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Below is what seems to me to be a very interesting observation from a member of TOD.
There is much in it, and it may be worth discussing here:
steve from Virginia on June 5, 2010 - 2:48pm Permalink | Subthread | Comments top
Since RR's post has little to say about the mechanics of the 'Demise of BP' or processes attended thereto, it will be interesting to see how this post develops through the commentary, the TOD collective 'wisdom of the crowd'.
A suggestion was made on one of the remediation threads that Gail or another with finance interest analyae BP's situation and outlook. It's probably too early to do more than make a sketch, but the trend in various aspects of the oil industry is pretty clear.
The primary economic issue is the relationship between overall oil output and the money that pays for that production. What happens with money - specifically cash dollars - is going to effect the economic 'container' within which the oil businesses function. Specifically, the price of oil - determined by supply and demand - is at an economic upper bound beyond which it cannot rise without causing overall economic failure.
Simply; as cheap oil disappears, the 'cheap oil economy' also disappears. Since our industrial economy requires the constant expansion of inputs at near- zero costs, the general outcome isn't hard to imagine. As costs rise - either in nominal or real terms - the businesses most dependent on low cost inputs fail first. As un(der)employment increases the spiral of diminishing demand takes hold. At some point even firms adapted to high input costs fail as they have fewer customers for their (expensive) products. I cannot claim any theories or special insights, but this seems to represent most closely what is actually taking place in the real world.
At issue is what money - specifically the US dollar - represents. All money is a proxy for something, it exists in place of some surplus output that is either inconveniently distant or currently unwanted. As the great proto- economist Jean- Batiste Say pointed out, "products are paid with products". At issue are what products? If oil is to be exchanged for something that thing exchanged must have equal value. What is being called into question by the alignment of dollars to oil is the value of the thing oil consumers offer in exchange for it.
Does the money (dollars) represent the economic product of the oil's use? Or, is it the representation of the oil itself? Exchanging oil for oil does not allow much for commercial use. By the mechanism of supply and demand the costs of production rise higher than the value of the products themselves. The economic value of products derived from oil shrinks as the value of the oil itself increases. Holding the oil is more profitable than using the oil. This can only change when the use of the oil can generate higher returns. The same returns that are currently constrained by the structure of the cheap oil economy.
The oil cycle is similar to the effect of the increasing value of gold - accelerated by declining gold production. Gold becomes gold too valuable to use for anything but to exchange for other gold. We can call this a 'value trap' akin to the famous 'liquidity trap'.
This self- amplifying cycle of increasing costs/value with diminishing returns is the large economic environment within which all companies including BP operate. As the value of energy and its dollar proxy increase further the result will be an increase in real energy and money costs where prices will remain stable or decline but money to buy energy will be increasingly hard to find.
The alternative is high nominal energy costs with cheap money where prices rise to much higher levels with money being available. I think this is much less likely because the upper bound represents demand destruction and resulting lower nominal prices.
Bottom line here is that BP will indeed go bankrupt and so will all the other industial companies. The cost cycle is well underway and has been visibly manifest since 2004 when the observation of high oil prices appeared in Federal Reserve Open Market Committee meetings. The Fed mistakenly interpreted this as inflation rather than as the inflection point on oil production relative to demand and the distortion in the money system that demand represented. The hard dollar effect became apparent last fall and has been amplifying in both intensity and effect since. Since the hard dollar effect is both self- reinforcing and cumulative, it can be safely said that the so- called compounding debt (or claims) spiral that is effecting Greece, Ireland, Portugal, Hungary and other countries is already taking hold here in the US.
The micro environment includes regulatory and remunerative issues such as what will the effects of this particular spill have on stockholder value? What effects will the spill have on the overall operating environment not only for BP but for other companies? Will the liabilities accreting to BP reach the point where the company dissolves and is restructured? What will the effects of this restructuring be?
This is a daily chart of BP's ADR's price (BP is a British company whose stock trades in London, ADR's are US stock equivalents) and you can see that the shareholder value has plummeted since the Deepwater Horizon blew out. The wisdom of the investing crowd suggests that the end of the problem is nowhere in sight, it also suggests that BP is an increasingly tempting takeover target. Events taking place over the past few days suggest that the BP management is in the process of 'walling off' liabilities into a 'Bad Bank' entitiy that would then be split off from the parent company, which would then merge with another oil firm such as Sinopec or Shell Oil.
