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POLLUTION: REGULATORY AND LIABILITY REGIMES AROUND THE

WORLD

WHAT ARE THEY MEANT TO ACHIEVE? WHO PAYS, WHO SHOULD PAY AND HOW MUCH?

WHAT NEEDS TO CHANGE? Nigel Chapman, Tim Taylor & Leigh Williams, Clyde & Co LLP

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CONTENTS Section Description Page

1 INTRODUCTION

3

2 PHYSICAL AND ECONOMIC FEATURES OF THE DEEPWATER OFFSHORE ENERGY INDUSTRY

4-13

3 CAUSES AND CHARACTERISTICS OF DEEPWATER INSTALLATION POLLUTION INCIDENTS

14-22

4 DEEPWATER OPERATIONAL SAFETY: REGULATION AND LICENSING.

23-41

5 OVERVIEW OF EXISTING LEGAL RESPONSES TO POLLUTION INCIDENTS: DAMAGES, PENALTIES AND FINES.

42-50

6 US OFFSHORE POLLUTION LIABILITY REGIME

51-60

7 UK OFFSHORE POLLUTION LIABILITY REGIIME

61-63

8 NORWEGIAN OFFSHORE POLLUTION LIABILITY REGIME

64-65

9 CHINESE OFFSHORE POLLUTION LIABILITY REGIME

66-68

10 BRAZILIAN OFFSHORE POLLUTION LIABILITY REGIME

69-70

11 NIGERIAN OFFSHORE POLLUTION LIABIILITY REGIME

71-72

12 THE ARCTIC

73-77

13 WHO PAYS?

78-96

14 REFORM

97-111

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1 INTRODUCTION

1.1 The principal purpose of this paper is to discuss how various legal and regulatory regimes around the world seek to reduce the risk of a major pollution incident from an offshore facility happening in the first place and how they respond when one does happen. The question of whether existing regimes can be improved and the role that insurance may have in any improved regime is considered at the end.

1.2 This paper focuses on the pollution risk presented by deepwater activities because this is generally perceived, in the light of the Deepwater Horizon incident of 2010, to present the greatest pollution risk (aside from operations in the Arctic which are discussed separately). Although the number of shallow water installations is far greater and so, on the face of it, present a greater risk of generating a pollution incident it is broadly correct to say that given the current state of technology and control techniques a shallow water blowout should be capable of being halted before it becomes 'catastrophic'. However, as explained in due course, the environmental damage that a spill causes depends upon a variety of factors. A small spill close to land can have far more devastating consequences than a massive spill far offshore and deep beneath the sea.

1.3 When any major pollution event happens that receives publicity there tends to follow a loud demand for more and tougher laws. This may be justified. However, in order to understand what type of additional laws are most likely to provide better protection for the future it is necessary to understand what is actually going wrong to cause pollution incidents in the first place. Tougher laws and bigger fines may be wholly ineffective because they fail to address and correct the specific defective operational behaviour or technical problems that are the proximate causes of serious pollution incidents. In any event, upon closer examination it may transpire that existing liability laws are already as tough as they can properly be.

1.4 Accordingly, this paper is going to consider the following topics:

(a) Key physical and economic features of the deepwater offshore energy industry.

(b) The causes of and characteristics of particular deepwater offshore pollution incidents.

(c) The current status of deepwater operational safety, regulation and licensing in key jurisdictions.

(d) Legal responses in key jurisdictions to injury and damage caused by a pollution incident.

(e) The particular challenges posed by exploration and production in the Arctic.

(f) Regardless of legal liability, the question of who actually pays for the loss and damage caused by a major pollution incident: the allocation of financial responsibility between operators, contractors and insurers.

(g) The need, if any, to improve existing regulatory and liability regimes, including whether the insurance industry should assume more pollution liability risk.

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2 PHYSICAL AND ECONOMIC FEATURES OF THE DEEPWATER OFFSHORE ENERGY INDUSTRY

2.1 Oil and gas from deepwater fields is becoming an increasingly important source of supply for the world's energy requirements. For example, about one quarter of the USA's crude oil comes today from deepwater fields in the Gulf of Mexico. This will grow. Globally, it is anticipated that about 10% of the world's oil requirement will be satisfied from deepwater fields by the end of this decade.

2.2 The major deepwater fields are concentrated in the Gulf of Mexico, off Brazil and off the coast of West Africa. There are also deepwater fields off the UK and Norway, India and Indonesia and sites are being explored off China, Australia, in the Adriatic and in the Mediterranean.

The World's deepwater exploration and production sites.

2.3 Deepwater drilling is more technically challenging than shallow-water drilling for three principal reasons.

(a) First, the 'exit point' for the oil will be very deep beneath the surface of the ocean and cannot be worked upon directly by personnel, either in diving equipment or submarines. Any work that needs to be carried out to the 'exit point' has to be carried out using remotely controlled ROVs which tend to be less effective than human beings. Connected with this, the drilling platform must have electrical power at all times in order to perform any function whether it is to control the BOP, to control an ROV or simply to remain on station using its thrusters. If electrical power is lost, the rig will become a 'lame duck'.

(b) Second, the geology of deepwater fields tends to be more complex and unpredictable than the geology of shallow-water fields making pressure control more difficult. Furthermore, the velocity and

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irregularity of underwater currents as well as extreme pressures and temperatures inside and outside the well bore put huge stresses on equipment. For example the pressure inside the well bore could be up to 25,000 psi with the internal well bore fluid having a temperature of up to 4000F and the external water temperature being close to freezing. This makes deepwater activities inherently more hazardous and containment of a spill, if it happens, more difficult.

(c) Third, deepwater operations tend to be some distance from land. This makes logistical support slower and less effective; when something does go wrong assistance will tend to arrive later than is ideal.

A typical deepwater drilling arrangement

An ROV

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Simplified schematic of well bore casing and BOP stack

Challenges of deepwater exploration and production

2.4 Deepwater operations (exploration and production) are considerably more expensive to conduct than their shallow-water equivalents. Deepwater exploration accounts for a disproportionately large amount of the total amount expended on offshore exploration; global annual expenditure on deepwater oil and gas exploration and production is around $30 billion compared to an annual expenditure on all offshore exploration and production of around $300 billion whilst the number of deepwater facilities is a lot less than 10% of the total. This difference in cost is for a variety of reasons. The equipment needed to conduct operations is more sophisticated, as is the support that is needed to make the equipment work. The daily rate for a drilling rig in shallow water is less than US$ 100,000 per day, compared with up to US$ 500,000 and more per day for (ultra) deepwater drilling. The time taken between initial discovery and production

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in deepwater fields tends to be much longer than in shallow water - around 10 years. The depth of sea makes installing the required infrastructure a much longer and more expensive process. In short, more kit is required for a greater length of time. This in turn means the cost of failing to find oil is necessarily very high.

Actual and anticipated Deepwater Drilling Expenditure Globally

2.5 The high cost of deepwater exploration and production means that the price of oil needs to be around $70 per barrel in the long term in order to make it an economically worthwhile activity. For ultra deepwater activities the price of oil needs to be higher still. Although the Energy Agency predicts that world energy demand will grow by some 40% by 2030 and that hydrocarbon fuels will continue to dominate the global energy mix and so the price of oil should continue to remain above the $70 per barrel mark, oil prices will continue to fluctuate in the short term and energy companies will always face shareholder pressure to improve margins at any given point in time. In other words, however profitable oil production might be in the long term there will always tend to be short term pressure on oil companies to reduce costs. The relevance of this to the risk of pollution incidents happening is discussed later.

