The Deepwater Horizon oil spill in the Gulf of Mexico continued spreading May 6. British Petroleum and U.S. federal agencies are continuing with their emergency response and mitigation efforts as the unprecedented spill continues. While the incident has not significantly interrupted shipping or energy refining and production, it does threaten several economic sectors and is sure to have political implications. However, until the full extent of the damage is assessed, it will be difficult to say whether the spill will result in a policy change regarding offshore drilling.

Analysis

The oil spill in the Gulf of Mexico continued spreading across the waters southeast of Louisiana on May 6. British Petroleum (BP), the company responsible for the spill, and several U.S. federal agencies continue apace with their emergency response and mitigation efforts. So far, the oil has not significantly interrupted any shipping or energy refining and production. In the past 13 days, the oil slick has tripled in size.

Although BP plugged one of three leakage points May 5, it does not anticipate the flow to be reduced yet, and BP executives reportedly told the U.S. Congress on May 4 that while the oil is officially estimated to be gushing out at 5,000 barrels per day (bpd) the rate could be as high as 60,000 bpd. In other words, the problem could be far greater and more pressing than previously thought.

Furthermore, as the oil spill grows, so does the magnitude of potential economic and political consequences. It poses an immediate threat to the fishing, offshore oil production, shipping and refining industries. It also presents policymakers with questions about offshore drilling, entailing long-term regulatory ramifications for the industry. However, until the full extent of the damage is assessed, it is difficult to say whether the spill will result in a fundamental change in the national policy toward offshore drilling.

The spill began with a disaster on the BP- and Transocean-operated Deepwater Horizon oilrig April 20. The rig was located about 40 miles southeast of Louisiana and had concluded an exploratory drilling into the Macondo oil deposit. Workers on the rig felt two big shudders, after which oil, gas and mud erupted from the well. A spark caused the oil to catch fire and set the entire rig aflame. It sank April 22, but the oil continued to surge out of the well. The cause of the explosion is still under investigation. Several technical problems have been identified — notably, the blowout preventer designed to seal off the well in emergencies failed to stop the gusher. There also is speculation concerning the fact that the process of cementing the well (protecting the pipe from the pressures of surrounding oil and gas) had been completed only 20 hours before the fire. But undersea drilling is inherently risky because it can unleash the immense pressure in the oil reservoirs under the seabed.

The chief difference between the Deepwater Horizon spill and the Exxon Valdez spill in Alaska in 1989 is that the Valdez was an oil tanker with a limited amount of oil to spill (250,000 barrels), whereas the Deepwater Horizon spill comes from a leaking well and thus is growing by the day, with no certain end in sight. BP and a host of U.S. federal agencies — including the Coast Guard, the Minerals Management Service and the National Oceanic and Atmospheric Administration (NOAA) — have been focused on containing the oil slick, using controlled burns and chemicals to disperse the oil, protecting the shoreline and addressing the economic and political effects.

Stopping the oil flow will be difficult and will take time. In the next five days, BP will begin an operation to lower a giant containment structure — a dome or cofferdam — into the sea to cap off the well and then funnel the hydrocarbons up to a special ship on the surface. The containment dome arrived at the Deepwater Horizon site May 6 and is expected to be in place for operations to begin by May 10. It is not clear whether this will work, as it has never been tried before, but it is the best shot at quickly reducing the flow of oil. Another possible solution would involve installing a second blowout preventer on top of the one that failed, but this is also untested and risks increasing the outflow of oil if it fails. The surest method of stopping the flow, already under way, consists of drilling a relief well that will allow the company to access the leak and seal it — but will take two or three months. A three-month delay would be the most prolonged, costly and environmentally damaging scenario and would make the Deepwater Horizon spill almost twice the size of the Valdez spill — assuming the higher estimated rates of leakage are not accurate (and BP’s most pessimistic estimate of 60,000 bpd is by no means an impossible output for a single well). However, the cofferdam technique could prevent the worst-case scenario. The situation is unprecedented, and while experts are devising solutions, the outcomes remain uncertain.

Economic Implications

The oil is expected to hit land as early as May 6. Coastal areas of Louisiana, Mississippi, Alabama and northwest Florida are in the slick’s path and face several economic risks — primarily in the fishing, shipping and energy sectors — as the oil approaches.

The area’s large fishing industry already has suffered. Louisiana produced about 417,000 metric tons (459,664 short tons) of seafood, for a total of $274.9 million, in 2008 — about 39 percent of which came from shrimp. Mississippi, meanwhile, produced about 92,000 metric tons (101,412 short tons) worth about $43.7 million, with menhaden accounting for 42 percent, and Alabama produced about 11,000 metric tons (12,125 short tons) totaling $44.3 million, almost half of the value of which came from shrimp. Authorities in Louisiana allowed shrimping season to start two weeks early to maximize the harvest before the oil reaches prime shrimping waters, though this special season has already concluded. On May 2, federal authorities placed a 10-day fishing ban on the federal waters surrounding most of the oil slick (while states have jurisdiction over the waters close to their shores). As the oil infiltrates the marshes and lagoons of the coast, it will become far more difficult to disperse and will affect delicate ecosystems. Shrimping industry experts and the NOAA also have expressed fear that the chemical dispersants being used could disrupt fishing. All this could have a negative impact on generations of submarine life — especially if the oil cannot be prevented from reaching the marshes where the life cycle begins — and thus serious ramifications for the fishing industry. Yet the overall economic damage will be limited to local areas, as commercial fishing makes up less than 1 percent of each state’s economy.

