Macondo, BP and Disaster

Relevance

The Macondo disaster has shocked the public and oil and gas industry insiders alike. The impact of the disaster will be significant and far reaching.The main players in this crisis have not distinguished themselves and we seek improved leadership from BP, the oil and gas industry more generally and from politicians. Amid all the recriminations, vindictiveness and evasion of responsibility the people most directly impacted by the tragedy must be wondering who, exactly, is on their side. A rigorous focus on, and resolution of, the following issues would, of course, help:

  1. Stopping leak
  2. Cleaning the spill, and
  3. Paying out damages to those impactedThere will be plenty of time for apportioning blame later, once all the facts are clear and understood. In the meantime BP should focus its efforts on managing the crises and President Obama’s administration should refrain from populist politics to reassure that it has the above priorities firmly entrenched. Grandiose statements about energy policy, sustainability and renewables are simply not relevant at the current time.

For now we must hope that the meeting between President Obama and Carl-Henric Svanberg, BP’s chairman, scheduled for today, marks a tipping point in better management of this crisis.

Analysis

BP or Anglo-American Petroleum?
BP’s U.S. based business is large, by any standards. Such is its size many may take the view that it is, in fact, a U.S. company. BP is the U.S.’s leading producer of oil and gas and the U.S. accounts for 1/4 of all BP production, 1/3 of its reserves and approximately 1/3 of its assets. Americans hold 39% of all BP stock (the U.K. holds 40%) and BP has many thousands more employees in the U.S. than in the U.K. 8% of BP’s total reserves base is in the Gulf of Mexico alone. There are currently two American executives, Robert Dudley and Byron Grote, on the main board along with four American non-executives: George David (of United Technologies Corporation); Paul Anderson, former CEO of BHP Billiton; DeAnne Julius, an economist; and Cynthia Carroll, CEO of Anglo American (a mining group). Given BP’s long history of business in the U.S., how could things have gone so wrong?

BP
In crises it’s perceptions that matter. Tony Hayward, the BP CEO, has done a great job perpetuating the perception that the current crises is beyond him. He has repeatedly failed a series of basic PR tests, right from the beginning. His initial tactic of laying the blame with other parties (Transocean and Halliburton, the main service providers during the drilling operation) back fired immediately and spectacularly, appearing to outsiders to be a cold attempt to absolve BP of any responsibility. Under most oil industry service contracts the investors remain liable for damages and specifically indemnify the service companies against losses, so the BP group is unlikely to pass the bulk of the financial pain to Transocean and Halliburton anyway.

Mr. Hayward stands accused of being slow to give information to government officials and congressmen and his early prediction that the environmental impact from the Macondo well will be modest shows a woeful lack of judgment. His effort to introduce light humour (“I would like my life back”) was met with incredulous disdain. While humour can be used to good effect to diffuse a very challenging situation and is seen as welcome stoicism in some parts of the world, this joke did not go down well on the Gulf Coast. He should have known better.

PR experts have criticised BP for using funds for an advertising campaign – BP maintains that this is a useful way for it to get its message across. The low profile of BP’s chairman, Carl-Henric Svanberg, who is new to the job, is also attracting the wrong sort of publicity. Many believe that he should have been camped out in Washington – leaving the operations on the Gulf Coast to Mr. Hayward.

BP has admitted that it does not have the tools to manage the incident immediately and even industry insiders not directly involved in the deep water operations have found this surprising and disquietening. It leaves BP open to broader questions of its ability to manage other risks and there is further concern that the industry as a whole is inadequately prepared to respond to such incidents in the deepwater. U.S. lawmakers on Tuesday this week were scathing in their attacks on ExxonMobil, Shell, Chevron, ConocoPhillips and BP as the companies presented their emergency response plans to congress. The absence of meaningful and specific emergency response plans in all companies is stunning and other operators have been noticeably absent in offering significant assistance to BP to deal with this tragedy.

Externalities
At this point it would be helpful to introduce a concept that economists use called externalities. Externalities exist when benefits or costs occur outside markets that are not reflected in market prices. Sulphur dioxide pollution from coal burning power stations is a good example of a negative externality: such pollution forms acid rain that falls on a distant population that then bares the cost associated with the resulting environmental damage. Of course, positive externalities can exist as well – if a proportion of the population is vaccinated against a disease then the whole population benefits due to the reduced occurrence of the disease. An ongoing problem for governments is how to handle externalities. In the case of the banks governments around the world decided to use vast sums of public money to prevent the knock-on effects of bank failure. In the U.S., auto manufacturers had large sums of public money made available to prevent them from going bust, which would have resulted in significant job losses and other economic impacts. Such government largesse is rarely available to oil companies. Detroit went bust because it failed to respond to the competitive pressure presented by Asian manufacturers and banks must be thankful that their bad trades are invisible to the public eye. However the U.S. government is less keen to bail out an oil company than either Wall Street or the auto firms. In fact the exact opposite is true – BP has been told it must pay along way down the chain of consequential losses.

U.S. Government
The issue of consequential losses is amongst the most unsettling of ideas promoted by President Obama and his officials. Some have suggested that should BP be liable for the pay of drilling workers that have lost wages due to the drilling moratorium. But where would such a chain of claims end? Should BP also pay for lost income at the restaurants where these workers had lunch? No one would ever go into business (not least the oil business) if they were held responsible for all consequential losses arising from damages caused. The impact on the U.S. of such a policy could be severely negative: it is by far the world’s largest holder of foreign assets and should other countries seek consequential losses for, say, the global financial damage induced by the U.S. banking system the impact would be catastrophic in many ways. No such moves were made by Union Carbide in the Bhopal case in India.

