The Hidden Impact of the Gulf Oil Spill

Jeremy Glaser: How will the Gulf oil spill affect BP and the rest of the oil industry? I'm Jeremy Glaser with Morningstar.com. Joining me today to discuss this is associate director Eric Chenoweth.

Eric, thanks for joining me today.

Eric Chenoweth: Thanks for having me.

Glaser: Maybe at first just looking at the short-term impact on BP, which is probably one of the most impacted stocks here, what do you think this means for investors and for the valuation of the firm?

Chenoweth: We adjusted our fair value shortly after the spill happened, and we made a small adjustment of two dollars per share. We drove that basically based on what's visible right now, and that is the spill, how expensive we think it could be, and what BP's share in that will be.

BP's the operator and owns 65 percent of the well, so they're likely to bear a lot of the lion's share of the cost. But I think the thing that's more interesting is what might not be seen and in what this might mean for the future of offshore drilling, which could be a bigger cost for the firm.

Glaser: So if we take that step back, and let's say Congress passes some draconian laws banning offshore drilling or making it much more expensive, who do you think would be the most hurt by that kind of legislation?

Chenoweth: We've tried to take a couple different approaches to thinking this through. We talked about the visible costs. The question is, is this a technology issue? Is the technology available to address new regulations?

I think a lot of it's going to come down to the investigation. Was this more human error, which means it's more of a visible issue, or was this a technological error that we can't get past?

If what we've been hearing, one side of it says blow-out preventers that exist today can only handle kicks that were a fraction of what we saw in this, that means there needs to be a whole retooling of the services industry and a lot of technology needs to come up to speed to address this, which could mean a lot of delays.

A lot of EMPs that have a lot of deep-water upside, like a BP or an Anadarko, both who were involved in this well, it would definitely threaten the speed with which they can develop their offshore properties.

But if technology can meet it, it could mean more a matter of higher cost to absorb, and that's a bit different because higher cost, while that would hurt, they could possibly overcome some of the issues in a shorter period of time. So it might just be a matter of cost and margin hit in that regard.

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Glaser: How big of an impact could it be on some of these firms with offshore exposure?

Chenoweth: It's hard to say at this stage, because we don't know. This is the thing that's so challenging right now. We just don't know exactly what happened, and even if we did know what happened, the next question is how does government choose to react to that information?

We can take a rational approach like we are, but at the end of the day, we still don't know the full extent of the damage from the spill. So if the damage turns out to be even worse than we can imagine, the government might decide to be even harsher than what we might be able to imagine right now.

Glaser: Could a clamp down in drilling have an impact on the price of oil?

Chenoweth: Sure. We've thought about this, too. A lot of the upside we've seen from the supply side over the next decade would come from the deep water. That's one of the promising areas, especially outside of OPEC. The Gulf of Mexico was a key part of that.

I think there's a lot of talk right now, and we did see a slowdown in some deep-water activity that was already going on just because no one wants to bear this risk right now, especially in the Gulf of Mexico.

But there are other countries out there. There's Brazil, and the Brazilians have a very big resource, and it's a different regulatory regime. Will they choose to slow down? I think they're probably less likely to. They haven't had an accident yet, and they might feel that they have the technology and the redundancies in place to handle it.

But it definitely takes away one of the bright spots in the U.S. if we are to regulate it to such a degree that it would slow down the drilling. A lot of people saw the deep-water Gulf of Mexico as offsetting natural declines onshore and in Alaska that we've been dealing with for the past five years.

Glaser: If we think about the impact on alternative energies, is this going to move the government to possibly incentivize solar and wind even more than they do so now?

Chenoweth: It definitely can't hurt in our opinion. We've talked to a few people who are consultants and work in this part of the government, and they tend to think that it's going to help them. It already is helping their cause just in the last couple of weeks.

Glaser: For investors who might be looking to invest in alternative energy, do you have any suggestions?

Chenoweth: I know one idea that we've had at five stars recently has been First Solar. That might be a name. It's a leader in the solar space, and it has a cost advantage that we really like.

Glaser: And for investors who might think that we're still going to allow quite a bit of offshore drilling, that this has been overblown, are there any stocks you think on the oil side that would be attractive right now?

Chenoweth: Sure. I think not necessarily oil, but a mix of oil and natural gas, and you look onshore where these folks should benefit. We like Range Resources, Ultra Petroleum, and ExxonMobil right now as well.

If you think about what Exxon's done in the past few years, they've done a lot to move onshore with the XTO deal and really position themselves to benefit from other areas besides the deep waters.

Glaser: Eric, thanks for talking with me today.

Chenoweth: Thanks for having me.

Glaser: For Morningstar.com, I'm Jeremy Glaser.