As the history of the drilling business suggests in Nigeria, Ecuador and elsewhere including in the US, the companies consider spewing waste into the environment a way to generally cut costs or are - at worst - a temporary business expense that can be 'amortized' by using what is effectively a client - the legal system - to spread liabilities over time.
Complicating the issue are two factors. One is the complicity in the oil business' operation by customers who know that conservation is a necessity, but who currently do all they can to avoid the issue. The question here is whether BP's corporate missteps will change public attitudes toward consumption without limits as well as about BP? If (when) customers disappear (use less oil) the industry will shrink.
The second factor is the diffidence of the government - particularly this government. The issue of the Demise of BP stands right alongside the likely Demise of the Obama Administration. By effectively treating BP as a special class of citizen with rights that other citizens cannot share, the Administration demonstates that it lacks the courage of its convictions. A basic conviction that all governments must express is primacy of law and stewardship. This isn't simply an 'Obama- the- politician Problem', rather a long- running 'America Problem' that has trickled down to other countries and economies. Nevertheless, Obama's regime hangs in the balance, because he is here and the problems can be blamed on him.
A one- time manifestation of conviction on the part of the Obama team to take more than symbolic actions to gain control of BP's assets would likely dissolve the BP corporate whole and leave a collection of component parts with questionable collective value. Alternative to a nationalization, the downward spiral of effects on the Gulf and Atlantic economies also diminishes the merger value of BP's parts or whole to potential suiters. BP's efforts to wall off Gulf operations from the parent are not outside the reach of courts which cannot be considered reliable oil company clients any more. The spill is off the American coast - close to TV stations and news media - rather than the Angolan or Persian Gulf coasts where there is little property to ruin with spilled oil ... or Alaska which has little real estate development upon its shoreline. Litigation will have its effect on BP's activities rather than on its cash, moreso if the spill reaches the UK/Ireland as the current flow would suggest. In this case, time would not be on the side of BP as litigants would be either licensing entities who would be seeking to 'pull the plug' on the company or those with infinite lifespans such as governments or other corporations. All of this reduces BP's takeover value. While BP's reserve assets have value, separating the assets from claims against them is easier said than done.
The current spill interferes with the axiom that potential oil development sites will inevitably be made available for production. Questions about technological limits, spill outcomes, costs v. benefits and agency wrangling will make production of all kinds more difficult. Oil businesses are businesses first; they have to sell a product and if the product is either unavailable or too expensive there is no business.
Which illuminates a third factor: the spill's effect on the US Gulf Coast (and perhaps Atlantic Coast) economies. Certainly this may NOT be the US' greatest environmental disaster - the Dust Bowl is probably tbe worst - but it will certainly be the costliest. Moratoria on Gulf oil drilling resulting from BP's cavalier practices is idling production and causing layoffs. There are knock- on effects from the drilling halts including declining sales of products and services to producers, families and downstream oilfield dependent businesses. The effects on fisheries and those dependent upon them in the Gulf is well documented. Since much of the current value of US real estate is located on the coasts, the effected areas will see drops in real estate value. Hard- hit Florida will likely be hit again as the coast's values have held up to now better than that of inland areas such as Orlando. The tourism, hospitality, liesure travel, sport fishing, recreational boating and entertainment industries will suffer as the coasts are turned into polluted industrial sites.
Keep in mind that the perception of harm is as hazardous to BP as the harm itself. The claims against BP for oil spill pollution will be as enduring as those against Manville for its asbestos products. As liabilities mount and are directed against BP it will be increasingly difficult for management to extract assets from under the onrush of claims against them. In a sense, the failure of the US government to freeze BP assets both in the US and abroad will make sorting out BP much more difficult and costly for the company, its shareholders as well as for those making claims. Robert Reich has suggested putting BP into receivership for other reasons, most of which have been illuminated here on TOD.
The issue of claims brings the topic back to the beginning; is the product of BP equal in value to what has been so far been exchanged for it? Suggestions are made that this is the Chernobyl of the oil industry. Until that manifests in the activities of all the oil industry participants - the auto users - and does so by voluntary reductions in consumption, the result will be the submergemce of BP under its aggregation of claims against it in front of the backdrop of the submergence of the world's industrial economies under the value claims laid against them.
