What Investors are Learning From The BP Oil Spill

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At the time of writing this post, a two-tonne plug is being lowered in to the Gulf of Mexico, in an attempt to stop one of the largest oil leaks in history. In Washington this week, the blame game began, as executives of BP, Transocean and Halliburton —  the three main companies connected with the oil spill — testified in the Senate.

Details continue to emerge, especially relating to environmental indicators. At the moment, there is little indication that the term “oil spill clean up” will turn out to be anything but oxymoronic. Rather, it is more likely that the majority of spilled oil will be dispersed and diluted or will sink in globs, wreaking havoc on marine life and coastal economies for years to come.

To compound the ecological damage, we are also learning of the significant failings and potential corruption of the Interior Department, its Minerals Management Service and how these oversights likely lead to the disaster.

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The April 20th explosion injured 17 workers and killed 11. The spill covers at least 2500 square miles of ocean surface and continues to spread to the southernmost shores of the U.S.

In the wake of our latest financial meltdown, shippers, shrimpers and tourism officials brace for the severe the economic impact resulting from an environmental crisis. Some analysts have already estimated that the spill could cost up to $3 billion and overtake the scale of Alaska’s Exxon Valdez disaster within two months. BP, the UK oil giant which owns the drilling rights for Deepwater, has seen billions of dollars wiped from its market value since the blast.

It is no wonder then that shareholders have reacted swiftly and unsympathetically. This week, BP’s investors were the latest plaintiffs to go to court over the spill, alleging the company had long put profits ahead of safety and now faces potentially billions in losses because of the ongoing disaster.

The first such lawsuit – Firpo v. Hayward – alleges that BP executives and its board “recklessly disregarded accidents and safety warnings for years” related to the Deepwater Horizon rig. A similar class action was filed in Montgomery, Alabma, by over 40 BP shareholders who contend the company’s poor safety record, coupled with the Deepwater rig accident, could ultimately destroy the company. In addition to BP, the Firpo suit also names as defendants Transocean Ltd., which owned the rig; Cameron International Corp., which provided the blowout prevention equipment that allegedly failed; and Halliburton Energy Services Inc., which cemented the well.

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A Lesson for Investors: The Demand for Disclosure

Over the coming weeks, data surrounding Deepwater Horizon could prove substantially off the mark. Still, mere estimations (and visuals) have already given investors a sense of the systemic risks associated with investing in the oil and gas industry and the consequences of poor disclosure and risk management.

While it is true that every company is exposed to sector-specific risk, oil and gas companies are particularly complex. The industry’s regulatory community is global in reach and involves a variety of players. In the public sector, governments have been charged with creating a global framework that blends foreign policy, geopolitics and a variety of markets.

Private sector companies are helping to create voluntary industry standards and are investing in research and development, oftentimes, with public funding. Through their distinct but interlocking roles, governments, businesses and legislators are attracting attention to climate change, energy and natural resource regulations.

This engagement is underscored by a number of global agreements such as the Kyoto Protocol and the United Nations Framework Convention on Climate Change. The United States is currently waiting on the Kerry-Lieberman climate bill that focuses on the danger of being beholden to oil-producing countries and includes drilling protection measures. Risk-related policies and regulations are now evident within the standard operating environment of the energy business, from rigs to utilities providers.

The emergence of global policies and regulations are, and will continue to impact the oil and gas sector specifically by increasing the costs of operating a business, by potentially reducing the attractiveness of investment and by altering the competitive landscape. As more regulatory-driven incentives to reduce risk exposure emerge, the outlook of investment opportunities will alter.

These emerging regulations aim to ensure greater efficiency and sustainability, but they are often opaque to common investors and are criticized for their institutional murkiness. Accordingly, an investor’s ability to fully recognize a company’s exposure to risk and regulation becomes almost impossible. This uncertainty is compounded by political and economic trends, and by individual companies quietly disregardful imposed regulations.

As the Deepwater incident reveals, shareholders are responding to uncertainty and complexity by demanding additional disclosure on environmental practices, safety protocols, overall risk exposure and a company’s response to forthcoming regulations. In particular, they are concerned about the potential for future carbon regulation, price volatility, resource scarcity, legal and reputational risks, employee death, contractor relationships and the impairment of residents to impact local economies. These issues are material to the company and ultimately impact its market value.

As regulatory frameworks and media coverage have begun to drive investment risks and opportunities, responsible investors are linking strong corporate disclosure and positive initiative with favorable financial performance. The development of the Global Reporting Initiative, supply-chain report cards and qualitative environmental metrics has fostered an increase in the availability and quality of data that is necessary to benchmark company performance objectively and to allow investors to incorporate clear information as part of the investment process.

Much like this last financial crisis or today’s climate change threats, the Deepwater Horizon tragedy is about risk, how it is priced and managed, and the consequences when risk management goes wrong.

The alleged cause(s) of the explosion serve to remind investors of the importance of corporate disclosure as an important step to good risk management. Disclosure is particularly crucial for those companies that compete globally, as they are subject to assessment of their abilities to comply with evolving international standards and the heightening expectations of their shareholders.