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Lessons From Exxon's Valdez Spill

Despite big differences, BP investors can still learn something from Exxon's Valdez spill.

Jeremy Glaser, 06/07/2010

Watching video from the Deepwater Horizon oil spill crisis in the Gulf of Mexico quickly conjures up images of another crisis--the Exxon (now ExxonMobil XOM) Valdez spill off the Alaska coast 21 years ago. Similar pictures of birds covered in oil and slicks washing up on shore might make it seem like the Valdez event would be instructive for investors pondering the outcome of the Gulf spill on BP BP. There certainly may be some lessons to be learned, but the significant differences between the two events make it hard to jump to any conclusions.

The largest differentiating point is that the Valdez held a finite amount of oil, meaning that the range of possible cleanup costs was much tighter than the estimates for the Gulf spill. The worst-case scenario was that all 54 million gallons of oil gushed out of the tanker. This made it possible for analysts to do back-of-the-envelope calculations on a rough initial cost to get the spill cleaned up.

BP has yet to stem the flow of oil from the sea floor, and the current attempts may not be successful for many more months. Even the relief wells aren't guaranteed to work, and unforeseen events such as a hurricane could complicate matters even more. There is no way to accurately predict how much oil will eventually be spilled. And without that baseline, it is almost impossible to come up with an accurate estimate of the final bill.

Effect on Shares
The incredible uncertainty surrounding the final tab of the Gulf disaster has been reflected in BP's stock price. Since the first reports of the fire on the oil well April 20, BP shares have fallen 37%. Compare this with the Valdez incident. Exxon stock was trading at a little more than $11 a share before news of the Valdez crash March 24, 1989.

The stock steadily fell during the coming weeks, bottoming out at $10.44 April 11, a fall of less than 7%. Exxon's share price was then able to quickly make up ground and keep increasing, ending 1989 7% above where the stock was before the accident.

Governmental Impact--Past and Present
The response of government will be another differentiating factor between the two events. In 1989, the government was certainly concerned about the spill, but the eventual impact on the oil and gas industry was quite muted. The response this time may be much more aggressive.

First off, attorney general Eric Holder has already opened up a criminal and civil probe into the Gulf disaster. Given the public furor surrounding the spill and the much larger population and economy of the Gulf Coast versus that of Alaska, chances are the penalties will be much larger and other punishments more severe. Our analysts think that civil and criminal penalties could reach $31 billion.

The secondary impact could also be significant for BP and the entire industry. Energy policy looks likely to be one of the primary domestic policy issues in the coming years. Regulation is likely to be stepped up across the entire industry. And with this spill fresh in legislators' minds, chances are that any plan that would expand drilling is going to be very challenging.

After the Valdez spill, new legislation was passed, but the impact appears to have been minor. Even today, oil tankers in Prince William Sound are not required to be double-hulled. Energy policy continued essentially unchanged from before. It is of course possible that outrage over the current spill won't translate into new costs for energy companies, but it creates another layer of uncertainty in an already-uncertain environment.

One lesson that is transferable, however, is that the consequences could drag on for decades. It took five years after the Valdez spill until the initial $5 billion-plus verdict was handed down against Exxon. The case has been working its way through the appeals process ever since and was even the subject of a 2008 Supreme Court decision. The complexity of litigation surrounding the BP spill could mean a process that drags on for years, and further pushes out the date when investors will know how much the entire crisis is going to cost them.

Both spills have also taken a reputational toll. Even today, many still associate Exxon with the Valdez spill, and chances are the Gulf spill will be forever linked to BP. Reputation is a squishy variable and one that is hard to factor into the investment case, but if a bad reputation leads to extra oversight and nervous business partners, it can have a real long-term effect.

So does all of this mean that BP is toast? Certainly not. The firm could very well get the spill under control, and it has substantial financial resources and borrowing capacity that should allow it to cover even the higher end of our analysts' current estimation of costs. But that doesn't mean it will be an easy road. Investors considering BP shares now need to be acutely aware of the uncertainties and potential liabilities that could stretch on for years because of this spill.

Jeremy Glaser is the markets editor for Morningstar.com.

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