources whereas the secondary data is the reprocessed collected information obtained from published authenticated sources. In order to analyze these two types of data the quantitative and qualitative research techniques are used. A quantitative research technique is the empirical investigation through mathematical, statistical and computational techniques. The qualitative research involves in-depth analysis of human behavior and its causes, usually in social sciences field. To achieve an accurate research results, the research framework has been developed and provided in the next section. 3.1.1 Research Framework The literature review section has provided the detailed theoretical framework of the project. The theoretical framework is based on the research questions and aligned with the research objectives. This paper mainly deals with the BP Oil Spill occurred in 2010 and the issues related to the incident in the light of economic theories. This research project involves descriptive research which is carried out with specified objectives. As the nature of the issue deals with the economic and financial impact of BP Oil Spill, the research is done with the help of primary and secondary data. The technique used is qualitative research technique. 3.1.2 Data Collection The reliability and authenticity of research depends on the authenticity of the data collected. Usually the primary data is considered as more reliable than secondary data. However this research is accomplished using more secondary data than primary data. The daily prices data and industry data of BP Plc has been collected from the Yahoo Finance website. The secondary data has been collected from the published books and journals, authenticated websites, national statistical websites etc. In order to understand the economic theories the published books have been referred. The BP Oil Spill incident details have been gathered from the published books and the data about the Government’s response and policies have been referred from the government organizations’ sites. 4 Chapter 4 4.1 Discussion and Findings The BP Oil spill or the Deepwater Horizon incident has raised several issues from the environmental, economic and financial points of view. The temporary measures taken by the government by issuing the moratorium to ban the drilling activities for six months did not address the causes but negatively impact the Gulf economies. The incident has resulted in negative externalities like losses for the Gulf fishing industry because of consumers’ perception about the quality of Gulf sea food, damage to marine life, lost human lives on site, badly affected coastal tourism and ill health effects. However some critics do not consider that BP has caused any negative externalities because some of the related parties have gained from the incidents. The company has paid a significant amount as compensation to the affected parties under two major statutes Oil Pollution Act and Clean Water Act. BP has estimated $41 billion costs of the oil spill and already paid more than $4 billion to the affected parties. The cost benefit analysis of the incident for BP provides that the benefits of oil production outweigh the costs involved in the cleanup and compensation because the oil has a worldwide demand and any increase in costs can be transferred to the consumers. Moreover such incidents are considered rare to occur. The only challenging aspect of the situation is the government regulation. The new policies regarding the containment and prevention of deepwater drilling accidents can raise the future costs for the company. BP has reported a net loss of $3.3 billion in the 2010 fiscal year. The incident has raised other regulatory as well as economic issues such as the confusion due to involvement of many regulatory agencies at federal, state and local level and their relationship with the responsible parties. The proposed drilling of relief wells concurrently with the exploration well drilling provides the appropriate measures to contain any future accidents but this will increase the costs of drilling. Other major concerns regarding this measure are the increase in complexity of the operations and requirement of different level of engineering. This will call for another set of policies and supervision from the government. The loss of revenue in the form of taxes will not get affected by the incident because the incident is not a natural disaster rather happened due to negligence on behalf of the corporations involved and partly due to lack of proper supervision from the regulatory authorities. Therefore the compensation received from the liable party is taxable income. The U.S. Government has not yet formulated strategies to mend the loopholes in the existing laws to deal with oil spills but the future government actions are likely to be affected by the findings of various commissions and private researches which are expected provide the causes of BP Oil Spill. From the environmental point of view the corporations as well as policy makers are uncertain towards the long-term consequences of the remaining oil in the region. Certainly they will have to take into account the ecological imbalances the incident has caused and the following health implications. 