Oil, water and the law of unintended consequences

If there really is a god who intervenes in human affairs, I’d love to hear his explanation for the peculiar connection between the Exxon Valdez oil spill and the global financial crisis.

In 1989, the supertanker ran aground in Prince William Sound in Alaska and spewed 750,000 barrels of crude oil along 2,000km of remote, pristine coastline. The captain was sleeping off a vodka binge at the time of the accident and the officer on the bridge was navigating between rocks and icebergs without the help of collision-avoidance radar, which Exxon had refused to fix for a year to save a few bucks.

A jury in Anchorage decided that Exxon should pay punitive damages of $5 billion, equivalent to a year’s profit. Needless to say, the company appealed the decision. By way of insurance, Exxon set up a $4.8 billion line of credit with JPMorgan in case it ended up having to pay, which the bank hedged by creating a new financial instrument, known as… a credit default swap.

So the worst ever oil spill in US waters led to the creation of a financial product that, in turn, led to the worst recession in recent US history. How’s that for an unintended consequence?

But it gets worse. Exxon’s legal challenges eventually dragged the case before the Supreme Court in 2008, which resulted in the fine being reduced to around $500 million. So the full credit line was never needed and nor was the CDS.

Then, in 2010, BP’s Deepwater Horizon oil rig exploded, killing 11 people and releasing as much as 5 million barrels of oil into the Gulf of Mexico, affecting 500km of Louisiana coastline. Yesterday, the oil company was ordered to pay $4.5 billion in damages.

The circumstances that led to the explosion bore the same hallmarks as the Valdez disaster — namely, safety took second place to costs. Or, in other words, the industry didn’t learn the lesson of what happened in Alaska 20 years before.

It’s hard to imagine a worse outcome.

Big fines may seem a good idea, but are they? Perhaps it would be better to devise a punishment that better fits the crime. It’s reasonable to force polluters to pay for the cleanup and to provide reasonable compensation to the victims, but perhaps a kind of corporate probation would do more good than huge punitive damages, as well as a hard-headed review of safety standards across the whole industry.

BP is still on the hook for tens of billions in other legal actions. Who knows what unintended consequences that will create…

By the way, the Valdez is still sailing. It’s now known as the Oriental Nicety and is owned by Hong Kong Bloom Shipping.