Increasing drilling depths globally

2.6 Having said that, in the US Gulf of Mexico, Deepwater and Ultra Deepwater production accounts for a much larger proportion of overall production than

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shallow water production. Furthermore, the transition has been very rapid, as the graphic below shows.

2.7 In other words, deepwater production is especially important to the US economy.

2.8 Turning now to the parties involved in a typical deepwater exploration/production venture. First, there is the operator. An operator will be an oil company.

2.9 There are two main types of oil companies:

(a) The International and Major Integrated Companies. These are the very large oil companies like Exxon, Statoil, Chevron, Gazprom, Petrobras, Shell and BP which operate globally and whose upstream (exploration and production activities), midstream (transportation, storage and trading activities) and downstream (refining and marketing activities) are all integrated. These entities are amongst the best capitalised companies in the world – Exxon has a market capitalisation in excess of $400 bn.

(b) Independent Exploration and Production Companies. These are smaller oil companies whose focus, as the label suggests, tends to be exploration and production rather than midstream and downstream activities. This group includes companies such as Apache, Devon, Pioneer, XTO, Marathon and Hess. The market capitalisation of these companies range from a few hundred million to tens of billions of dollars.

2.10 The operator will be the party who has been given the licence or permit by the relevant national authority to explore for oil at the particular site and will be the party who is primarily responsible for what happens. On large projects there may be a consortium of operators who share the risks and rewards in particular proportions. The key point about the operator(s) is that it stands to benefit most from the project since if the drill is successful it may earn a great deal of revenue for a long time into the future. At the same time, the operator stands to lose the most if the drill is unsuccessful. Given that the operator assumes the 'extremes' of the spectra of risk and reward

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in relation to any given project, it will have overall control over virtually every aspect of the project, whether it is operational or financial.

2.11 Aside from the operator there will be a host of contractors whom the operator engages to perform various functions such as providing and operating the drill ship, supplying the BOP, conducting the drilling operation, supplying the cement and carrying out cement operations, supplying the control mud and carrying out mud operations, monitoring data and so on. It has been said that an offshore drilling operation is analogous to the Saturn rocket missions in the 1960s: there were a whole host of contractors who manufactured equipment and provided services to the missions with NASA, the equivalent of the oil company operator, co-ordinating and taking ultimate responsibility for the entire project.

Relationships between operator and contractors in a typical offshore exploration project

2.12 Since, generally, oil exploration and production is very lucrative if executed successfully, multinational oil companies are amongst the best capitalised and most profitable companies in the world. For example, as Judge Barbier observed in the Deepwater Horizon litigation, BP's market capitalisation in 2011 was $133 bn compared to that of the rig owner/operator, Transocean, whose market capitalisation was $16bn. Indeed, it is perhaps worthwhile in the context of the present discussion to take note of the size of the major oil companies relative to the size of companies in other industries since this may inform what 'reinforcements' are necessary or appropriate for existing regimes. Major oil companies are a major constituent of the largest companies in the world, as can be seen from the table below.

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Top 80 global companies by market capitalisation as at 31 March 2012: source FT Global 500.

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2.13 As will be observed from the table above, there 16 oil and gas producing companies in the top 80 global companies in the world, with a market capitalisation ranging from $75 bn in the case of Rosneft to $409 bn in the case of Exxon Mobil. This does not include the privately held Middle Eastern oil companies. The oil and gas producing sector is amongst the best capitalised industrial sectors in the world.

2.14 Turning now to how the participants in an exploration or production venture arrange their relationships. In light of the fact that most of the risk, reward and control over a particular operation is assumed by the operator (who will also tend to be the most financially substantial entity in the operation) a set of standard form contracts has developed over the last 20 years in the industry which place the burden of paying for third party liability claims (public and private) arising out of a subsea pollution incident on the operator. More specifically, in a typical exploration project the contracts between the operator and contractors will contain a provision whereby the operator promises to indemnify the contractors for any third party liability they may incur arising out of a subsea (i.e. emanating from a well) pollution incident regardless of whether that pollution incident has been caused by the breach of contract or negligence (including gross negligence) of the contractor. The forms of liability usually covered by the indemnity include a liability to pay compensatory or punitive damages and fines and penalties imposed by the Government. The enforceability of such an indemnity is considered later.

2.15 So far as the risks that are assumed by a particular contractor are concerned, it will take responsibility for loss or damage to its property, and personal in injury to its employees arising from pollution which emanates from its equipment (regardless of whether the pollution has been caused by the negligence of the operator). It will be appreciated that few major pollution incidents will tend to emanate from a contractor's equipment as opposed to the well. An exception might be an FPSO that has a large amount of oil stored in it.

2.16 This regime is incorporated into industry model form services contracts, such as the UK's LOGIC contracts or the US IADC standard contracts.

2.17 Furthermore, the state authorities have traditionally tended to view the operator as primarily responsible for a pollution incident rather than the contractors and so the target for the imposition of any fines or penalties has tended to be the operator rather than the contractors.

2.18 This allocation of risk, and in particular, the operator's assumption of responsibility for the consequences of a subsea pollution incident not only reflect what is perceived to be commercially 'fair' but promote economic efficiency. In particular, in light of the indemnity, the contractor will make the assumption he is not running any subsea pollution liability risk (including a liability for fines and penalties) and so he does need to factor that risk into the price he charges for the services he provides or to purchase insurance cover for it. As will be discussed later, the particular commercial insurance products that are available to and which are purchased by contractors reflect this traditional allocation of risk. Broadly speaking, the default position of the commercially available liability insurance covers is that they exclude liability in respect of a pollution incident emanating from a well

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(which will tend to be the primary source of a major offshore facility pollution incident)1.

2.19 However, as is discussed later, the assumptions that have been traditionally been made about who will be liable for the consequences of a pollution incident are being seriously called into question by the Deepwater Horizon litigation which is currently taking place.

2.20 It is a feature of many pollution control and compensation regimes that there is an actual or practical cap on the quantum of a wrongdoer's liability. On the one hand, statutory regimes such as the USA's Oil Pollution Act 1990 (OPA) incorporate a monetary limit of liability for compensatory damages (where there has not been culpable misconduct) and, on the other, civil tort-type claims will tend to bar recovery for pure economic loss thereby significantly limiting the number of potential claimants. The reason for 'caps' on liability is that it is argued that, firstly, unlimited liability may needlessly destroy a socially useful business activity and, secondly, the risk of unlimited liability will tend to discourage participation in socially beneficial but risky industries without promoting better standards of behaviour from existing participants. In other words, ramping up the potential financial consequences of a pollution incident from severe but manageable to corporate annihilation could be counter-productive. Nevertheless, there is a school of thought which says that oil companies should not be given any concessions and they should forced to bear all the costs of their mistakes because their activities are so potentially damaging to the environment and anything less will be an incentive for unsafe behaviour. This is a theme that is returned to later.

2.21 Having said that, as the Deepwater Horizon incident has demonstrated, the liability caps in relevant liability regimes, such as the OPA can be illusory because it does not take much, in terms of 'bad behaviour', for those caps no longer to be available to the polluter.