5 Chapter 5 5.1 Conclusion The BP Oil Spill is considered the worst oil spills in American continent after Exxon Valdez in 1989. The lack of negligence and preparedness has been considered major causes of the incident. The incident has been a major wake up call for the policy makers for their poor environmental protocols. Despite technological advancement the corporation could not avoid such accident which caused the lives of 11 workers. Moreover the marine life was damaged which caused losses to the Gulf fishing industry. Such incidents add to the already imbalanced world ecological environment. The suspended oil drilling for six months following the incident lead to the loss of economic activity. The incident has marked a very poor image of BP in the minds of people and this will prevail in the coming decade. This paper has tried to analyze the financial and economic factors related to BP oil spill and the factors contributing to this issue. The financial performance of BP has been discussed to find if the incident has affected the financial position of the company. It has been found that the company is in loss making phase but has not shown any signs of bankruptcy. It has a high EPS growth. The government has been trying to find the exact causes of the incident and taking short-term measures to prevent such accidents. The long-term strategic decisions have not been taken yet which poses uncertainty about the government’s future policies towards the oil exploration firms. 5.2 Recommendation The causes and long-term environmental consequences of oil spills are not understood properly by the government. The benefits from oil exploration and the oil consumption pattern of US have led the federal government to allow the oil drilling activities. Merely by compensating the affected parties will not ensure that such things will not happen in future. Understanding this corporations and government should work towards developing cost effective techniques which can be used to prevent and contain such accidents. 5.3 Limitation There were quite a few limitations faced while conducting the research. Firstly the secondary information relevant to the research was either unavailable or available in insufficient quantity. Secondly the secondary data was not presented in the form required by this research paper. The validity of a research depends on the authenticity of previous research works. To find the validity and authenticity of prior research papers posed a major challenge in data collection. Some of the paid researches could not be accessed. The time constraint was a major factor in writing this paper. The formulation of a long-term change strategy is usually based a sufficient timeline to acknowledge the efforts made by the government and corporations which was not available for this research. Therefore the research paper is more an analysis of the past events and factors rather than forward looking. References Boyes, W. & Melvin, M. (2011). Fundamentals of Economics 5th ed. Cengage Learning. Brown, S.P.A. (2010). Some Implications of Tightening Regulation of U.S. Deepwater Drilling. Retrieved on December 02, 2011- from http://206.205.47.99/rff/documents/RFF-BCK-Brown-Regulations.pdf. Hagerty, C.L. & Ramseur, J.L. (2011). Deepwater Horizon Oil Spill: Highlighted Actions and Issues. Retrieved on December 03, 2011- from https://www.fas.org/sgp/crs/misc/R41407.pdf. Hiles, A. (2011). The Definitive Handbook of Business Continuity Management 3rd ed. John Wiley and Sons. Mason, J.R. (2010). The Economic Cost of a Moratorium on Offshore Oil and Gas Exploration to the Gulf Region. Retrieved on November 29, 2011 from- http://www.saveusenergyjobs.com/wp-content/uploads/2010/07/The%20Economic%20Cost%20of%20a%20Moratorium%20on%20Offshort%20Oil%20and%20Gas%20Exploration%20to%20the%20Gulf%20Region.pdf. McEachern, W.A. (2010). Microeconomics 9th ed. Cengage Learning. Pannerselvam, R. (2004). Research Methodology. PHI Learning Pvt. Ltd. Ramseur, J.L. & Ramseur, J. (2011). Liability and Compensation Issues Raised by the 2010 Gulf Oil Spill. DIANE Publishing. Taylor, J.B. & Weerapana, A. (2007). Economics 6th ed. Cengage Learning. Trefis Team. (2011). BP's 2010 Performance Muddied by Gulf Oil Spill. Retrieved on December 02, 2011- from http://community.nasdaq.com/News/2011-03/bps-2010-performance-muddied-by-gulf-oil-spill.aspx?storyid=62608. Upton, H.F. (2011). Deepwater Horizon Oil Spill and the Gulf of Mexico Fishing Industry. DIANE Publishing. Yahoo Finance US. (2011). BP p.l.c. Common Stock Stock Chart | BP Interactive Chart - Yahoo! Finance. Retrieved on December 03, 2011- from http://finance.yahoo.com/echarts?s=BP+Interactive#chart4:symbol=bp;range=2y;compare=^gspc;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined. Yahoo Finance US-a. (2011). BP Industry: Major Integrated Oil & Gas | BP p.l.c. Common Stock Stock - Yahoo! Finance. Retrieved on December 03, 2011- from http://finance.yahoo.com/q/in?s=BP+Industry. Appendices Appendix 1: Lost Economic Activity in Gulf region Source: (Mason, 2010, p.1) Appendix 2: Price Movement 2010-2011 Appendix 3: Price Movement of BP with S&P 500 for 2 years Source: (Yahoo Finance US, 2011) Appendix 4: BP Plc Vs Industry Source: (Yahoo Finance US-a, 2011) Read More