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Paul Hodgson: three years on, how Deepwater Horizon is leaking cash for BP

How important are sustainability metrics for executive pay?

Three years later and the Deepwater Horizon spill in the Gulf of Mexico is still in the news, probably because the leaks continue – the continuous outflow of cash out of BP to settle claims.
After a five-month interruption, the Deepwater Horizon civil trial resumed at the US District Court in New Orleans. Phase one, which ran from February to April this year, covered the causes of the accident on 20 April 2010, which killed 11 men and resulted in what may have been the world’s largest oil spill.
Phase two covers the effort to plug the well, and the question of how much oil escaped before it was finally sealed 86 days later. Phase three will investigate damages under the US Clean Water Act, which could amount to an additional $18bn if the company is found guilty of gross negligence. If BP is found guilty, then not only will it face the maximum penalty under the Clean Water Act, it will also be exposed to claims for punitive damages from any government agencies, businesses or individuals affected by the disaster, adding another $34bn worth of claims. Then further claims could be possible for natural resources damages on top of that.
Phase two of the trial is contentious at the moment because several parties have aligned themselves against BP. Transocean and Halliburton, the other two companies involved in the spill, have joined with the local and state governments in the civil trial to accuse BP of underestimating the flow of oil so that it could attempt to cap the spill using a technique that it knew would not work.
Transocean and Halliburton – both of which have already tried to lay all the blame for the spill at BP’s door – are taking this course because, if it is successful, they will only have to pay damages for a smaller amount of spilled oil. They claim that BP could have capped the well two months earlier, and that they should therefore not be responsible for oil spilled after that date.

BP publicly put estimates of the flow from the spill at 5,000 barrels per day, but internally recognised it could be up to 100,000 barrels per day. The top kill method, initially used by BP, of pumping heavy drilling fluid (which is more toxic than oil) down the well would only work if the oil was flowing at less than 15,000 barrels per day. If the 5,000 barrels estimate had been right, it would have been a successful method of closing down the spill, but since it is apparent that BP recognised internally that the flow was too high for this method it is difficult to understand why it engaged in the effort in the first place.

Equipment that was eventually used to cap the well was developed in the weeks after the accident, because BP had no plans to deal with a deepwater spill. But then neither did any other oil company engaged in deepwater drilling. Neither did US regulators require them. In this industry, money is spent on exploration and production, not on safety.The ill-judged nature of this rush for immediate profit can be very clearly seen on BP’s bottom line. But this industry-wide lack of preparedness is making for serious legal problems. Judge Carl Barbier is concerned as to the morality, as well as the legality, of finding a company grossly negligent if its practices were in line with the rest of the industry.
With the supreme illogicality of the law, currently individuals and businesses that did not suffer losses from the spill, but who live near it, are allowed to claim compensation. BP won a partial victory when an appeals court ruled against this flow of settlements. However, until this is conclusively settled – possibly by the US Supreme Court – the settlement payments are still being made.
If this level of loss does not provide an incentive for spending on prevention against environmental and safety disasters, I don’t know what will. But why weren’t preventive measures already in place?
Most, if not all, of the blame can be laid at the door of poor governance, which at all three of these companies was deeply compromised, not least in the lack of accountability that could have been enforced through remuneration policies.
Prior to the spill BP had sustainability metrics in place for just under a third of its annual bonus plan. In its 2010 annual report it noted that: “All key safety and operating metrics (including days away from work case frequency (DAFWCF), recordable injury frequency (RIF), oil spills, loss of primary containment, and process safety high potential incidents) showed good results and significant improvements in all cases from 2008.” It also noted that the company’s good results in 2009 showed management’s continued focus on people, safety and performance. In addition to the cash bonus, any deferred shares from the annual bonus plan will only vest contingent on an assessment of safety and environmental sustainability over the three-year deferral period. With the Macondo oil spill, none of these shares have since vested. In addition, as a result of the spill the safety and environmental violations overrode the normal metrics for bonus outcomes during 2010.

In 2011, an additional balanced scorecard of strategic imperatives was introduced to measure performance over the long-term. These included “safety and risk management culture, external reputation, and internal staff alignment and morale.” Results are measured externally. In its latest annual report, published in 2013, the effects of the Deepwater Horizon incident continue to prevent any shares from the long-term incentive plan vesting, due to BP’s total shareholder return (TSR) underperforming the rest of the oil majors, though the report claims that safety measures all improved and were very strong compared to the prior year.

