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.
How much damage does the market think the oil spill has done?
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