Monday, June 14, 2010

BP: Too big to fail? [update 4]

OB-IV874_bpvalu_D_20100611163307 IT’S ONE OF THE OLDEST rules in the common law book: Produce something unsavoury on your property, or unleash something extraordinarily unsavoury, and you bear sole responsibility for whatever damage it might do to your neighbours.

That’s the rule that might bury BP.

The calculation is simple. The cleanup bill for BP’s fiasco in the Gulf of Mexico fiasco looks to be around $100 billion. And after last week’s collapse in its share price, BP’s market capitalisation is still around $100 billion, just enough to pay the costs of all those whose livelihoods have suffered damage by their actions.  And therein you see the big problem for the big oil company—and for the big British pension funds that have relied on BP’s returns to bankroll Britons’ retirement

It’s not good enough to argue that BP is too big to fail. Damage your neighbours’ property—or the fishing grounds and shrimp harvests in which your neighbours have property—and it’s your responsibility to pay for the cleanup, even if that buries you.  (Note that it buries you, but not your assets, which still go on after your demise, just in other hands.)

And it’s not going to be good enough to argue that British pension funds are too big and too important to be able to fail. Risk must come with consequences, if law is to mean anything at all.

SO WHAT WENT WRONG and who was responsible?  The mainstream answer was put up by Rachel Maddow last week, who demonstrates that brains are no good unless you use them. “Tonight on the show,” she says on her blog, "we're looking at why BP wasn't prepared to deal with the Deepwater Horizon disaster. Short answer: No one made the company get ready.”

It might  be a short answer, but it’s sure as hell a wrong one. It isn’t a who that makes a company formulate plans to mitigate or avoid disasters, it’s a what.

Contrary to Rachel’s contradictory world-view, what does (or should) motivate companies like BP to mitigate or avoid disasters is one very basic thing, and that’s their own long-term self-interest.

I can almost hear Rachel’s “WTF?!” as I say that. But as BP’s imminent demise demonstrates, if you’re not set up to properly handle the many things that can go wrong in unleashing something as unsavoury (in the wrong places) as BP’s product, then your long-term future is a dismal one—as is the future of all those who were relying on your acumen and decision-making ability, like the beneficiaries of those pension funds for example.

Clearly, if your long-term survival and prosperity is important to you—and why wouldn’t it be?—then the more unsavoury the stuff with which you deal, or the more damaging the consequences of its uncontrolled release, then the more care you must take to insure against  its unplanned release, and to deal with it if that happens.

On the basis of BP’s obvious unpreparedness, it looks like BP has betrayed its own self-interest, and after paying the bill for that failure they will be left only to provide the fertiliser for the better management of their assets by others.  In that, there is a powerful ethical lesson for everyone involved in business.

    “…the likes of Tiger Woods and Bernie Madoff and Elliot Spitzer, all of whom would conventionally be called “selfish” for what they did, should actually cause you to call into question your conventional view.  None of these mean at all look like they’ve been rationally selfish—in fact they’ve all been decidedly unselfish in any rational sense--and that, in fact, is the leading cause of their downfall.”
The Unselfish Actions of Today’s “Selfish” Men - THE UNDERCURRENT

UPDATE 2: Another memo to Rachel Maddow [hat tip Gus Van Horn]:

    "’If you could control an oil spill with lawyers and regulation-writers, and by signing papers and obtaining court injunctions . . . then maybe the U.S. government could do something’ said Byron W. King, an energy analyst at Agora Financial. ‘But really, Uncle Sam has almost no institutional ability to control the oil spill. For that, you need people with technical authority, technical skill and firms with industrial capabilities.’"

And also, one might add, a keen sense of their own rational self-interest.

UPDATE 3: You think maybe a tantrum from the president might fix things?  Um . . .