While it can be seen that BP’s safety, environmental and financial performance is having a significant negative effect on executive remuneration, the real question is why this link to remuneration did not have a more significant effect on executive behaviour. If executives at BP really believed that they would not receive remuneration as a result of the lack of spending on prevention of safety and environmental incidents, why did they not increase the amounts being spent? Are we to believe that linking sustainability to pay does not work? Or is it just because pay had not thus far been affected, therefore there was little credence that it would be? It seems shocking that this amount of damage – both to the environment and to the value of BP – should need to be inflicted before executives begin to take these issues seriously.
But what of the other two companies involved? Halliburton’s record elsewhere is not of the best, including bribery and corruption incidents in Angola and Nigeria, as well as the spill of pollutants in Oklahoma in 2011, and, more recently, an antitrust lawsuit against price fixing in hydraulic fracking services. In this instance it would seem that, since the disaster, Halliburton’s primary aim has been to avoid paying damages and deny responsibility, rather than reform its approach to safety. In response to the US government’s Macondo Report, the company stated: “Every contributing cause where Halliburton is named, the operational responsibility lies solely with BP.”
The authors of the report were of a different opinion. It said the collective actions of BP, Halliburton and Transocean led to at least eight violations of federal law. At the very least, sections of the report painted a picture of sloppiness in Halliburton’s operations.

Again since the accident, it would appear that Halliburton’s behaviour regarding sustainability has seen little improvement. Perhaps this is linked to the fact that Halliburton uses no official sustainability measures to measure performance. Its financial metrics – cash value added (a profit less the cost of capital metric) and return on capital employed (ROCE) – are two of the most effective measures of real performance, though it does not help that the company’s ROCE target for its 2010-2012 performance cycle is significantly lower than its target for 2009-2011. The company’s latest remuneration report pays lip service to health and safety objectives for CEO David Lesar, but there are no measurable targets or outcomes. For 2010, the report did not even do this. Indeed, the report did not even mention Deepwater Horizon, simply stating that Lesar met all his targets.Transocean’s record is even worse, despite a clear link between remuneration and sustainability targets. For example, Brazil is suing Transocean, along with Chevron, over an oil spill off the coast of Brazil in November 2011. Indeed, such was the country’s anger that executives were prevented from leaving. There have been many other incidents.
But the issues at Transocean are not confined to a poor safety record. A proxy fight waged at the 2013 annual general meeting by US hedge fund manager Carl Icahn led to very significant votes against the few sitting directors who were up for election. The board is elected in classes, so shareholders only get to vote on directors every three years. In addition, Icahn has been trying to get the company to pay a dividend to shareholders for at least the last four years.
As with the current attempt to blame BP for the whole incident, Transocean indulged in the same deniability tactics as Halliburton. In a June 2011 press release, the company claimed an internal investigation found that the causes of the spill lay entirely with BP.
As has already been noted, at the time of the accident a fifth of the cash bonus for executives at Transocean was based on safety performance, including a measure referred to as HPDO, or high potential dropped object. HPDO is a dropped object that has a potential of causing a serious injury and is calculated by multiplying the mass of the object by the height dropped and then applying an industry standard formula to determine potential severity. The remuneration report comments: “Our ultimate goal is expressed in our Safety Vision ‘an incident-free workplace—all the time, everywhere’.”
But how does this safety component of the cash bonus work? For an example, let’s choose 2010, the year of the spill. This is how it’s described in the remuneration report:
“…notwithstanding the tragic loss of life in the Gulf of Mexico, we achieved an exemplary statistical safety record as measured by our total recordable incident rate (“TRIR”) and total potential severity rate (“TPSR”). As measured by these standards, we recorded the best year in safety performance in our Company’s history, which is a reflection on our commitment to achieving an incident free environment, all the time, everywhere.”
Perhaps “As measured by these standards…” is not quite a strong enough qualifier. But adjustments were made based on the accident because the remuneration committee exercised its discretion and modified the TRIR payment to zero. The bonus based on TPSR did, however, pay out.
Given the fact that 11 of Transocean’s employees died in the accident – what the company prefers to call an “incident” – which led to possibly the largest ever oil spill, some additional negative discretion might have been advisable, and not just exercised over a small portion of the cash bonus but over every aspect of incentive remuneration.
Understandably, given the negative shareholder and public reaction to this announcement, the senior management team, including CEO Steven Newman, announced that they were donating their safety bonuses to the Deepwater Horizon Memorial Fund. Only the safety bonuses, however, not the bonuses they earned based on the other performance metrics. Since then, the proportion of the bonus based on safety measures has increased to 25%.
So what are we to make of this record of failure? On the face of it, BP and Transocean would seem to be at the forefront of best practice as regards the use of sustainability targets to influence pay. Yet the way these policies actually transpire and their doubtful effect on management behaviour would seem to call into question the effectiveness of using these metrics at all.The answer to this problem is twofold. First, pay is not the answer to everything. It can only do so much to influence behaviour. Secondly, every type of influence must be brought to bear on companies with the ability to cause as much damage as these have. This includes influence from shareholders, stakeholders, government regulation, litigation, reputation, and the markets. Because this is a question of value. And until markets begin to factor in health and safety spending and environmental protection spending to the potential future value of a company, management will be reluctant to devote real resources to them. Until it sees that the market punishes the stock price of companies that open themselves up to the kinds of damages that BP is paying, and that Transocean and Halliburton may also pay, by willfully ignoring potential future losses, the management of these companies will not change.

Paul Hodgson is an independent governance consultant