2.22 It is also relevant that the profile of the participants in any given project is not always the same. For example there are some (but not many) deepwater projects that are being solely undertaken not by the fully integrated oil giants but by the medium and smaller sized independent operators. The smaller and medium sized operators necessarily do not have the same financial wherewithal to pay out large amounts of money for the consequences of a pollution incident for which they may be responsible. Accordingly, it is necessary to identify whether any operations being conducted or proposed to be conducted by the medium sized or smaller independent operators pose a threat of serious pollution damage, to estimate as accurately as possible what the cost of that damage might be and to consider whether the response of such entities would be adequate in the event of such a pollution incident. In short, are the balance sheets of these operators (plus whatever assets they may have, such as insurance) strong enough?

2.23 Finally, so far as the role of insurance is concerned, the global commercial market premium in respect of offshore energy risks is about $3-$4bn. Of that the majority is for paying first party property damage risks. Only about $1-1.5bn of that premium is for paying third party liability risks, such as

1 See Peter Cameron's article 'Liability for Catastrophe Risk in the Oil and Gas Industry' September 2012 for an excellent discussion of this topic. www.dundee.ac.uk/cepmlp/gateway/files.php?file=P_Cameron.

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pollution. There is also a concern that offshore energy risks have historically been underpriced. In short, as matters stand there appears to be little if any additional capacity for the commercial insurance market to assume more pollution risk than it currently does.

2.24 Any proposed changes to the existing legal regimes around the world need to take into account, at least, all of the above considerations. Furthermore, those considerations are not all of the same importance nor do they all pull in the same direction. To put it another way, if the various factors that feed into the subject are not separated out and given appropriate and proportionate treatment, a great deal of time and effort could be spent on implementing changes to regimes that will not make any difference to the likelihood of a major pollution incident occurring in the future or the final outcome for those persons who were to be affected if one were to occur.

2.25 To give an example, it might be assumed that more pollution liability insurance is a necessary component of any effective regime. But is it? What purpose does it actually serve in this specific context? This can only be properly answered by considering the constitution of the parties that make up this particular element of the industry, the quantum of the risks they are running, the regulations that control their activities, the nature of the laws that make them liable and, in particular, what liabilities they can and cannot insure.

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3 CAUSES AND CHARACTERISTICS OF DEEPWATER OFFSHORE INSTALLATION POLLUTION INCIDENTS

3.1 In order to assess the adequacy or otherwise of existing legal regimes it is necessary to understand something about the causes and characteristics of major offshore oil pollution incidents. This is a technically complex issue. However, it is possible to make some simple and broadly correct observations about the immediate causes of previous major pollution incidents.

3.2 A potential for an uncontrolled blow-out is the biggest risk that an exploration or production operation faces. This is when oil and/or gas escapes from the well and ignites, destroying the drilling rigs and/or production platform and causing loss of life.

Offshore oil and gas production platform blow out. Alaska, Cook Inlet

3.3 A blowout is always preceded by an uncontrolled inflow of oil or gas into the well bore from the reservoir.

3.4 The principal means of preventing a blowout is the use of drilling fluid or mud. This not only cools the drill bit and enables drilling debris to be brought to the surface but generates a counter-pressure in the well bore to prevent oil and gas flowing from the reservoir into the well bore. The movement in the fluid must be continuously monitored so that a blowout can be detected early and appropriate steps (such as increasing the weight of the drilling fluid) to halt it can be taken. In order to protect the integrity of the reservoir, drilling is often carried out using drilling fluid that has a weight which matches or is slightly lower than the expected reservoir pressure. As the depth of wells increase so does pressure and temperature. The drilling fluid must be suitable for those conditions.

3.5 Where the use of drilling fluid/mud is insufficient to control a blow-out, the blowout preventer 'steps in'. This is essentially a very large valve that sits directly on top of the wellhead and closes the well in when the density of the drilling fluid is no longer adequate to prevent the inflow of oil and/or gas into the well bore. In order to create failure redundancy, a typical blowout preventer consist of a number of valves which work in different ways 'stacked' on top of one another, hence the term 'BOP stack'. The valves in deepwater BOPs are operated hydraulically. The BOP stack will be rated according to how much pressure it can contain. For wells at a very great

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drilling depth, the BOP stack needs to be able to contain massive pressures.

A BOP stack

3.6 Once a section of well has been drilled, a metal casing (which is essentially a long section of pipe) is installed into the well bore and cemented in place order to stabilise and seal the well bore from the reservoir. The quality of the cementing job is critical to ensuring that there is an effective barrier between the well bore and the reservoir. The key elements of installing effective casing are (a) ensuring the cleanliness of the space between the casing and the well-bore (b) the casing being centrally located in the well-bore and (c) the strength of the cement, which can often depend not only its composition but enough time being given for it to set before drilling operations are resumed.

3.7 Accordingly, in summary, the critical anti-blowout measures and devices are:

(a) The drilling fluid or mud.

(b) The cement between the casing and the well-bore.

(c) The BOP stack.

3.8 There has only been one true deepwater pollution incident, namely the Deepwater Horizon / Macondo well incident on 20 April 2010 which resulted in 4.9 million barrels of oil flowing into the Gulf of Mexico and the loss of 11 lives.

3.9 From a technical perspective, it is generally agreed that the root cause of this leakage was three things:

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(a) Defective cement and cementing jobs.

(b) Human error in the interpretation of data resulting in, the first instance, with heavy drilling mud being removed from the well prematurely and pre-emptive action (such as the activation of BOP shear rams) not being taken quickly enough.

(c) The BOP stack failing to seal the well because the shear rams could not cut through the riser which had become offset.

Schematic of cement casing jobs in the Macondo well

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Shear ram failure in the Deepwater Horizon BOP stack – drilling pipe became offset so that the ram just crushed rather than cut through it.

3.10 There have been two similar pollution incidents to Deepwater Horizon, albeit that they did not occur in true deep water.

3.11 The first similar pollution incident was the IXTOC 1 blowout which happened on 3 June 1979. The IXTOC 1 was an exploratory oil well being drilled by the semi-submersible drilling rig Sedco 135-F in the Bay of Campeche of the Gulf of Mexico in waters that were about 50 m deep. The operator was Pemex. The well suffered a blowout resulting in 3.3 million barrels of oil being spilled into the Gulf (i.e. comparable to Deepwater Horizon / Macondo). A kick occurred resulting in a flow of hydrocarbon going up the riser. As in the Deepwater Horizon / Macondo incident, the BOP stack failed to cut the riser and seal the well because the sheer rams were in line with the riser collars and could not cut through them.

IXTOC 1 blow-out and pollution incident in 1979

3.12 The second similar pollution incident was the Montara Wellhead Platform blowout in the Timor Sea which happened much more recently, on 21 August 2009. The well kicked and gas and oil flowed from the reservoir up the riser and unabated into the Timor Sea for 10 weeks. The operator was

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PTT Exploration and Production Public Company Limited. The cause of the blowout was that the 9 5/8" cemented casing shoe was defective, in particular it was 'too wet'. The Montara Commission of Inquiry found that this defect would have been obvious from the contemporaneous records.

The Montara incident in 2009

3.13 It will be observed that there is a technical root cause that is common to all three of these pollution incidents: the cementing job was defective and/or the shear rams in BOP stacks were not sufficiently strong or sufficient in number of properly designed to seal the well in all circumstances. Expressed more broadly, the cause of these incidents is that some basic equipment did not do its job properly and/or there was some human error in respect of some rudimentary well control techniques.

3.14 So far as the underlying reasons why these technical failures have occurred, organisational and economic theory offers an explanation along the following lines2:

(a) Accepting the premise that it is more economically efficient in the long term for an oil company to pay for the costs of avoiding a pollution incident rather than paying for the consequences of one happening, a rational company will prioritise avoiding pollution incidents because its long-terms profits will be enhanced. In other words, the rational oil company will spend money on and so foster a culture of operational safety over short-term profit making.