    “’Since the oil rig exploded, the White House has tried to project a posture that is unflappable and in command.
    “’But to those tasked with keeping the president apprised of the disaster, Obama’s clenched jaw is becoming an increasingly familiar sight. During one of those sessions in the Oval Office the first week after the spill, a president who rarely vents his frustration cut his aides short, according to one who was there.
    “‘Plug the damn hole,’ Obama told them.’
    “That’s the politician’s answer to every intractable problem: give orders, issue threats, and wait for obedience. But the creative human mind cannot take orders like that. Notice I didn’t say, ‘refuses to take orders.’ I said, ‘cannot take orders.’
    “By that I mean, the task of plugging a leak 5,000 feet below the surface of the Gulf of Mexico is an engineering feat. BP’s acknowledged role in causing the leak does not alter the fact that careful study, creative thought, and the exacting deployment of technical and mechanical skills over long distances are all necessary in order to fix the leak. No amount of jaw clenching or bug-eyed threats from politicians can bring the solution one inch closer to reality. The human mind does not operate by force from outside. If engineering achievements could be conjured up by barking orders, the Soviet Union would be a thriving nation overflowing with engineering marvels, instead of a dead husk…”
“Plug the damn hole!” – THOMAS BOWDEN

The implacable enemy that Obama faces is not BP, but reality:

    “Now, as the economy implodes under the weight of government debt, taxes, and every manner of statist intervention, (including environmental regulations that resulted in deep water drilling! [HT: Gus Van Horn] and now, the shut down of oil rigs that work!) Obama and his supporters find themselves up against an intransigent and implacable force - reality.”

Which as King Canute should have taught them, is the one thing over which politicians really do have no power.

UPDATE 4Noodle Food has another good link:

    “The standard argument [made by Maddow and others is] that the problem behind the BP oil spill was a problem of capitalism. Instead, [this article by Wendy Milling] shows how it was an industrial accident significantly worsened by anti-capitalist government policies to become a disaster.”

Read Milling’s article, "No Thomas Frank, Capitalism Is Perfect.”  Great title, great arguments. For example:

    “Assaults on capitalism are rooted in a crybaby metaphysics, and they rely on obfuscations, equivocations, and an attitude of militant evasion. One trick is to make inappropriate demands of capitalism, then stomp and pout and denounce capitalism when those demands are not met.”

Stomp and pout?  You’d think she’d been reading Martyn Bradbury. 

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13 Comments:

Blogger Shane Pleasance said...

Amen.

6/14/2010 11:09:00 am  
Blogger Mark said...

I can’t comment on whether BP were negligent in this affair or not. i.e. to what extent are these sort of accidents always going to happen, and the occasional price one pays for living in an industrialized country with high living standards? However I can say from personal experience that being made to write 500 page “response plans” (the document that Madow justifiably takes apart) rarely makes things safer, and often make things less safe.

This is because you’re forced to enter an alternate universe when you write these plans – the mind of the bureaucrat, not the real world. What’s typically demanded is all sorts of waffle and weasel worlds that sounds nice to bureaucrats – not real and practical solutions, of which they typically no little. When a government authority has to approve it, a concise and specific action plan that addresses the real dangers rarely cuts the mustard. You’re encouraged to write a long and pretty - but meaningless document. The result is that when a real emergency happens, your “response plan” is totally impractical (or it’s buried amongst 500 pages of waffle),you may not have thought about the real solutions, and you’re therefore left floundering,

6/14/2010 11:17:00 am  
Blogger twr said...

Is there any evidence that any other oil company is any better, or that they are likely to become better as a result of this? The most likely outcome is that they will continue to consider this just a risk of being in that business.

6/14/2010 11:44:00 am  
Blogger Dinther said...

I wonder what would happen if BP folds under the pressure they are under? Who will clean up if BP is not around to do it?

With all the hysteria I can not help but wonder how much greater the damage will be if BP would give up and go out of business.

Shit happens. Even big shit. We all love to use oil so rather than wagging fingers I'd say BP might welcome some help.

6/14/2010 12:19:00 pm  
Blogger PC said...

@Mark: That's right. The underlying assumption being that the bureaucrats have discoverd how to ensure permanent safety for all atime and forever, and all you have to do is sign up to their 500-page blueprint and everything will be fine.

But the uncertainty of problem-solving can't be addressed that way. That's what entrepreneurs are for.

@TWR: "The most likely outcome is that they will continue to consider this just a risk of being in that business."

In which case, if companies wish to leave their whole existence at the mercy of risks they should have planned to address, the most self-interested action of investor would be to shun them.

6/14/2010 12:21:00 pm  
Anonymous Falafulu Fisi said...

PC have you ever designed house that is anticipated to withstand earthquake which can measure a 15 or more on the Richter scale? If not then why not? Taking on extra risks on anything comes with higher costs. The higher the risks, the higher the costs of risk that one takes, the higher the costs that one must pay.

