The Gulf of Mexico Oil Disaster: The Fallout From This Damaging Oil Spill

Marc Lichtenfeld
by Marc Lichtenfeld, Chief Income Strategist Natural Riches Natural Riches

The Gulf of Mexico Oil Disaster: The Fallout From This Damaging Oil Spill

by Marc Lichtenfeld, Advisory Panelist

Wednesday, May 5, 2010: Issue #1253

As oil from the destroyed rig in the Gulf of Mexico continues to spill into the water, creating an oil slick the size of Delaware, there's no doubt that the damages are going to be extremely high - both financially and environmentally.

British Petroleum (NYSE: BP), who leased the rig that exploded, has stated that the cleanup efforts are costing $6 million per day. Estimates for the total cost of the cleanup have ranged from $1 billion to $7 billion. And the cost to the fishing industry could be as much as $2.5 billion. Florida tourism could suffer to the tune of $3 billion.

Eventually, the companies responsible for the disaster and their insurance companies will pay the price, too.

While BP has said it will pay all cleanup costs and legitimate insurance claims - which is the right thing to say - it will probably try to either pawn off the responsibility or recover damages from others.

That includes Transocean (NYSE: RIG), the company who owned the rig and Cameron International (NYSE: CAM), whose blowout preventer failed to keep the oil from spilling into the Gulf. For its part, Transocean has insurance for the $560 million rig that sank.

So who is going to actually cough up the money?

The Companies That Will Pay the Price of the Oil Spill

This is going to hurt BP.

Even if the company can show that other firms had a greater responsibility for the accident, whatever BP pays will come out of its own pocket because it self-insures.

As a result, don't be surprised to see them drag this out in court, despite saying all the right things now.

In terms of compensation to the families of the 11 employees that were killed in the explosion, there's a precedent from 2005. Back then, BP paid $2 billion to the families of 15 workers that died in an accident.

The families affected today will likely receive a payout - although Transocean could be on the hook, since it employed the workers.

This is where reinsurance is important.

Reinsurance

Reinsurance companies act as insurance to other insurers, offsetting the primary insurance company's risk and making up for some of their losses.

Why do insurance companies do this? Simply put, to spread their risk and lessen the financial blow that would result from a major payout - like the ones that will come from Gulf of Mexico oil spill, for example.

In return for their obligation and risk, the reinsurance company takes a portion of the original insurance premium paid to the primary insurer.

Several reinsurance companies have stated what their own losses could be due to the spill...

  • PartnerRe (NYSE: PRE) - $60 million to $70 million.
  • Hannover Re (NYSE: HVRRY.PK) - on the hook for $53 million.
  • Transatlantic Holdings, a division of AIG (NYSE: AIG), said it's responsible for $15 million.

However, AIG's losses aren't limited to Transatlantic. A spokesman for Cameron International told me that AIG insured Cameron's general liability for $500 million. It's not yet clear what AIG's total exposure is to the disaster.

Matching Sensible Contrarianism With Proper Timing

If you're looking for a way to play the situation, the simple answer is this: don't.

Being a contrarian, I started looking at the various companies to see if there are any good investment angles. But it's way too early to even have a vague idea of how it will all shake out.

However, once some of the costs and liabilities are better understood, we'll likely see another jolt down for some of these stocks.

Of course, BP is the whipping boy for the disaster. But the reality is that it contracted with Transocean to do the work. I'm not saying that BP isn't responsible - far from it - merely, that others could ultimately end up paying a higher price.

But the fact that BP self-insures makes any kind of damages especially high. For now, both it and the other stocks probably have further to fall, but I suspect BP will be a potential contrarian pick during the next wave of selling.

And as we've preached here time and again, to be successful, you need to have a strong contrarian instinct - but the most successful ones do so when they not only identify viable contrarian opportunities, but synch them up with the right timing, too. At the moment, however, this situation needs more time to play out - hopefully with the best possible outcome for the Gulf states.

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld

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