(b) However, that premise is undermined and so the desire on the part of the oil company to invest in and focus on safety is weakened where (a) the expected costs of a pollution incident are underestimated by it and/or (b) the company does not have sufficient assets to pay for the consequences of a pollution incident and/or (c) the managers, employees or sub-contractors of the oil company are personally not focussed on safety despite what the owners of the company might want (so-called 'agency conflicts').

2 For an excellent discussion of this subject see Deepwater Drilling: Law, Policy and Economics of Firm Organization and Safety, Cohen et al (2011) at http://www.rff.org/documents/RFF-DP-10-65.pdf

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(c) As concerns under-estimation of cost, two things are responsible for this. First, inadequate risk assessment. This is well illustrated by Macondo itself. Prior to the Macondo blow-out, the risk model used by the oil industry and the US Government suggested that the most likely size of a large spill at the Macondo well was 4,600 barrels and no more than 26,000 barrels over the entire 40 year life of production on six sites, including the Macondo well. That is to be compared with the actual spill of 4.5 million barrels. The proposition is that the financial downside represented by a worst case of just 4,600 barrels spill meant that BP may not have been sufficiently incentivised to focus on safety; the financial downside was under-estimated and, in consequence, the safety spend by BP was too small. Second, under OPA, the maximum damages liability is just $75 million and the maximum Oil Spill Financial Requirement, that is the minimum amount which the oil company needs to demonstrate it is worth in free assets, is just $150 million. Again, the existence of 'low' liability limits in legal regimes is said to make oil companies complacent so they are insufficiently incentivised to make safety a priority over short-term profit.

(d) As concerns sufficiency of assets, the point here is that what is at stake for the owners of a company when an oil pollution incident happens is loss of the company's assets. However, if those assets are worth less than the cost of dealing with a spill the company's incentive to spend money to avoid a spill is weakened. Put simply, if the possible costs of a spill are greater than the company's assets the owners of the company have less to lose if an accident happens and so will invest less money on avoiding accidents. However, it will be observed that the majority of oil companies who are currently engaged in deep offshore exploration are the fully integrated oil companies who do have sufficient assets to deal with a major spill (at least as large as Macondo in the environment where Macondo happened), as BP have shown.

(e) As regards managers, employees and sub-contractors not being focussed on safety this is primarily a consequence of what behaviours are rewarded in an organisation. If the criteria by which a manager or employee is assessed reward safety above all else, safety ought to become the culture of the firm. However, micro-economic theory and practical reality are not the same thing. Ultimately, the primary function of any company, including an oil company, is to generate profits. There will always be a tension between investment in safety, which is a cost that diminishes profit in the short-term, and the desire to make profits now and satisfy shareholders. Depending upon where a company is in the economic cycle and the particular personalities of the people who run or own the company the desire to focus on short-term profit may occasionally predominate. That is where independent governance, regulation and supervision have an important role to play. The purpose of independent supervision is intended to detect and correct the organisational 'imperfections' that generate behaviour that is not focussed on safety.

3.15 Turning now to the environmental damage that is caused by oil that is spilled, this is, as one would expect, a very complex subject. However, in simple terms, it depends on a number of factors:

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(a) The amount of oil that is spilled.

(b) The type of oil that is spilled.

(c) The natural ability of the sea to disperse and degrade the oil spill.

(d) The proximity of the oil spill to land.

(e) The population/property density of the land that is affected.

(f) The availability of equipment, manpower and infrastructure to deal with and clean up a spill.

Graphic representation of environmental impact of an oil spill

3.16 Not surprisingly, the worst oil spills in terms of environmental damage have been caused by tankers carrying heavy crude shedding their loads near to shore. Where a large spill happens close to land, there is insufficient time for the oil to degrade through biological action before it reaches land. Once the oil, particularly heavy oil, reaches land it can take many years to break down. The Torrey Canyon spill off the Scilly Isles in 1967 and the Exxon Valdez spill in Prince Williams Sound, Alaska in 1989 are the most notorious. The coastlines were clogged up with thick oil for years and hundreds of thousands of marine animals died. However, the carriage of oil by oil tankers gives rise to different issues to those raised by deep-sea exploration and production, not least because of the often financially insubstantial nature of the entities that own and run oil tankers.

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The Exxon Valdez spill in 1989

3.17 As concerns deepwater oil spills and, in particular, the Deepwater Horizon spill, although 4.9 million barrels of oil entered the Gulf, the environmental damage that has so far been detected has been modest by comparison. This is primarily because the Deepwater Horizon was some considerable distance offshore and the Mexican Gulf contains very active marine bacteria that have degraded much of the oil long before it has reached land3. Accordingly, although BP has set aside a vast sum of money to pay for the damage caused by the spill, the science suggests that damage to property and wildlife appears to be relatively limited. This is to be contrasted to what would happen to a major oil spill in the Arctic, where the effect of microbes on oil spills is far less potent (leaving aside all the other problems of mobilising and deploying containment and clean up equipment in that extremely hostile environment).

The action of bacteria on an oil spill

3.18 The Deepwater Horizon incident was, of course, incredibly serious, not least because 11 men lost their lives. However, a huge amount of high quality, independent scientific research has been conducted by some of the most

3 There is natural seepage of 400,000 barrels of oil annually into the Gulf of Mexico and there probably has been for many millions of years.

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sophisticated research facilities in the world4 into the effects of the spill and such research is ongoing. The results of that research, whatever they may be, necessarily should be factored into any assessment of the changes that need to be made to current legal regime. To put it another way, it is important that policy making on pollution is informed not by media-fuelled public outrage and/or political expediency but by good quality science. Accordingly, if significant environmental damage from hydrocarbon leakage from a particular deepwater offshore facility far from land is unlikely as a matter of scientifically proven fact there is no particular sense in tying up billions of dollars in anticipation of such damage. It would be far better to spend the money on improving equipment and techniques so as to minimise the risk of leakage and, indeed, the loss of human life which appears, in the case of the Deepwater Horizon incident, to have been the most serious consequence of all.

4 See, for example, "The Gulf Oil Spill: Where did all the Oil Go?" Lecture on 14 February 2011 by Terry Hazen, head of the Ecology Department and Center for Environmental Biotechnology at Lawrence Berkeley National Laboratory. http://www.youtube.com/watch?v=LM-wSf4cPag

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4 DEEPWATER DRILLING AND OPERATIONAL SAFETY: REGULATION AND LICENSING

4.1 To state the obvious, effective prevention of a pollution incident is eminently preferable to sorting out the mess after it has happened. Although, as discussed later, stringent damages regimes may have some deterrent effect, rules that demand demonstration of actual compliance with standards of best possible practice both before the exploration and production activity is permitted to take place at all and for its entire duration are likely to be the most effective means of reducing the likelihood of major pollution incidents in the future and mitigating their effects when they do happen. Enforced tangible improvement in the quality of equipment and working practices has been the driver of the reduced number and severity of serious accidents in every industrial field practised by man rather than the prospect of being held liable for unlimited damages.