It is very common that people wouldn't want to pay for high risk events even if those events are rare (on probability scale) exactly as if you would inform your clients that the cost of designing a house that can withstand earthquakes of magnitude 15+ is very costly, even though the likelihood of such event is rare (perhaps it occurs once every 100,000 years or so).

I bet you that none of your clients will ever want to pay extra costs for such a full proof house against rare earthquakes of 15+ magnitudes.

Industries want to scale and I think paying extra for the insurance against anticipated disasters (but rare) as we've seen in this case with BP here would be uneconomical. BP must suffer the consequence of its management incompetents, but that's not a good reason to stifle or prohibit (some of) their operations. It is anti-capitalism. It is always easy to say something in hindsight when it’s already happened.

6/14/2010 12:28:00 pm  
Blogger StephenR said...

One trick is to make inappropriate demands of capitalism, then stomp and pout and denounce capitalism when those demands are not met.”

Went to a debate on capitalism at the university of auckland a few weeks back, and both sides just ended up talking past each other with what seemed to be about four different definitions of the word, though no one bothered to try defining it in the first place. It's a tricky thing for all, it would seem....

6/14/2010 01:04:00 pm  
Blogger StephenR said...

Is there any evidence that any other oil company is any better,

This may or may not suffice, but The Daily Show had BP committing a few hundred various violations over the past several years, with Exxon and two others combining for about 10. A BP guy was asked about it but didn't do too well.

6/14/2010 01:07:00 pm  
Blogger twr said...

"In which case, if companies wish to leave their whole existence at the mercy of risks they should have planned to address, the most self-interested action of investor would be to shun them."

True, but much like with finance companies, many investors didn't know the risk or chose to ignore it. The other problem which makes it hard to BP or any others to do anything about it is that investors, particularly the corporate/fund ones who make up the vast majority of the shareholders of most companies have to deal with clients who are focussed on the best returns in the short term. Management has the same focus, as their remuneration is based on short term performance rather than what happens in 20 years. BP obviously chose to take that risk and the investors obviously did too.

6/14/2010 01:45:00 pm  
Anonymous V said...

http://www.ritholtz.com/blog/2010/06/10-thoughts-for-those-buying-bp/

This is worth a read, particularly points #6,7 and 9.

BP generates significant monthly cash-flow, that should be used to pay compensation over a longer time period.

Yes it's market cap is $100 billion (on paper), but the problem occurs in trying to obtain that in a monetary form following a bankruptcy/liquidation.

In reality, (and this should be quite clear), if you tried to liquidate, the question is then well who would buy the company?
Nobody would purchase the company with undefined cleanup liabilities attached. Therefore the structure of paying the cleanup costs is important.

In some ways BP is worth more alive than dead, as much of a paradox as that seems.

6/15/2010 02:54:00 am  
Anonymous ng said...

PC -
Small point but surely the market cap is the Market's best guess as to the value of BP/s assets, less their liabilities? In other words, if BP's market cap is $100b, then doesn't that mean that the Market thinks that after BP has paid all the damages, etc. there will still be $100b of value remaining?

Every article I've read sees BP as a takeover target, but not as a serious bankruptcy risk.

6/15/2010 08:36:00 am  
Blogger PC said...

@Ng: Hi Ng, I thought the Eficient Market's Hypothesis had been pretty thoroughly exploded by the financial crisis, no?

6/15/2010 08:59:00 am  
Anonymous requitas said...

If I expect BP to accept responsibility for the Deepwater Horizon spill and cleanup, I must also expect the same of those responsible for the Gulf War spill, or risk hypocrisy and/or anti capitalist sentiment.

In an economic climate where consumers appear to demand goods and services at a lower price, seemingly with little regard for the environmental or social costs, is it not reasonable and consistent for corporations to do the same?

Can my statement concerning the actions of that corporation have any merit if I am guilty of the same action without having made restitution?
How many of us have spilled pollutants through haste or negligence and not cleaned it up?
How many times did we justify it with arguments of time or money expense?
The difference in scale does not invalidate the argument.

It is unreasonable, unfair and hypocritical to expect greater moral conduct of corporations than ourselves as individuals.

Our corporations embody what we are willing to tolerate in ourselves.

Instead of, or as well as; tearing them down, maybe we should grow ourselves up.

6/17/2010 08:46:00 pm  

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