Deepwater Horizon

Transocean owns operates complex offshore oil rigs, including the one that blew out in the Gulf of Mexico back in 2012, killing 11 workers and despoiling the Gulf of Mexico.  There do not appear to be any similar lapses in its continued effort to push its taxes down as close to zero as possible, however.

Multinational companies have a few common strategies to reach this goal, and Transocean seems to use them all.  First, locate enough of your corporation in a tax haven country so that it passes the laugh test.  The shift in the domicile of corporate headquarters alone can dramatically reduce the tax cost even if most operations remain in countries with much higher tax rates.  Second, use techniques such as internal transfer pricing between divisions so that the vast majority of corporate profits happen to end in the tax haven country.  Third, where domestic operations remain important, use tax-favored or tax-exempt corporate structures such as Master Limited Partnerships, to soften or eliminate the tax bite.

Transocean has also been quite creative in trying to shed liabilities, particularly after the Gulf spill.  It initially claimed it had almost no exposure by classifying its rig as a ship and arguing for protection under a the Limitation of Liability Act of 1851. 

Transocean's Roster of Tax Avoidance Strategies

1)  Corporate inversion.  Completed in 1999, the move shifted the corporate headquarters from the US to the Cayman Islands, cutting the firm's marginal tax rate from 31.6% to 16.9% in the process.  US taxes dropped by an estimated $2 billion during the 1999-2009 period.  Tax Notes, a trade publication,1 quotes the US Treasury on this issue:

Although an inversion transaction requires significant restructuring as a corporate law matter, the effect of such a transaction on the actual management and operation of the inverted company is generally limited.

Robert McInyte of Citizens for Tax Justice published a useful overview of the corporate inversion issue and why common company justifications are often off-base.  Firms often argue that US corporate rates are too high; but McIntyre notes that existing subsidies mean that their actual rates are far lower.  Further, he writes that "reducing the nation's corporate tax rate cannot address the fact that many corporations are employing various means to avoid U.S. taxes altogether."

2)  Relocation of corporate headquarters after the inversion.  Transocean moved its corporate headquarters from the Cayman Islands to Switzerland in 2008.  This was done because Caribbean tax havens were coming under pressure, and Switzerland was deemed more resistent to US efforts to close corporate tax loopholes.

3)  Shifting profits and assets to low-tax jurisdictions.  Transfer pricing and shifting of assets from high-tax to low tax jurisdictions has been a recurring issue for Transocean, and one that frequently ends up in litigation between the firm and taxing authorities in multiple countries, including the US.  There is a great deal of money at stake here, and the firm fights hard to win.  A long-running case in Norway, for example, was recently decided in favor of the corporation, though the government is appealing the ruling arguing that a loss would undermine core principles of corporate taxation within the country. 

4)  Coming home to America, but only without taxes:
Transocean launches a tax free Master Limited Partnership

On July 22nd, Transocean Partners LLC, a spin-off from Transocean Ltd, filed an initial public offering with the U.S. Securities and Exchange Commission.  The new company will be a tax-free Master Limited Partnership, or MLP.  As we detailed in a report released last year (Too Big to Ignore: Subsidies to Fossil Fuel Master Limited Partnerships), MLPs provide substantial tax advantages to a growing number of firms.  The vast majority of MLPs are in the oil and gas sector.

The current deal size is quite substantial, and the implications if asset distributions continue are even more worrying.  The IPO will put three drillships into the LLC, 51% of which will be sold the public and 49% retained by the parent company.  The value of the IPO is estimated at $350 million, making the cap value of the new corporation about $686 million, or roughly $228 million per rig.  Bloomberg News notes that the company owns 74 additional rigs, and is building 9 more.  Should distributions of these rigs to MLPs reach their logical conclusion -- with all rigs held in this tax free format -- the assets back in the US, though corporate-tax free, could be as high as $19 billion.2

As a further indication of the complexity of these corporate structures to arbitrage differing tax and liability regimes,

Marshall Islands-registered Transocean Partners says it will be resident in Scotland for “tax purposes”.

“The company does not expect to pay Marshall Islands taxes, nor does it expect to pay “a material amount” of tax in the UK,” it said.

And there you have it.

• 1Stuart Webber, "Escaping the U.S. Tax System: From Corporate Inversinos to Re-Domiciling," Tax Notes, July 25, 2011, pp. 273-295.
• 283 current and planned rigs not in an MLP x $228m/rig.