4.2 Why is governmental regulation of operations in the oil and gas industry necessary? Economic theory says that if oil companies are fully liable for all the costs caused by pollution they will be sufficiently incentivised to prioritise safety without being forced to do so by an external agency. However, economic theory and practical reality often do not coincide. There are various reasons why companies cannot be relied upon to prioritise safety entirely of their own accord. These have been discussed previously. However, in essence, a company may not prioritise safety because it (or persons within it) perceives the costs of not making safety a priority are less than the costs of prioritising it. In other words, the company perceives that it will make more money if it does it does not focus on safety. This perception can exist because the company has underestimated the costs of a pollution incident, because its damages liability is capped, because its assets are less than its potential liability or because managers or other personnel within it are, for whatever reason, not focussed on safety.

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4.3 In short, outside regulation and enforcement is necessary to supplement the free-market economic incentives that exist to operate safely because they are not adequate to ensure safe operation.

4.4 It is has been observed that one of the reasons Macondo happened was that the US regulator did not do its job properly. According to a New York Times article on 21 July 2010, Lloyd's Register who carried out a survey of four of Transocean's drilling rigs in the Gulf, including the Deepwater Horizon, found various problems with them including:

(a) Blowout preventer rams and failsafe valves not having been fully inspected since 2010 despite them needing to be inspected every three to five years;

(b) 54% of workers on board the Deepwater Horizon expressing fear of reprisals if they reported concerns or problems;

(c) The ballast system of the Deepwater Horizon having mechanical problems and the rig's mud pumps being in poor condition.

4.5 These are the sorts of issues that an effective system of state supervision would or should have picked up and acted upon or, ideally, prevented from coming into existence in the first place. It is also noteworthy that Lloyd's Register were, as is usual, engaged by the rig owner, Transocean and reported to it. This is a problem inherent in supervision that is not answerable to a true 'third party' in the venture, a theme to which we will return later.

4.6 It is possible to categorise a particular regime according to whether it is prescriptive or performance-based.

4.7 Prescriptive regulation sets specific technical or procedural requirements with which regulated entities must comply absolutely.

4.8 Performance-based, or 'goal-based' regulation (in the case of the UK, Norway and Australia), identifies outcomes which the operator must demonstrate he is capable of achieving rather than specifying a fixed list of technical equipment that must be utilised. Such an approach allows the operator flexibility when determining how they will carry their operations.

4.9 A review of the more developed regulatory regimes indicates a general increase in the use of performance-based regulation. This approach is said to permit greater flexibility in manner of operations, encouraging innovation and cost effectiveness. However, prescription may be the more appropriate approach where particular absolute technical standards must be complied with to ensure maximum safety and to facilitate monitoring and enforcement.

4.10 What follows is relatively brief overview of various key jurisdictions' regulatory regimes, the extent to which specific technical requirements are imposed on operators, and the penalties that can potentially be incurred for failure to adhere to regulatory requirements. It also looks at the changes which have been made by those jurisdictions to their regulatory regimes in the wake of the Deepwater Horizon incident. The following jurisdictions are considered:

(a) The USA

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(b) The UK

(c) Norway

(d) Australia

(e) Brazil

The United States and the Outer Continental Shelf Lands 4.11 The primary piece of legislation that regulates the activities of the offshore

oil and gas sector in the U.S. is the Outer Continental Shelf Lands Act 1953 (OCSLA). There are also many additional regulations which apply more specifically to various elements of operations in the offshore oil and gas industry

4.12 The U.S. system is considered to be one of the most prescriptive regulatory systems. It was criticised in the wake of Macondo as having not been sufficiently potent and effective and has undergone a great deal of development since. It is said to have been adversely affected historically by

(a) prioritising revenue generation over safety (a consequence of both the licensing/permitting and safety oversight functions being the responsibility of one agency, the Minerals Management Service);

(b) budgetary cuts impacting the number and quality of its staff and equipment;

(c) its oversight being periodically opposed by the industry as being duplicative of that of other agencies, such as the National Coastguard; and

(d) the industry's reporting of information and data to it being sketchy and unreliable preventing it from properly monitoring what was actually happening 'on the ground'.

It has been said that the inadequacy of the oil US systems is demonstrated by the fatality rate for US offshore oil and gas workers having been four times higher per hour worked than in Europe5.

4.13 Authority for the promulgation and enforcement of safety regulations is now vested in the Bureau of Ocean Energy Management (BOEM) and the Bureau of Safety and Environmental Enforcement (BSEE), formerly the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE)6.

4.14 The revenue and safety functions are now split. The Bureau of Ocean Energy Management is responsible for managing the United States' offshore resources 'in an environmentally and economically responsible way'. Its functions include issuing leases, plan administration, environmental studies, National Environmental Policy Act analysis, resource evaluation and economic analysis.

5 http://www.oilspillcommission.gov/sites/default/files/documents/A%20Competent%20and%20Nimble%20Regulator%20A%20New%20Approach%20to%20Risk%20Assessment%20and%20Management.pdf 6 The Environmental Protection Agency and the U.S. Coast Guard are also involved in specific aspects of offshore regulation and related issues.

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4.15 The BSEE, on the other hand, enforces safety and environmental regulations. Its functions include all field operations (including permitting and research), inspections, offshore regulatory programs, oil spill response, training and environmental compliance.

Regulation and licensing of US operators: technical requirements.

4.16 The US system prescribes specific technical requirements for all offshore structures, technical equipment and operations. In summary:

(a) Prior to conducting drilling operations, an operator is required to obtain approval for an Application for Permit to Drill (APD)7. Potential lessees must submit detailed information about the drilling program, operational safety and pollution-prevention measures. Design criteria for well control and casing, specifications for blowout preventers and a mud program must also be submitted. The lessee must show that he will be employing the best available and safest technology in order to enhance the evaluation of abnormal pressure conditions and to minimize the potential for uncontrolled well flow.

(b) Once it has been granted, an APD will then be regularly reviewed so as to ensure continued compliance with regulatory requirements.

(c) In respect of platforms, a lessee is required to design, fabricate, install, inspect, and maintain all platforms and structures on the Outer Continental Shelf (OCS). The lessee must be able to assure their structural integrity for the safe conduct of operations8. As part of this requirement, a program has been established to ensure that new structures are designed, fabricated, and installed using standardised procedures to prevent structural failures. Third party expertise and technical input is to be deployed in the verification process through the use of a Certified Verification Agent. Once installed, platforms will continue to be inspected.

(d) Production safety equipment must be designed, installed, maintained, and tested in a manner which ensures the safety and protection of the human, marine, and coastal environments. All tubing installations open to hydrocarbon-bearing zones below the surface must be equipped with specific safety devices that will shut off the flow from the well in the event of an emergency. All surface production facilities, including separators, treaters, compressors, headers, and flowlines must be designed, installed, and maintained in a manner that provides for efficiency, safety of operations, and protection of the environment. Surface and subsurface-controlled safety valves and locks must conform to technical requirements, and are required to be tested by the lessee at specified intervals.

4.17 Since Macondo, operators have been required to demonstrate that they are prepared to deal with the potential for a blowout and worst-case discharge. Permit applications for drilling projects must meet new enhanced standards for well-design, casing, and cementing, and be independently certified by a professional engineer. Operators must maintain comprehensive safety and environmental programs. These programs prescribe performance-based

7 Code of Federal Regulations (CFR) - 30 CFR 250.414. Applications for platform approval are filed in accordance with 30 CFR 250.901. 8 Design requirements are presented in detail at 30 CFR 250.904-250.903.

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standards for offshore drilling and production operations, including equipment, safety practices, environmental safeguards, and management oversight of operations and contractors. Companies have to develop and maintain a Safety and Environmental Management System (SEMS)9. A SEMS contains 12 features including management of change, training, investigation of incidents and auditing. Notably, SEMS were already a feature of the United Kingdom's and Norwegian operational safety regulatory regimes prior to Macondo.

