Petrochemical disasters, particularly oil spills, have certainly had catastrophic effects on ecological balance. From water contamination to chemical poisoning of organisms and many others, the environment is adversely affected by petrochemical disasters. Companies such as Spill Tech Environmental can help to clean the contamination up but still does not solve the financial knock on affect it has. The effect of oil spills is however felt further than the immediate scene of the accident. First, it leads to contamination of coastal areas with high amenity value, has serious negative implications for the tourism and mariculture industries, and perhaps what is felt by everyone, is that oil spills cripple the economy.
As corporations and individuals dependent on coastal areas attempt to clean up the mess, they incur serious economic losses. Though the oil dealers and the tourism and fisheries sectors are the ones that feel the greatest impact after oil spillage, some numerous other industries and sectors suffer disruption and a decline in their revenue. The stock market has been one of these sectors since time immemorial, and the correlation, that perhaps seems a little far fetched to many, has led to the question of how the two relate.
To understand the relationship between oil spills and the stock market, you must understand the relationship between them and the economy as well as the relationship between the economy, oil, and the stock market.
Oil Spills and The Economy
As recreational activities like angling, diving, swimming, and boating are affected by oil-contaminated shores, they have negative impacts on the tourism sector, both locally and internationally. Though this disruption only lasts for a short while, sometimes wide-scale pollution and public perception remain long after the oil has been taken care of. This results in more long terms and damaging economic impacts. Following this, local businesses fail and the hotel industry suffers unprecedented losses which in turn affect suppliers, tour operators, transport companies, national parks, and many other businesses that are supported by the tourism and hospitality industry.
Company share prices are also deemed to decline. Take for example an oil company known as BP, who suffered a catastrophic oil spill in the Deepwater Horizon rig in the Gulf of Mexico in 2010, which led to a 12% loss in market capitalization half a year after the accident. The accident was a result of an explosion that led to the death of 11 workers. The explosion led to collapsing of the platform which spilled huge amounts of oil that reportedly reached the Louisiana coast. To date, the accident remains one of the worst oil spills in history but what were the effects of the accident on the economy?
Consider this: the Gulf fishing and tourism industries produce $3.5 – $4.5 billion a year yet it cost BP $4 billion to contain and clean up the mess and another $4 – $5 billion in penalties. The effects of the accident, however, were not just limited to BP, and not for the short while of the catastrophe. To date, they continue to be felt in the Gulf of Mexico, particularly in the tourism and fisheries industries. A recent study by the Canadian Journal of Fisheries and Aquatic Sciences revealed that in 7 years, an 8.7-billion-dollar loss has been felt by the economy of the Gulf of Mexico. This loss includes losses in wages, profit, revenue, and more than 20,000 jobs.
Using BP as a case study, the relationship between the economy and the oil spill is obvious. Local businesses, international businesses, and the government in itself suffer innumerable losses. As a result of losses suffered by oil companies and businesses comes inflation and the reduction of consumer spending as gas prices rise in an attempt to recover from the financial loss. Higher gasoline costs have knock-on effects throughout the broader economy, which brings us to the relationship between the economy and the stock market.
The Economy, Oil Prices, and The Stock Market
As oil prices rise and inflation soars, the cost of production and manufacturing rises as well since many industrial chemicals are refined from oil. This affects the cost of doing business, which in turn affects consumer spending. A healthy economy leaves more disposable income in people’s wallets while a crippled economy (one where every business, industry, and individual seems to be struggling to make ends meet) barely leaves anything in the consumers’ pockets. This explains why there is a direct relationship between a drop in fuel prices and the stock market.
From large investors to the level of an individual consumer, more discretionary income means more stimulation for the stock market. Without enough disposable income, this automatically means fewer investments in the stock market, especially in firms that are directly impacted by oil prices. An increase in oil prices also raises input costs for most businesses and consumers which makes them spend more money on oil and leaves little for other businesses and investments in the stock market.
To explain further, most product and service sectors in the stock market, particularly the sector of transportation has a strong correlation with oil prices. This is expected since the dominant input cost for transportation firms is fuel. Investors, therefore, cut their investments in the stocks of corporate transportation companies when oil prices are high or when the economy is deteriorating following an oil spillage. This is especially the case because an oil spill means more taxation, and regulatory fines, not to mention the poor corporate image. The hazard amplifies the risk of investment, meaning more reluctance to invest in the sector.
That said, oil spills increase oil prices as firms attempt to recover from the loss. As such, this leads to a decline in economic growth and increases inflation expectations over shorter periods as businesses and individuals attempt to keep up with the high fuel costs. Decreased economic growth prospects, in turn, lower companies’ earnings expectations, resulting in a reduction in stock prices.
This relationship is however more complex than conventional wisdom. Some industries thrive when oil prices are high. Oil companies can exploit higher-cost shale deposits thereby creating jobs and encouraging investment. Lower prices could, in turn, hurt uncustomary oil activity but work well for manufacturers and the transportation industry.
The diversity of industries, therefore, presents complexity when concluding the interrelationship between oil spillage, the economy, and therefore the stock market. Nevertheless, oil Spillage harms the stock market since it leaves oil companies on the wrong side of potential investors. That said, how does the stock market react to oil spills?
How Oil Spills Affect the Stock Market
After an oil spill, the rate of economic growth declines as businesses close down, tourism reduces, and inflation increases. As economic growth prospects decrease, corporations’ earning expectations reduce. This is also attributed to the fact that consumers are attempting to recover from prevailing economic hardships. Stock prices therefore reduce.
Additionally, an increase in operational costs due to the dwindling economy compresses company profit margins. As such, most investors are skeptical about the future of corporate earnings which again, increases the downward pressure of stock prices. That said, following an oil spill, all the factors and risks involved discourage any potential investor who may look forward to an increase in stock prices. It signifies a decline in real long term yields as compared to profits.
A previous study of the EURO STOXX index in 1987 showed a positive impact when oil prices were low/medium, during economic growth. The opposite was true where the euro performed negatively during high oil prices and economic decline. Despite this, however, it was obvious that the performance differed significantly across different sectors. Technology and cyclical good sectors were affected by a decline in the economy while the energy and utility sectors seemed to be less affected.
Nevertheless, the stock market is negatively influenced by oil spills. In this respect, underperformance can be attributed to skeptical investors, low investment power by individuals, and poor business performance due to a crippled economy. As the affected oil company recuperates, though it may be insured against the business interruption and physical damages, there are further-reaching implications that are more difficult to predict and assess.
Conclusion
Petrochemical disasters are not minor accidents. They lead to catastrophic effects that have a rippling effect. Taking the BP incident as an example, the company lost around $25 billion in market value in 10 days following the oil spill. Though precise assessments of the exact impact on stock market prices and activity are absent, the financial implications of such accidents are obvious.
Many may assume that investors do not perceive industrial pollution as a serious matter, but the truth of the matter is that the effects of oil spills are far-reaching than the environmental implications involved. Even with a comprehensive assessment of a firm’s stock returns following the accident, the future remains uncertain and the macro risk factors involved limit the number of willing investors. Shareholders suffer a significant loss of about 1.3% over the two days immediately following disasters, and this is even greater if the firm has a record of bad environmental and safety records.
Conclusively, the stock market is negatively impacted by oil spills especially after an oil company is declared responsible for all cleanup operations and cost of response. However, the overall economy and stock market remain too complex to expect one commodity to drive all business activity in a predictable way which is why the effect of oil spills on the stock market remains a grey area.