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There is much in it, and it may be worth discussing here:
steve from Virginia on June 5, 2010 - 2:48pm Permalink | Subthread | Comments top
Since RR's post has little to say about the mechanics of the 'Demise of BP' or processes attended thereto, it will be interesting to see how this post develops through the commentary, the TOD collective 'wisdom of the crowd'.
A suggestion was made on one of the remediation threads that Gail or another with finance interest analyae BP's situation and outlook. It's probably too early to do more than make a sketch, but the trend in various aspects of the oil industry is pretty clear.
The primary economic issue is the relationship between overall oil output and the money that pays for that production. What happens with money - specifically cash dollars - is going to effect the economic 'container' within which the oil businesses function. Specifically, the price of oil - determined by supply and demand - is at an economic upper bound beyond which it cannot rise without causing overall economic failure.
Simply; as cheap oil disappears, the 'cheap oil economy' also disappears. Since our industrial economy requires the constant expansion of inputs at near- zero costs, the general outcome isn't hard to imagine. As costs rise - either in nominal or real terms - the businesses most dependent on low cost inputs fail first. As un(der)employment increases the spiral of diminishing demand takes hold. At some point even firms adapted to high input costs fail as they have fewer customers for their (expensive) products. I cannot claim any theories or special insights, but this seems to represent most closely what is actually taking place in the real world.
At issue is what money - specifically the US dollar - represents. All money is a proxy for something, it exists in place of some surplus output that is either inconveniently distant or currently unwanted. As the great proto- economist Jean- Batiste Say pointed out, "products are paid with products". At issue are what products? If oil is to be exchanged for something that thing exchanged must have equal value. What is being called into question by the alignment of dollars to oil is the value of the thing oil consumers offer in exchange for it.
Does the money (dollars) represent the economic product of the oil's use? Or, is it the representation of the oil itself? Exchanging oil for oil does not allow much for commercial use. By the mechanism of supply and demand the costs of production rise higher than the value of the products themselves. The economic value of products derived from oil shrinks as the value of the oil itself increases. Holding the oil is more profitable than using the oil. This can only change when the use of the oil can generate higher returns. The same returns that are currently constrained by the structure of the cheap oil economy.
The oil cycle is similar to the effect of the increasing value of gold - accelerated by declining gold production. Gold becomes gold too valuable to use for anything but to exchange for other gold. We can call this a 'value trap' akin to the famous 'liquidity trap'.
This self- amplifying cycle of increasing costs/value with diminishing returns is the large economic environment within which all companies including BP operate. As the value of energy and its dollar proxy increase further the result will be an increase in real energy and money costs where prices will remain stable or decline but money to buy energy will be increasingly hard to find.
The alternative is high nominal energy costs with cheap money where prices rise to much higher levels with money being available. I think this is much less likely because the upper bound represents demand destruction and resulting lower nominal prices.
Bottom line here is that BP will indeed go bankrupt and so will all the other industial companies. The cost cycle is well underway and has been visibly manifest since 2004 when the observation of high oil prices appeared in Federal Reserve Open Market Committee meetings. The Fed mistakenly interpreted this as inflation rather than as the inflection point on oil production relative to demand and the distortion in the money system that demand represented. The hard dollar effect became apparent last fall and has been amplifying in both intensity and effect since. Since the hard dollar effect is both self- reinforcing and cumulative, it can be safely said that the so- called compounding debt (or claims) spiral that is effecting Greece, Ireland, Portugal, Hungary and other countries is already taking hold here in the US.
The micro environment includes regulatory and remunerative issues such as what will the effects of this particular spill have on stockholder value? What effects will the spill have on the overall operating environment not only for BP but for other companies? Will the liabilities accreting to BP reach the point where the company dissolves and is restructured? What will the effects of this restructuring be?
This is a daily chart of BP's ADR's price (BP is a British company whose stock trades in London, ADR's are US stock equivalents) and you can see that the shareholder value has plummeted since the Deepwater Horizon blew out. The wisdom of the investing crowd suggests that the end of the problem is nowhere in sight, it also suggests that BP is an increasingly tempting takeover target. Events taking place over the past few days suggest that the BP management is in the process of 'walling off' liabilities into a 'Bad Bank' entitiy that would then be split off from the parent company, which would then merge with another oil firm such as Sinopec or Shell Oil.