4.18 There are also plans by BSEE to introduce regulations that:

(a) will enable any employee on a facility to cause all work to cease – a Stop Work Authority – when an activity or event poses a threat to property, life or the environment10;

(b) will identify who has ultimate authority on each facility for operational safety;

(c) that give all employees the right to report a possible safety or environmental violation and to request a BSEE investigation of the facility; and

(d) require third-party, independent audits of operators' SEMS programs

4.19 In August 2012 BSEE issued three important documents addressing response, enforcement and safety issues. Those documents are (1) new guidance concerning regional Oil Spill Response Plans (OSRPs), (2) a statement of policy regarding direct enforcement against contractors engaged in offshore activities and (3) a 'Final Rule' implementing new safety measures relating to well control operations occurring on the outer continental shelf. The first and third documents are discussed immediately below.

4.20 As concerns Oil Spill Response Plans, BSEE published a Notice to Lessees (NTL) No 2012-N-06 entitled "Guidance to Owners and Operators of Offshore Facilities Seaward of the Coast Line Concerning Regional Oil Spill Response Plans" on 10 August 2012. Oil Spill Response Plans are required by 30 C.F.R. Part 254. This Notice has been informed by what has been learned from Deepwater Horizon. Its purpose is to ensure consistency in the preparation of Oil Spill Response Plans and, substantively, to encourage the development of effective oil spill response techniques, particularly continuous high-rate spills. These plans will be evaluated by BSEE's Oil Spill Response Division. It will determine whether the planned response is adequate for a worse case discharge by considering the following factors: (a) location of the potential worst case discharge, (b) proximity to sensitive resources (c) nature of the event, (d) estimated discharge volume, (e) characteristics of the oil, (f) source control containment methods, (g) weathering and (h) other resources at risk.

4.21 As concerns the Final Rule on technical requirements, this was published on 22 August 2012 and became effective on 22 October 2012. It substantively modifies drilling, well completion, well workover and

9 http://www.boem.gov/uploadedFiles/Reforms%20Fact%20Sheet.pdf 10 Interestingly, the UK's 2010 Energy and Climate Change (ECC) Select Committee Report on Deepwater Drilling also observed in the context of assessing the adequacy of the UK's regulatory regime that it was imperative that there was someone offshore with the authority to halt drilling operations at any time, without recourse to onshore management.

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decommission regulations related to well control. It adopts many of the recommendations of the Deepwater Horizon Joint Investigation Team Final Report. The regulations focus very closely on cementing and BOP integrity. Specifically, the Final Rule:

(a) Prescribes new casing installation and cementing requirements;

(b) Requires independent third-party verification of blind-shear ram capacity and subsea BOP stack compatibility;

(c) Prescribes new casing and cementing integrity tests;

(d) Prescribes new function tests for secondary BOP intervention;

(e) Prescribes new documentation for BOP inspections and maintenance;

(f) Requires a 'Registered Professional Engineer' to certify compliance with casing and cementing standards; and

(g) Prescribes new well control training requirements for deepwater operations.

4.22 Given the recurring technical reasons for many of the world's serious pollution incidents, the focus of the Final Rule is perhaps not surprising.

Enforcement measures – Inspection and Penalties for Non-Compliance 4.23 Under OCSLA11, BSEE are required to conduct onsite inspections in order

to ensure that lease terms, approved plans, and safety and pollution-prevention requirements of regulations are met12. Each inspector will inspect from one to three different drilling rigs or platforms per day. Aerial surveillance of additional offshore structures is also conducted.

4.24 During 2009 in the Gulf of Mexico, inspectors (under the old BOEMRE) carried out 614 drilling inspections, 3,862 production inspections, 296 workover and completion inspections, 7,201 meter inspections, 63 abandonment inspections, and 4,765 pipeline inspections. Nevertheless, the Macondo incident still happened.

4.25 In addition to this, BSEE also has a program to conduct unannounced drills to test spill response preparedness of operators in the Gulf of Mexico.

4.26 Non-compliance with regulations is followed by prescribed enforcement actions. A written notice may subsequently be followed up with the shut down of platforms, wells, equipment, and pipelines in the event that a violation is not resolved within a period of 14 days.

4.27 OCSLA provides for the suspension or temporary prohibition of an operation or activity when such a suspension is deemed to be necessary for compliance with a certain regulation13.

4.28 In the case of more serious and prolonged violations, the lease of permit may be permanently revoked..

11 OCSLA (43 U.S.C. 1348(c)) 12 Further information on the baseline for the inspection of lessee operations and facilities can be found in the National Potential Incident of Noncompliance (PINC) List (USDOI, MMS, 1990a) 13 The OCSLA, as amended (43 U.S.C. 1334(a)(1)), and regulations appearing at 30 CFR 250.10

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4.29 Failure to comply with any of the provisions of OCSLA can lead to both civil and criminal fines14. Civil penalties for an individual can be for up to US$ 40,000 per day. Criminal fines for an individual can amount to the imposition of a fine, not exceeding US$100,000, and/or imprisonment for up to ten years.

4.30 On 15 August 2012, BSEE published Interim Policy Document No. 12-07 entitled "Incidents of Non-Compliance (INC) to Contractors". This expresses BSEE's intention to issue INCs to contractors as well as lessees and operators) for serious violations of BSEE regulations.

4.31 Further, more severe sanctions may also be imposed under additional regulations. BP faces the possibility of such sanctions being imposed including penalties of up to US$4,300 a barrel spilled into the Gulf under particular provisions of the Clean Water Act 1977. This is discussed later under the heading 'liability regimes'.

The UK and the UK Continental Shelf (UKCS) 4.32 Unlike the U.S. system, the UK has adopted a performance-based

approach, referred to as 'goal setting'. This requires companies to continually demonstrate that they are taking measures to minimize the risk of oil and gas releases to the point that any risks are 'as low as reasonably practicable' (ALARP).

4.33 The 1988 Piper Alpha tragedy and the Cullen Report that followed are the origins of the current UK system.

4.34 The central body of legislation governing the offshore oil and gas sector is the Petroleum Act 1998 (PA). Under the PA, the Department of Energy and Climate Change (DECC) and the Health and Safety Executive (HSE) are authorised to draw up and implement regulations specific to offshore oil and gas operations.

4.35 Like the current US system, the UK regulatory responsibilities are divided between permitting/licensing/revenue on the one hand and safety on the other.

4.36 The DECC is responsible for licensing, exploration and development of oil and gas. Under the Petroleum Act 1998, DECC regulates offshore activity by issuing production licences of different lengths. These generally have an ‘exploration’ term up-front, leading to later ‘appraisal and development’ and then ‘production’ terms, if oil is found. Licences tend to be offered within yearly rounds, and DECC has so far run a series of 26 offshore licensing rounds.

4.37 Safety and risk management are under the offshore office within HSE, a division of the Department for Work and Pensions.

4.38 The DECC geologists and engineers evaluate development plans from the perspective of optimal resource recovery. HSE is responsible for setting standards and oversight of the safety case for all drilling and production activities.

