Really Big Oil, Really Small Fines

Last week, Andrew Mayeda of the National Post uncovered changes that Canada's National Energy Board (NEB) had quietly made to offshore drilling regulations. Before these changes, companies had to meet specific requirements, most notably, in the type of blowout preventer and other pressure safety equipment that had to be installed while drilling. Under the new regulations, companies only have to set goals that will protect the environment, the specific equipment they install is up to them.

In this posting, I will compare the penalties for environmental infractions in both the United States and Canada and will then discuss the size of the penalties in context of the profitability of the enterprises involved in drilling in frontier areas.

In the United States, the legislation that penalizes companies for environmental infractions, like what is presently occuring in the Gulf of Mexico, is administered by the Environmental Protection Agency (EPA). The Oil Pollution Act (or OPA) was signed into law in August 1990, largely as a result of the Exxon Valdez spill in Alaska. Its intent is to provide the resources necessary to respond to oil spills by fining those companies that are responsible for non-compliance.

Here's an excerpt:

Key Provisions of the Oil Pollution Act

§1002(a) Provides that the responsible party for a vessel or facility from which oil is discharged, or which poses a substantial threat of a discharge, is liable for: (1) certain specified damages resulting from the discharged oil; and (2) removal costs incurred in a manner consistent with the National Contingency Plan (NCP).

§1002(c) Exceptions to the Clean Water Act (CWA) liability provisions include: (1) discharges of oil authorized by a permit under Federal, State, or local law; (2) discharges of oil from a public vessel; or (3) discharges of oil from onshore facilities covered by the liability provisions of the Trans-Alaska Pipeline Authorization Act.

§1002(d) Provides that if a responsible party can establish that the removal costs and damages resulting from an incident were caused solely by an act or omission by a third party, the third party will be held liable for such costs and damages.

§1004 The liability for tank vessels larger than 3,000 gross tons is increased to $1,200 per gross ton or $10 million, whichever is greater. Responsible parties at onshore facilities and deepwater ports are liable for up to $350 millon per spill; holders of leases or permits for offshore facilities, except deepwater ports, are liable for up to $75 million per spill, plus removal costs. The Federal government has the authority to adjust, by regulation, the $350 million liability limit established for onshore facilities.

§1016 Offshore facilities are required to maintain evidence of financial responsibility of $150 million and vessels and deepwater ports must provide evidence of financial responsibility up to the maximum applicable liability amount. Claims for removal costs and damages may be asserted directly against the guarantor providing evidence of financial responsibility.

§1018(a) The Clean Water Act does not preempt State Law. States may impose additional liability (including unlimited liability), funding mechanisms, requirements for removal actions, and fines and penalties for responsible parties.

§4301(a) and (c) The fine for failing to notify the appropriate Federal agency of a discharge is increased from a maximum of $10,000 to a maximum of $250,000 for an individual or $500,000 for an organization. The maximum prison term is also increased from one year to five years. The penalties for violations have a maximum of $250,000 and 15 years in prison.

§4301(b) Civil penalties are authorized at $25,000 for each day of violation or $1,000 per barrel of oil discharged. Failure to comply with a Federal removal order can result in civil penalties of up to $25,000 for each day of violation.

From what I understand, under the Oil Pollution Act, BP will be on the hook for a maximum penalty of $75 million (and, of course, removal and other cleanup costs) as the holder of an offshore lease or permit as outlined in section 1004. That sounds like quite a bit, especially when you add in the cleanup costs, but let’s take a look at some of the financial numbers from BP and the other 4 largest publicly traded oil companies:

Company Year Earnings (millions)

ExxonMobil 1Q 2010 $6300

2009 $19280

2008 $45220

2007 $40610

Royal Dutch Shell 1Q 2010 $5481

2009 $12581

2008 $26277

2007 $31331

Chevron 1Q 2010 $4550

2009 $10483

2008 $23931

2007 $18688

Conoco-Phillips 1Q 2010 $2100

2009 $4858

2008 ($16998)

2007 $11891

BP 1Q 2010 $6079

2009 $16578

2008 $21157

2007 $20845

Those are some pretty big numbers, ExxonMobil for example, had a net income that was nearly the same size as Canada's federal budget deficit for the past fiscal year.

If we look at the net income for all five companies from 2009 (which was a bad year because of the economic meltdown), the average is $12.756 billion. Since the maximum fine for a spill is $75 million, the fine works out to be an average of 0.588% of their annual net income. If we compare that to an average Canadian family with a median household income of $66,500 (2007) that gets a speeding ticket for $250 (and it's not hard to get one that size), the ticket works out to be 0.376% of their annual gross income. From this very rough calculation, you can see that, as it stands now, fines that currently penalize violators of the U.S. Government's Oil Pollution Act are no worse than an equivalent traffic fine to Joe Citizen. Certainly, the oil companies have to clean up the aftermath of an oil spill but insurance covers much of that cost.

In Canada, the situation is even more lopsided since the penalties for environmental damage caused by oil spills are far smaller. Remember that the same multinational oil companies are operating in Canadian waters, often through their Canadian subsidiaries. From what I can determine, under the Canada Shipping Act which came into force in July 2007, the maximum penalty for a pollution offence is $1 million. As well, the maximum penalty is $1 million under the Fisheries Act, $1 million under the Migratory Birds Convention Act and $1 million under the Canadian Environmental Protection Act. I have not been able to find any other fines that could be levied but if any reader has any additional information, please feel free to pass it along.

The Harper government has recently recommended in its 2010 Budget that responsibility for conducting environmental assessments for energy projects drilling in frontier areas (i.e. the Beaufort Sea) be administered by the energy industry-friendly National Energy Board rather than under the auspices of Canadian Environmental Assessment Agency which is accountable to the Minister of the Environment. This should concern Canadians since the National Energy Board members appear to have marginal qualifications to assess environmental issues related to offshore drilling. Unfortunately, that is what they are being called on to do. As I stated in my posting of May 2, 2010, Imperial Oil Resources (aka ExxonMobil) has applied to drill a well in the Beaufort Sea without drilling a same season relief well (in case of a blowout) since they claim that improved blowout preventer technology should prevent an oil spill.

I would suggest otherwise. So, most likely, should BP.

Both the United States and Canadian governments need to markedly increase fines where oil companies are found guilty of oil spillage incidents. Unless fines are severe enough to cause some notable measure of financial difficulty for these multinational oil companies, they will not be in any hurry to improve their safety practices. Cost-benefit analysis could result in cost reduction at the expense of the environment since reducing costs adds to earnings over the short term (and also increases the value of executive stock options).

Even if oil companies make herculean efforts to prevent environmental damage, accidents still happen but Canadians need to know that our politicians are doing their best to protect both the environment and those who rely on the marine ecosystem for their livelihood.