I've been critical in the past of Transocean, the company that owned the Deepwater Horizon rig that blew up in the Gulf Coast last year.  They have used whatever tools at their disposal to shed liability for their role in the Gulf accident and spill.   They have restructured their corporation to shed nearly all of their US federal income taxes, despite the US being a central part of their business.  So when I read that senior executives are donating their bonuses to the families of the victims, I was a bit skeptical.  Turns out there was reason to be.  The executives donated their bonuses after a little public relations mishap, when the firm claimed 2010 as their best safety record ever despite the worker deaths and rather large spill that put at risk key industries in the Gulf region.  The timing of the donation kind of works against their claim to have done this because it "was the right thing to do"; and frankly, I'm rather surprised that given the accident the executives earned bonuses at all.   Executives later announced it had not been their intent to "diminish the effect the Macondo tragedy has had on those who lost loved ones..."  How strange people took it that way.  The firm still denies any responsibility for the accident. 

The Deepwater Horizon oil spill clearly demonstrated that really bad accidents -- the ones that the industry (and too often the government as well) say never happen -- do actually happen sometimes.  Not merely a figment of some pointy-headed actuary, these low probability but very large damage events really do need to be built into government policy. 

I had hoped that connections would be drawn between the oil spill and nuclear accidents, as there are number of important parallels.  Like oil spills, nuclear accidents are infrequent but can cause devastating damage if they do occur.  In both markets, Congress has set caps on private sector liability by statute.  The result has been to shift liability risks away from the private operators onto surrounding residents or taxpayers, effectively subsidizing oil and nuclear power.  My hope had been that the scale of damages from the BP spill would highlight the inadequacies of nuclear liability insurance, forcing much needed strengthening of both.

Enter energy investors Howard Newman and Craig Jarchow.  In an article in Rollcall, they make exactly the opposite points:  that the nuclear liability system works so well it should be adopted almost whole cloth to deal with oil spills.  In their own words:  "For a solution, we need look no further than the nuclear-power industry's Price-Anderson Nuclear Industries Idemnity Act."

They are wrong.

While they share a similar end goal to mine ("the cost of insuring oil spill liability should be paid by the oil industry, not the taxpayer"), Newman and Jarchow overstate the coverage that Price-Anderson provides while understating what is actually needed to properly internalize operational risk in both energy markets. 

Some examples:

• Primary insurance cover is too low.  Newman and Jarchow highlight the $300 million in insurance that the reactors must purchase to cover damages to people and property off-site.  While this may look rich compared to the $75 million limit now in place on economic damages from an oil spill, there is little cause for celebration.  There have been 50 years of actuarial data on the nuclear industry to guide underwriters, massive growth in the population and real assets at risk surrounding nuclear plants, ever higher valuations on damages to human health and loss of life, and tremendous innovation in methods to syndicate risk in the marketplace.  Yet, once you adjust for inflation the mandated coverage level for primary insurance today is actually lower than when the Price-Anderson Act first became law in the 1950s.   Arguments that insurers simply can't write more coverage seem unlikely:  plant owners routinely purchase more than ten times as much coverage to protect their own assets (onsite damage to plant and equipment and business interruption) as what they buy to protect all of us outside their gates.  Rather more likely is that they simply don't want to pay for more.

• Aggregate coverage amounts and adequacy have been overstated.  Scale of the insurance pool is the main benefit of Price-Anderson according to Newman and Jarchow.  "[T]he entire nuclear industry is on the hook for more than $10 billion of third-party liability if an individual facility's coverage is exceeded," they note, touting this as "enormous insurance capacity without bankrupting the industry."  This is certaintly better than the situation in many other parts of the world.  But that doesn't mean it is good.  Their conclusions suffer three main problems:  
  • Value isn't really $10 billion.  These "retrospective premiums" are paid in over seven years, not immediately.  This reduces the aggregate cover to roughly $7.6 billion on a present value basis.  Even that is not guaranteed.  Despite letters of credit that reactors will make good on their retrospective payment commitments, the market distress to all reactors that will follow any substantial nuclear accident will create significant financial stress on owners.  Bankruptcy, government dispensation to slow or eliminate retrospective premiums, concentrated ownership of large numbers of reactors by single firms (with each required to make separate payments each year) all suggest total take will be lower than expected.  Available insurance for non-payment of these premiums is quite limited.
    
