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The Worst-Case Economic Scenario for the Oil Spill

Over the weekend, David Kotok of Cumberland Investors, a much-watched CNBC market analyst, put out a very gloomy analysis of the economic impact of the BP offshore oil spill. Entitled “Oil Slickonomics,” the note traces out three possible scenarios, depending on how quickly the government and BP contain the spill, but Kotok reminds us, “There is no ‘good’ [scenario] here.”

In the best case, he thinks:

Containment chambers are put in place and they catch the outflow from the three ruptures that are currently pouring 200,000 gallons of oil into the Gulf every day. If this works, it will take until June to complete. The chambers are 30-foot-high steel configurations that must be placed on the ocean floor at a depth of one mile. This has never been done before. If early containment is successful, the damages from this accident will be in the tens of billions. The cleanup will take years. The economic impact will be in the five states that have frontal coastline on the Gulf of Mexico: Texas, Louisiana, Mississippi, Alabama, and Florida.

And in the worst, he thinks:

This spew stoppage takes longer to reach a full closure; the subsequent cleanup may take a decade. The Gulf becomes a damaged sea for a generation. The oil slick leaks beyond the western Florida coast, enters the Gulfstream and reaches the eastern coast of the United States and beyond. Use your imagination for the rest of the damage. Monetary cost is now measured in the many hundreds of billions of dollars.

Moreover, he teases out the macroeconomic impact in any possible case:

Federal deficit spending will certainly rise by tens, and maybe hundreds, of billions as emergency appropriations are directed at larger and larger efforts to clean up this mess. At the same time, federal and state revenues tied to Gulf-region businesses will fall….

We expect that the Federal Reserve will extend the timeframe that we have come to know as the “extended period” in the making of its monetary policy. We do not expect the Fed to raise interest rates at all for the rest of this year, and maybe well into next year. We expect to see the deterioration of the economic statistics for the US to reveal the onset of this oil-slick crisis in May, and the negative impact will intensify during the summer months. A “double-dip” recession probably has been made more likely by this tragedy.

We are at the highest level of cash in our U.S. stock accounts that we have seen in over a year and a half. We expect a market correction will present entry points at lower stock prices. We have exited the financial sectors, including the insurance ETF. We now worry about the banks that are exposed. We do not own the major oil stocks now. Some of them face enormous liability payments.

In short, Cumberland believes that the oil spill has likely increased the chance of a double-dip recession due to the enormous economic damage to the Gulf states (already not faring too well, particularly Florida), financial and energy company exposure to the crisis, the outsize impact on small businesses and the new federal deficit spending required — all of this on top of the tremendous environmental impact.

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