How does the stock market respond to petrochemical disasters?

Marie-Aude Laguna, Gunther Capelle-Blancard

05 May 2010

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On April 20, the Deepwater Horizon rig, operated by the oil company BP in the Gulf of Mexico, exploded. All of the onboard workers were evacuated, except eleven workers, presumably dead.

Two days later, the platform collapsed and released huge amounts of oil. As of April 30, oil from the rig has reached the Louisiana coast. This accident is considered one of the worst oil spills in history, and a massive ecological disaster. The volume of the leak could exceed Alaska’s 1989 Exxon-Valdez accident.
Needless to say, the accident will have long lasting and dramatic consequences both for the environment and for the local industries of Louisiana and Florida (e.g. fisheries and tourism). One question is whether and to what extent BP will bear the cost of this catastrophe?

As stated by BP, the company is insured against most of the direct costs of the accident (such as physical damages and business interruption). Nevertheless, most costs triggered by the catastrophe are actually indirect and much more difficult to predict, for instance regulatory compliance costs, legal expenses and fines, as well as damage to the firm reputation. Most importantly, if the accident proves to be due to negligence, a strict interpretation of the “polluter-pays” principle will have severe consequences for BP.

Petrochemical disasters and the share price

In absence of precise assessments, stock market prices should provide useful information about the financial implications of the oil spill, and indicate whether investors perceive industrial pollution as a serious matter. Back of the envelope estimates show that between April 20 and April 30, BP has lost about $25 billion in market value, which represents a 12% decline. But, can these estimates be considered as relevant and abnormally big?

To answer this question, a closer look at the stock market reaction to previous industrial disasters can be of some help. In a recent article (Capelle-Blancard and Laguna 2010), we examine the stock market's reaction to petrochemical disasters. This subject matter is particularly relevant because many scholars have suggested that the threat of a severe market penalty can complement government regulation by providing incentives to comply with safety and environmental standards and to innovate in order to prevent accidents.

To carry out our analysis, we have surveyed the previous studies on industrial accidents (including the Exxon-Valdez oil spill) and built an original sample of 64 explosions in chemical plants and refineries worldwide from 1990 to 2005 (including the explosion of a BP refinery in Texas in 2005)1. In order to assess the reaction of financial markets, we perform a standard daily event study. The strength of the event study methodology is that it is based on the overall assessment of many investors who quickly process all available information in assessing each individual firm’s market value. It is a forward-looking approach that allows researchers to separate the effect of specific news from macro risk factors on the firm stock returns.

Our results show that, on average, shareholders suffer a significant loss of about 1.3% over the two days immediately following disasters. Multivariate regression analysis finds that losses in the first days are strongly related to the seriousness of the accident. One fatality or serious injury is associated with an additional loss of $164 million, while the occurrence of a toxic release corresponds to an additional drop of around $1 billion. We also observe that stock market losses are more severe for firms that have bad environmental and safety records.

How our estimates compare with the stock market response to the Deepwater Horizon Oil Spill? To make our results directly comparable, we need to provide accurate estimates of the abnormal loss incurred by BP following the oil spill. By using the event-study methodology, we estimate that the BP incurred an abnormal return drop of approximately 6% over one week. Actually, the stock market response to the catastrophe was not immediate. The most extensive drop in market capitalisation was observed after April 28 when (following unsuccessful attempts to secure the source of the leak) authorities declared that the oil spill was of national significance and President Obama made a clear statement that BP would be “ultimately responsible for funding the cost of response and cleanup operations” (see Figure 1).

Figure 1. Cumulative abnormal returns following the Deepwater Horizon rig explosion

Note: Cumulative Abnormal Returns are estimated using the Market Model over the period [-10,-250] in event-day by using the FTSE 100. Event-day is day relative to the accident date.

The short-term abnormal loss incurred by BP is, to some extent, more pronounced than following disasters such as the explosion of a BP refinery in Texas in 2005 and the explosion of the Total AZF plant in Toulouse in 2001. This is not so surprising given the unprecedented magnitude of the catastrophe both in terms of casualties and ecological damage.

In our paper, we also look at the stock abnormal returns over a longer event window. We find that accidents that caused a toxic release are associated with higher losses than non-polluting accidents (even if they caused casualties). Moreover, we show that this difference increases over time. A toxic release is associated, on average, with an additional abnormal loss of approximately 12% six months after the accident. This result suggests that investors might be slow to recognise the extent of the loss after a polluting accident, possibly due to lack of information with regard to the legal implications of the accident in the very short-term. This result therefore suggests that BP will certainly incur additional shareholder losses in the subsequent months.

But the question remains whether this drop in share price represents a serious threat for managers and provides a sufficient incentive to improve environmental and occupational safety. According to Chazan and Casselman in The Wall Street Journal (2010), on September 2010 BP wrote to the US Minerals Management Service to plead against additional regulation of the oil industry, arguing that the current voluntary system of safety procedures was adequate. Will the Deepwater Horizon Oil Spill make a change? How the catastrophe will be settled in the courts should certainly create a bigger precedent than the immediate response of investors.

References

Bowen RM, RP Castanias and LA Daley (1983), “Intra-Industry Effects of the Accident at Three Mile Island”, Journal of Financial and Quantitative Analysis, 18:87-108.
Capelle-Blancard G and M-A Laguna (2010), “How Does the Stock Market Respond to Chemical Disasters?”, Journal of Environmental Economics and Management, 59(2),192–205.
Chazan, Guy and Ben Casselman (2010), “BP opposed stricter safety rules”, The Wall Street Journal, 28 April.
Kalra R, GV Henderson Jr and GA Raines (1993), “Effects of the Chernobyl Nuclear Accident on Utility Share Prices”, Quarterly Journal of Business and Economics, 32(2):52-77.
Salinger M (1992), “Standard Errors in Event Studies”, Journal of Financial and Quantitative Analysis, 27:39-54.
White MA (1996), “Investor Response to the Exxon Valdez Oil Spill”, Working Paper, University of Virginia.


1 A few studies addressed similar issues for the nuclear accident at Three Mile Island in 1979 (Bowen et al. 1983), the Bhopal toxic chemical leak in 1984 (Salinger 1992), the Chernobyl nuclear explosion in 1986 (Kalra et al. 1993) or the Exxon-Valdez oil spill in 1989 (White 1996). Results indicate that in the first month following those two major accidents, abnormal losses range between -12% (for the Exxon-Valdez oil spill) and -30% (for the Bhopal explosion).

 

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Topics:  Energy Environment

Tags:  BP, petrochemical disaster, oil spill

Assistant Professor, Université Paris-Dauphine

Deputy-Director, CEPII; Full Professor, Paris 1 Panthéon-Sorbonne University

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