14 43 U.S. Code 1350(c)

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4.39 The HSE operates under the Health and Safety at Work etc, Act 1974 (Application outside Great Britain) Order 2001 (AOGBO)15. The HSE currently employs 115 inspectors, and oversees an inspection programme which checks industry compliance with the applicable safety regulations. Those regulations include:

(a) The Offshore Petroleum Production and Pipelines (Assessment of Environmental Effects) Regulations 1999 and Offshore Petroleum Activities (Conservation of Habitats) Regulations 2001 (SI 2001/1754) which governs the location and timing of drilling and pipeline activities, and seismic surveys.

(b) The Offshore Chemicals Regulations 2002 (SI 2002/1355) under which use and discharge of offshore chemicals (including drilling fluids and muds) require a permit.

(c) The Offshore Petroleum Activities (Oil Pollution Prevention and Control) Regulations 2005 which require unauthorised discharges to be reported.

(d) Merchant Shipping (Oil Pollution, Preparedness, Response and Co-operation Convention) Regulations 1998 (SI 1998/1056) and Offshore Installations (Emergency Pollution Control) Regulations 2002 which require an approved Oil Pollution Emergency Plan to be in place before any drilling or development activity starts.

(e) The Offshore Installations and Wells Regulations 1996, which require proper surveys, materials on wells, blowouts prevention equipment and trained or qualified personnel.

(f) Numerous Health and Safety requirements.

4.40 The concept of the 'safety case' is at the core of the UK system. The burden is on the companies to demonstrate proper risk assessment and proper risk management with an underpinning of minimum requirements. In the abstract, the concept of the 'safety case' requires a demonstration by 'duty holders' (i.e. lessee operators) that all hazards that could cause a major accident have been identified, that all major accident risks have been evaluated and that measures have been, or will be, taken to control the major accident risks to ensure compliance with the relevant statutory provisions. As previously mentioned, the standard is to manage risks to “a level as low as reasonably practicable” (ALARP).

4.41 HSE issues extensive guidance for risk assessment and development of safety cases. “These guidelines describe a framework that is intended to help decision-makers assess the relative importance of codes and standards, good practice, engineering judgment, risk analysis, cost benefit analysis and company and societal values when making decisions. They aim to encourage the development of transparent decision-making processes, thereby helping duty holders meet their regulatory obligations.”

4.42 The HSE requires a safety case for each 'facility'. Mobile offshore drilling units (MODUs) are also required to have a safety case for any drilling operation. The safety case must be presented to and defended before a review team at the HSE prior to any activities taking place. HSE is involved

15 The HSE currently has plans to revoke AOGBO by April 2013. This will then be replaced with a new order that will update the 2011 AOGBO so as to address emerging offshore energy technologies.

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in reviewing the 'safety case' right from the initial design stage. The operator must notify HSE 21 days before any planned activities are due to commence so that the well design can reviewed. These reviews focus on major hazards safety. A third party evaluation is required for well designs and all safety critical elements of the project including equipment, such as blowout preventers.

4.43 Within the HSE, the offshore program has a team of inspectors with backgrounds in oil and gas and other high-risk industries. There is a preference for inspectors to have advanced degrees in technical fields and/or extensive relevant working experience. The strategy is to recruit personnel who are already experts in their field and then train them to be inspectors.

4.44 Documented safety management systems are required by the regulations. Site inspections are planned based on the activities and historical experience at a specific facility. Manned platforms are subject to inspection 3-4 times per year, and drilling units at least once a year. Pre-meetings are held with the companies prior to the offshore visits. Surprise inspections are not considered useful, as the intention is to test and validate the key elements of the safety case, including the management systems. Each facility’s safety case is thoroughly reviewed at least once every five years.

4.45 The HSE encourages offshore workers, especially through the trade unions, to be involved in managing their own health and safety. The Offshore Installations (Safety Representatives and Safety Committees) Regulations 1989 provides the legal framework for safety representatives among the workforce who are independent of the management. These safety representatives have independent powers to investigate complaints, potential hazards, and accidents, and to make representations to management and the HSE on behalf of the workforce.

4.46 Sanctions for failure to comply with the statutory and regulatory requirements include fines, imprisonment and disqualification.

Post Macondo response

4.47 Following the Deepwater Horizon incident, steps were taken by the UK oil and gas industry itself (rather than the regulator), through Oil & Gas UK, the leading representative body for the UK's oil and gas industry, to improve safety standards. In July 2012, Oil & Gas UK launched its first ever Health & Safety Report, which will now become an annual feature. It is also two years into a three-year programme to reduce hydrocarbon releases by 50 per cent. As a result of this a 40 per cent reduction in major and significant releases has already been reported. An 80 per cent improvement in the performance standards of safety critical equipment have also been recorded by independent inspectors16.

Increased Financial Responsibility

4.48 In respect of wells to be drilled after 1st January 2013, operators must demonstrate to DECC that they have properly estimated the potential costs blow out pollution incident and that they have the financial wherewithal to bear those costs.

16 This program of inspection is known as Level 3 Verification Non-Compliance, for the period from Q1 2008 to Q4 2011.

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4.49 The DECC guidelines propose methods to assess two elements of this exposure:

(a) The cost of bringing a well under control following a blowout; and

(b) The cost of remedial measures and payments of compensation to third parties for pollution damage.

4.50 The figures for each element are aggregated to produce the minimum amount of financial capability to be demonstrated to DECC. However, this does not in any way limit the liability of the operator and its partners.

4.51 The operator can either provide financial evidence for the joint venture as a whole, or collate individual pieces of financial responsibility evidence from its partners.

4.52 There are four levels of financial responsibility which depend upon the characteristics of the well to be drilled. The applicant has to apply a detailed modelling analysis to show into what category their particular operation falls. This takes into account the location of the well, its depth, water depth and the geological environment and calculates the most likely 'worst case scenario' oil spill. The levels are Band 1: US$250 million, Band 2: US$375 million, Band 3: US$500 million and Band 4: US$750 million.

4.53 So far as concerns calculating the cost of well control, DECC now requires the operator to consider in its Oil Pollution Emergency Plan (OPEP) the use of a capping device (if appropriate – see below) and to “be suitably prepared to drill a relief well”. The intention of the guidelines is to provide a methodology which can be applied consistently across the industry to estimate the costs of a capping device and relief well drilling.

4.54 So far as calculating the cost of remedial measures and compensation is concerned, there are a number of categories of well for which the calculation for remedial measures and compensation is not necessary. In these cases the likelihood of any pollution is extremely remote and costs are highly unlikely to exceed US$250m. For these wells it is considered that the existing financial responsibility requirement demonstrated by the operator to OPOL (currently $250m) will be sufficient to meet the pollution impact of any incident. This category includes gas wells, gas condensate wells (other than HP/HT wells) and wells which require artificial lift to flow.

4.55 So far as methods of demonstrating financial responsibility are concerned, there are three main options (which can be used in combination).

(a) Reliance on credit/financial strength rating (not less than “BBB-” from Standard & Poor’s; not less than “B+/bbb”, from A.M. Best; not less than “Baa3” from Moody’s; not less than “BBB-” from Fitch (“Investment Grade”);

(b) Insurance (including from a captive). The insurer(s) should be authorised by the Financial Services Authority or be exempt from authorisation in the UK but subject to an equivalent level of regulation for the purposes of the Solvency II Directive. The credit rating of the insurer must be Investment Grade;

(c) Parent company/affiliate guarantee. The credit rating of the Parent company/affiliate must be Investment Grade.

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4.56 It is understood that that following adoption of this financial responsibility regime for new exploration and appraisal wells, it is intended to introduce it to all wells.

OSPRAG and the Well Capping Device

4.57 One of the major developments arising out of the Deepwater Horizon incident was the formation of the Oil Spill Prevention and Response Advisory Group (OSPRAG).