The oil slick also presents risks to the energy sector. Federal offshore drilling in the Gulf produced about 1.15 million bpd of oil in 2008, about one-third of total domestic crude production. Offshore energy production facilities are highly sensitive to external conditions and frequently have to stop operations when threatened by spills, storms or other unusual circumstances. Floating oil in surrounding waters poses the threat of fire, most obviously, and is a threat to workers’ health. Hence, nearby rigs could have to shut down if the oil spreads to them. Three platforms already have been evacuated, though these were precautionary as they were close to the Deepwater Horizon site; two of these were natural gas producing sites, but their output was negligible (and natural gas output, at about 2.3 trillion cubic feet in 2008, has been falling drastically over the past decade). As the oil slick expands, however, other rigs in the Gulf could face this problem.

Shipping also will be threatened. While oil does not damage ocean-going vessels, it will cling to their hulls, and it is illegal for ships to enter U.S. ports or waterways if they will contaminate the waters. Incoming dirty ships would have to transfer their cargo or be cleaned, which takes time, and cleaning the ships could create delays and port congestion. At present, the oil slick has not disrupted the main shipping lanes, but as the slick grows, much of the near-shore and coastline is at risk. The Louisiana Offshore Oil Port (LOOP) — a major location for importing oil — remains accessible as it is much further west of the bulk of the spill — but it is not impossible that the slick could affect access. The major ports at Pascagoula, Miss., and Mobile, Ala., have seen no interruptions yet but their shipping lanes could be narrowed as the oil slick continues to move northeast. The main Southwest Passage into the New Orleans port remains open, though the three-day trajectory of the oil slick provided by NOAA suggests the waters around the passage could become tainted. This could affect a whole string of ports, from Plaquemines to Baton Rouge and most notably New Orleans, the country’s 13th-largest port by total overseas trade. The entire Mississippi River system – a critical transportation route for the economy of the U.S. heartland — will feel reverberations if delays result from the need to clean oil off of ships.

Shipping problems could cause delays in getting oil supplies to refineries in the affected Gulf Coast areas. However, unlike offshore production rigs, refineries will not be induced to cease operations easily — they are built to withstand hurricanes. The refineries can receive oil via sub-sea pipeline infrastructure, and currently commercial stockpiles are relatively high (national stockpiles are at 1.1 billion barrels). Refiners also have the option of seeking assistance from the U.S. Strategic Petroleum Reserve (SPR), with 726.6 million barrels, which the Department of Energy has offered to tap if supply shortages threaten the U.S. consumer market. The maximum draw down rate of the SPR is about 4.1 million bpd — greater than the total capacity of all refineries in Louisiana, Alabama and Mississippi that could conceivably see their oil supply affected by shipping interruptions, which is roughly 3.5 million to 4 million bpd. Thus, there should not be any shortages in refined oil products such as gasoline from this incident (especially as long as the LOOP remains operational).

Political Consequences

The political ramifications also will increase in magnitude as the spill expands. Offshore oil production accounts for about one third of global oil production, and the demand for it will not disappear. However, the United States already strictly regulates offshore drilling, and regulations will increase as a result of the Deepwater Horizon incident.

California Gov. Arnold Schwarzenegger already has scrapped his plan to expand offshore drilling as a means of bringing in more revenue to ease the state’s fiscal woes. The California electorate is especially concerned with environmental issues — perhaps more than with fiscal ones — but Schwarzenegger’s statement will change the national debate. U.S. President Barack Obama has not called for a review of his policy to expand offshore drilling beginning in 2012, which was just announced in early April, but he has placed a moratorium on new leases until the completion of a Cabinet review of oil rig safety, expected at the end of May. It will be difficult for Obama to press ahead with offshore drilling; his core supporters already were disgruntled by his expansion plans, and the Deepwater Horizon incident lends strength to their opposition. The expansion was linked to a proposed bill in Congress on energy reforms including carbon emission reductions and cap-and-trade, and a halt on offshore drilling could easily derail the bill.

Instead, Obama and lawmakers will focus on raising the liability limit on companies responsible for oil spills — currently at $75 million, but proposed to be raised up to $10 billion. BP is already preparing to pay an enormous tab for the losses of capital goods, litigation, reimbursement for local economies and the U.S. government. With profits at $16.8 billion in 2009, BP has some room to maneuver, but it is facing a serious blow to its reputation and balance sheet. Still, the wrath of litigation and regulation to come will be costly for oil companies and offshore operations. BP will bear the brunt of U.S. wrath, but the fallout from Deepwater Horizon will affect the entire oil industry.

Questions about deepwater drilling technology will abound, and resolving these questions will be costly. The Deepwater Horizon rig was worth about $560 million and was one of the most advanced in the world; it broke the record in 2009 for drilling the world’s deepest well at some 35,000 feet beneath the Gulf. There are only about 70 comparable rigs in the world. As the investigation into the incident continues, questions will arise as to whether such rigs are reliable and technically sound, and it is by no means a stretch to think that expanded and intensified inspections, maintenance reviews and the like will result in significantly raising the costs of — and risks of investing in — deepwater drilling.

As the oil slick continues to expand, so too will the economic and political ramifications. The immediate things to watch for are the increasing size of the oil slick, the halting of oil production at affected rigs, the oil’s approach to shipping lanes to ports and refineries, and the progress of attempts to plug the well and stop the outflow. The success of the containment dome method is especially critical. The full extent of the damage will not be known for some time, but it will determine the depth of the impact the incident will have on the future of offshore drilling, and how difficult it will be for the public to accept it as a necessary risk in developing advanced technology in pursuit of a domestic energy supply.