As the history of the drilling business suggests in Nigeria, Ecuador and elsewhere including in the US, the companies consider spewing waste into the environment a way to generally cut costs or are - at worst - a temporary business expense that can be 'amortized' by using what is effectively a client - the legal system - to spread liabilities over time.
Complicating the issue are two factors. One is the complicity in the oil business' operation by customers who know that conservation is a necessity, but who currently do all they can to avoid the issue. The question here is whether BP's corporate missteps will change public attitudes toward consumption without limits as well as about BP? If (when) customers disappear (use less oil) the industry will shrink.
The second factor is the diffidence of the government - particularly this government. The issue of the Demise of BP stands right alongside the likely Demise of the Obama Administration. By effectively treating BP as a special class of citizen with rights that other citizens cannot share, the Administration demonstates that it lacks the courage of its convictions. A basic conviction that all governments must express is primacy of law and stewardship. This isn't simply an 'Obama- the- politician Problem', rather a long- running 'America Problem' that has trickled down to other countries and economies. Nevertheless, Obama's regime hangs in the balance, because he is here and the problems can be blamed on him.
A one- time manifestation of conviction on the part of the Obama team to take more than symbolic actions to gain control of BP's assets would likely dissolve the BP corporate whole and leave a collection of component parts with questionable collective value. Alternative to a nationalization, the downward spiral of effects on the Gulf and Atlantic economies also diminishes the merger value of BP's parts or whole to potential suiters. BP's efforts to wall off Gulf operations from the parent are not outside the reach of courts which cannot be considered reliable oil company clients any more. The spill is off the American coast - close to TV stations and news media - rather than the Angolan or Persian Gulf coasts where there is little property to ruin with spilled oil ... or Alaska which has little real estate development upon its shoreline. Litigation will have its effect on BP's activities rather than on its cash, moreso if the spill reaches the UK/Ireland as the current flow would suggest. In this case, time would not be on the side of BP as litigants would be either licensing entities who would be seeking to 'pull the plug' on the company or those with infinite lifespans such as governments or other corporations. All of this reduces BP's takeover value. While BP's reserve assets have value, separating the assets from claims against them is easier said than done.
The current spill interferes with the axiom that potential oil development sites will inevitably be made available for production. Questions about technological limits, spill outcomes, costs v. benefits and agency wrangling will make production of all kinds more difficult. Oil businesses are businesses first; they have to sell a product and if the product is either unavailable or too expensive there is no business.
Which illuminates a third factor: the spill's effect on the US Gulf Coast (and perhaps Atlantic Coast) economies. Certainly this may NOT be the US' greatest environmental disaster - the Dust Bowl is probably tbe worst - but it will certainly be the costliest. Moratoria on Gulf oil drilling resulting from BP's cavalier practices is idling production and causing layoffs. There are knock- on effects from the drilling halts including declining sales of products and services to producers, families and downstream oilfield dependent businesses. The effects on fisheries and those dependent upon them in the Gulf is well documented. Since much of the current value of US real estate is located on the coasts, the effected areas will see drops in real estate value. Hard- hit Florida will likely be hit again as the coast's values have held up to now better than that of inland areas such as Orlando. The tourism, hospitality, liesure travel, sport fishing, recreational boating and entertainment industries will suffer as the coasts are turned into polluted industrial sites.
Keep in mind that the perception of harm is as hazardous to BP as the harm itself. The claims against BP for oil spill pollution will be as enduring as those against Manville for its asbestos products. As liabilities mount and are directed against BP it will be increasingly difficult for management to extract assets from under the onrush of claims against them. In a sense, the failure of the US government to freeze BP assets both in the US and abroad will make sorting out BP much more difficult and costly for the company, its shareholders as well as for those making claims. Robert Reich has suggested putting BP into receivership for other reasons, most of which have been illuminated here on TOD.
The issue of claims brings the topic back to the beginning; is the product of BP equal in value to what has been so far been exchanged for it? Suggestions are made that this is the Chernobyl of the oil industry. Until that manifests in the activities of all the oil industry participants - the auto users - and does so by voluntary reductions in consumption, the result will be the submergemce of BP under its aggregation of claims against it in front of the backdrop of the submergence of the world's industrial economies under the value claims laid against them.
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