    The authors note as a feature the ability for the government to fund the restropective premiums immediately, subsequently "recouping its costs from the industry over time".  This arrangement will likely provide more industry subsidies (through artificially low interest charges on delayed payments).  More importantly, there seems little novel about such an option.  Even absent any insurance program governments could front the funds and try to recover it over time (such as through litigation).  However, such an approach would not constitute an effective risk internalization strategy in my book.
  • Coverage levels are far below need.  Far from demonstrating the value of P-A, the BP oil spill actually underscores the inadequacy of the nuclear limits.   BP has already pledged to fund a segregated trust fund of $20 billion.  While this is still far short of the estimated damages of any major nuclear accident (estimates in the $100 billion range*), BP's current pledge is nearly three times the aggregate coverage available from reactor owners for all offsite damages in a nuclear power plant accident.  Shortfalls following a nuclear accident are most likely to fall on the taxpayer, or in uncompensated damages to health and property for the surrounding population. 
  • What coverage is available varies widely by type of nuclear facility.  Price-Anderson requirements differ by type of entity.  While Newman and Jarchow focus on reactors, coverage levels are lower or non-existent for other portions of the nuclear fuel chain such as enrichment facilities.

The authors underscore how the incentive alignment of Price-Anderson promotes plant safety.  The theory here is interesting (shared losses for accidents anywhere should promote more self-policing), but I think far from proven.  There have been enough near misses at US reactors since Three Mile Island to indicate that if self-policing is happening, it isn't very robust.  Their promotion of a prospective premium for oil, collected as a fee per barrel, is a good one and perhaps could be adopted in P-A reform.  The approach is not without risks, however.  One needs to be concerned that the industry characterizes the fee as covering the entire risk rather than just part of it, increasing the actuarial shortfall.

What the article doesn't mention at all is simply eliminating the liability cap.  If the upper tier of damages is as improbable as industry says it is, an actuarily-fair premium should be no big deal for either industry.  Congress wouldn't get to dump uncompensated risks on to the surrounding population or taxpayers, and Newman and Jarchow's stated goal of having the cost of liability insurance borne by the industry rather than the taxpayer would really be met.

_________________________________

Bob Herbert (NYT) has a more realistic view on liability in these industries here.

Thanks to Simon Carroll for links to the Rollcall and NYT articles.

*See, for example, Beyea, J., E. Lyman, and F. von Hippel. 2004. "Damages from a major release of ¹³⁷Cs into the atmosphere of the United States," Science and Global Security 12:125–139.

Fortune Magazine's Roger Parloff, with assistence from insurance specialist Christopher Kende, provides a good rundown on liability for the Deepwater Horizon oil spill in the Gulf.  One important thing I took away from this review, though not explicitly mentioned in the article: even though accidents are an inevitable part of trying to do very difficult things, the liability rules to address damages remain (a) fiendishly complex and the domain of specialized experts; and (b) are full of gray areas such that many of the actual payments are not predictable in advance, and years (and sometimes decades) of litigation is the norm to resolve disagreements.   We can, and should, do better. 

Useful findings from the Parloff and Kende primer include:

• There are enough openings to waive the $75 million cap on oil spill liability set by the Oil Pollution Act (OPA) of 1990 that BP is unlikely to be limited to this level of payouts.  Rather, their payouts for a spill of this magnitude are likely to be much higher, and more in line with the actual damages the spill is causing.  These openings include the fact that there is include no cap on reimbursing state and federal cleanup costs, and that caps are waived in the case of gross negligence or non-compliance with the existing health and safety laws by any of the parties involved with the rig explosion.

• Current liability laws do allow for recovery of indirect damages, such as from lost tourism revenue, or associated tax collections from tourists.  The delineation of how far removed impacts can be before no compensation is paid is not particularly clear, and will likely be resovled via litigation over the coming years.

• The Limitation of Liability Act of 1851, invoked by Transocean (the rig operator) to cap their own liability at $27 million (see earlier blog posting on this issue), will not cap the firm's liability for oil spill pollution damages.  According to Kende, this portion of liability was superceded by the rules of the 1990 Oil Pollution Act.  However, the antiquated law will probably limit Trans Ocean's liability for personal liability and wrongful death, as the exemptions for negligence threshold under this law would be quite difficult to prove.  Given that 11 workers were killed in the blast and many more injured, the Transocean cap could well either result in quite low payouts to harmed parties, or shift the liability to other companies involved with the disaster but which are not protected by the 1851 law because they don't operate vessels.  

One final point not addressed in the Fortune article:  though the US liability laws leave much to be desired, they tend to be far better than what exists in other parts of the world.