The interference from the administration in BP’s dividend decision is also unhelpful. Calls by some politicians for a dividend cut are unnecessary – it is the responsibility of BP’s board of directors to make sure it can meet its obligations to all stakeholders and the dividend decision is one that they alone should make. At no time has the company tried to shirk its responsibilities for payments for damages and politicians should maintain distance from the internal workings of a publicly traded company. At a different time and in a different place these moves would be seen as a creeping “socialist” dictat, rather than a market based solution.

To cap it all, senior officials from the Obama administration have been calling for new legislation which could be applied retroactively to BP. This seems to break every tenet of the principle of the rule of law and is likely to be unconstitutional. Equally, laws cannot be directed at solely one company and any such move would have serious implications for not only the whole oil and gas industry, but also the wider economy.

Governments can manage dire situations such as the current disaster without employing a lynch mob mentality or abusing constitutional rights: The 1988 Piper Alpha incident in the North Sea offers a good example. In this disaster there were 167 fatalities due to poor safety management by the operator Occidental, a U.S. company. There is no record of Margaret Thatcher ramping up the political rhetoric or trying to brush aside the constitution to seek vengeance against a single company, or indeed seeking to impose penalties for externalities.

Impact on Investment and Investors
The moratorium on deep water drilling in the Gulf of Mexico is in place until November 2010. Delays to drilling could impact Gulf of Mexico by production by 80-100mbd, a respected industry consultancy says. Smaller oil companies with a large part of their interests held in the Gulf of Mexico will be impacted disproportionally and potentially severely. Such companies will not be able to replace declining reserves and will also face increased costs, including: slower and more expensive permitting; increased liability insurance; higher spill fund levies; higher offshore service rates; and increased drilling costs due to greater checks and more rigorous safety procedures. Larger companies have global scope and flexibility to manage these risks better and can more easily invest in less well regulated markets. Many companies will face an increased cost of capital to cover, for example, more stringent lending requirements from banks that are exposed to the increased risk. Companies with a large percentage of reserves in the Gulf of Mexico include: BHP Billiton, Hess, Anadarko, and Apache.

Oil Price
With its initial deepwater discoveries in the Gulf of Mexico, BP was hailed as a pioneer, the conquering hero bringing new supplies to the deficit U.S. oil market and reducing the country’s reliance on foreign oil. Now the Macondo disaster changes things yet again, this time for the worse (from a U.S. perspective). The short term impact on oil price is likely to be low, as existing supplies are unaffected, and indeed so far this has been the case, with oil trading at around $75/bbl, its recent average. In the medium to long term though the picture looks very different. Reduced supplies and increased costs due to tighter regulation in the U.S. (and in other OECD countries whose standards may need to rise) will shift the oil supply curve to the left putting upward pressure on price. OPEC will become more powerful and its position will be enhanced as the relaxation of licensing restrictions in U.S. sensitive areas now seems unlikely (e.g. Eastern Gulf of Mexico and the Atlantic Offshore Continental Shelf).

Regulators
BP’s Macondo disaster brings to an end a rather laissez faire approach to oil and gas policy introduced during the Bush era. Amid claims of market failure, new safety regulations and offshore drilling oversight are inevitable, in the Gulf of Mexico and perhaps elsewhere. The Minerals Management Service (MMS, the government agency that monitors the offshore safety practices of the oil and gas industry, amongst other things) is likely to be completely overhauled with some of its responsibilities moved to other agencies.

U.S. Politics
The Macondo disaster could not have come at a worse time for President Obama. His administration’s struggles over health care, Wall St and the troubled economy have drained it of energy and no small measure of political capital. Furthermore, allegations by some in the communities affected that Mr. Obama does not connect with or show empathy for those impacted seem to be sticking. A Washington Post poll says that 69% of voters feel that Mr. Obama is mishandling the crisis, higher even than for President Bush over Katrina. His response to such criticisms, no doubt with one eye on the mid term elections later this year, has been a crudely populist approach that could actually make matters worse for all concerned. Mr. Obama has succumbed to a media led campaign that could never deliver satisfaction for the people on the Gulf Coast most affected by the tragedy and which has been personal and vindictive, almost demonizing BP. The end result has been to cast himself in the role of furious and hapless bystander. Comments such as seeking an “ass to kick” and “…boot on the neck of BP…” (used by 2 administration officials) raise the concern that BP could be sacrificed in a broader effort to reposition Mr. Obama with electorate. His tactic seems to be to deflect criticism of his own performance in response to spill by keeping public attention on BP – even going so far as to highlight BP’s “foreignness”, for example through repeated references to British Petroleum (a name that the company dropped a decade ago).

Meanwhile, the other parties involved in the tragedy, Transocean and Halliburton barely receive a mention (the latter’s decision to precede with $1B dividend pay out attracting little attention by comparison). One consequence of this approach is to put BP is under greater financial stress (for example its share price down about 40% and insurance costs for its corporate bonds increased to junk levels) making it less likely that the company will have the financial strength to pay damages (although no one is suggesting the firm will not be able to meet the current estimates of damages). Still others worry that the Obama administration is light on oil and gas advocates, and that the proponents of renewables within the administration are taking the opportunity to trash the industry.

Conclusion

The impact of the Macondo disaster will be far reaching. Regulatory standards for deep water exploration will be tightened, adding to industry costs and pushing up the price oil. Most deep water potential is non-OPEC and therefore OPEC’s power will be enhanced and U.S. security of oil supply will likely be diminished. Public suspicion and mistrust of the oil and gas industry has been further heightened, and will lead to new calls for subsidies and other inducements to encourage renewable energy growth. The industry will need to work as one to convince the U.S. government (and others) that it can define real and meaningful emergency response plans.

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