4.58 Established in May 2010, OSPRAG comprised senior representatives from regulators, trade unions and from across the industry. The group was formed in order to co-ordinate the UK's response to safety, environmental and commercial issues arising from the Deepwater Horizon incident. However, it was not a regulatory body itself.

4.59 The Technical Review Group (TRG) was one of four review groups created under OSPRAG. A key element of the TRG's work was to review industry practices and procedures in respect of well examination, verification and primary well control; blow-out preventers; competency of workers offshore; and various other human factors17.

4.60 The TRG's conclusions following the review indicated that there is a high degree of confidence in the UKCS regulatory regime and that it drives the right, health, safety and environmental behaviours.

4.61 On the basis of their findings, several recommendations were proposed which were primarily based upon what was identified as being 'best practice' in the course of the review18. However, no new regulations, or updates to existing regulations, have yet been advanced save for the increases in financial responsibility requirements that were discussed earlier.

4.62 However, one major technical development, in November 2010, was the procurement by Oil & Gas UK of a well capping device which could close off a well in the event of a major well control incident. Design and development of the device was overseen by OSPRAG's Technical Review Group, working alongside BP.

4.63 The device can be deployed at water depths of between 100m and 3,048m, and onto wells flowing up to 1,034 bar (15,000 psi) in pressure.

4.64 To date, only one capping device has been developed and is currently located in north east Scotland. The device is only intended for use on spills which happen in the UKCS.

4.65 The HSE have stated that whether or not the regulatory regime will be changed currently depends on the findings of the investigations into the Deepwater Horizon incident.

17 The review consisted of specially developed questionnaires, and was carried out on a self-assessment basis by all relevant operators, drilling contractors and leading well services contractors. 18 Details of the TRG recommendations can be found in OSPRAG's Final Report, Strengthening UK Prevention and Response, September 2011.

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The OSPRAG Well Capping Device Norway 4.66 Norway's regulatory regime is mainly performance-based, but is

supplemented with some prescriptive elements which have increased in number since Macondo. In essence, the thrust of the regulations is to describe what must be achieved, not how it must be achieved. The intention behind this approach is that the operator is encouraged to make safety a priority which it actively and intelligently considers so that it becomes part of its corporate culture rather than looking to the regulator to take the initiative.

4.67 A large amount of safety legislation and regulation applies to the Norwegian oil and gas sector, including statutes relating to labour and working conditions, health and health care, pollution prevention, petroleum-related activities, and fire and explosion prevention19.

4.68 The current regime in Norway was borne out of Alexander Kielland tragedy in March 1980. This was a drilling rig under lease to Phillips Petroleum that was being used as a 'flotel' to house offshore workers at the Efofisk Field in the Norwegian North Sea that capsized killing 123 of the 212 people on board.

4.69 By the mid-1980’s Norwegian regulators considered that it was imperative to move away from the traditional inspection-based approach to performance based regulation.

4.70 Management of offshore activities is divided amongst a number of Norwegian government entities. There is basic split between revenue related functions on the one hand and operational safety on the other. This avoids the conflicts of interest that have been observed to have been

19 The five applicable sets of regulations are the Framework Regulations, the Management Regulations, the Facilities Regulations, the Activities Regulations and the Information Duty Regulations.

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inherent in the US system before Deepwater Horizon. The Norwegian Petroleum Directorate (NPD) is responsible for revenue matters, negotiating lease concessions based on competition amongst companies on technical competence and financial commitments. The Petroleum Safety Authority, under the Department of Labour, is responsible for safety issues.

4.71 Companies must be approved by the PSA, which sets standards and limits on participation depending on the location of the operation, both at the initial leasing stage and prior to any development activity taking place. Companies new to the region or lacking experience are permitted to operate only as part of an experienced team of operators and contractors.

4.72 The NPD participates on the management committee of each oil/gas field development and has access to all the data and plans pertaining to the development, which it shares with the PSA. The NPD approves development plans with a view to ensuring efficient recovery of oil and gas, whereas the PSA must be satisfied as to the safety of the operation before it proceeds. If the PSA considers that the companies involved have not properly considered all the risks, a project is not allowed to proceed.

4.73 Guidance documents are issued by the PSA that describe standards of operational safety that it regards as acceptable. However, the burden is placed on the operators to produce specific safety proposals that will persuade the PSA that the operation will be safe rather than the PSA telling the operator what specific steps it must take.

4.74 As regards specific elements of the Norwegian regime, the PSA has developed the concept known as an Acknowledgement of Compliance (AOC) for drilling rigs. This is similar to the UK's 'safety case'. A rig owner must go through a detailed certification process and meet the requirements for the equipment and workforce. If the rig leaves the Norwegian North Sea, it must continue to operate under all the terms and conditions of the AOC or it will have to go through an extensive recertification process in order to operate again in Norwegian waters.

4.75 Four weeks prior to any drilling activities, a company must file a consent application that includes use of a drilling rig that has received an AOC, a spill response plan, and specific drilling plans. The PSA reviews the plans. It may approve them and permit the drilling to take place, or require modifications or more information.

4.76 The PSA staff is largely comprised of technical professionals with degrees in fields ranging from engineering to anthropology. Personnel performing offshore audits and verifications are skilled to a high level in incident investigation, auditing practices, risk management and human behavioural sciences. The PSA has worked with the University of Stavanger to develop a graduate level curriculum that has evolved into a Masters in Risk and Safety Management.

4.77 The PSA staff participate in all its activities: that is, development of regulations, audits, and verification of industry operations offshore.

4.78 Audits of company facilities are scoped prior to visits to offshore facilities with the team hand-picked to have the appropriate set of skills for the particular job.

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4.79 The concept of the 'safety case' is as core to the Norwegian system as it is the UK system. However, the Norwegian system places less emphasis on the generation of documentation to evidence the establishment of the safety case.

4.80 The agency sets priorities in its annual supervision plan for audits and verifications. This is a strategic document which is not disclosed to the public or the industry operators. Inspections are organised according to the risks the PSA perceives to exist informed by, amongst other things, well loss of control incidents, hydrocarbon leakage incidents and worker accidents. The PSA visits each facility at least once every three years.

4.81 Where the PSA considers that safety is endangered it can demand that an operation cease. Other sanctions which the PSA may impose are compulsory orders requiring the taking of concrete measures to improve safety and penalties. Criminal proceedings may also be brought and pursued in serious cases involving moral culpability.

4.82 As regards the prescriptive elements of the Norwegian regulatory regime, the Norwegians require a systematic application of two independent and tested well barriers in all operations. In addition to this, Norwegian operators are required to have an additional casing shear ram in all blowout preventers and all well control equipment is to be re-certified every five years.

4.83 Following the Deepwater Horizon incident, the Norwegian Oil Industry Association, OLF, made a series of recommendations to enhance the regulatory regime in respect of both technical and management issues. The key regulation, NORSOK D-010, has recently been fortified in a number of respects including the procedures to be followed for cementing, casing, pressure testing and well control and the technical specification of BOP stacks.

Brazil

4.84 Brazil's regulatory regime is predominantly prescriptive in nature. However, the regulations apply mainly to management and governance issues offshore, and tend not to prescribe specific technical requirements. However, outside of the main regulatory regime the environmental agencies are requiring greater adherence from operators to specific technical requirements offshore.

4.85 Brazil suffered its own offshore tragedy in 2001, involving a Petrobras P-36 rig. The P-36, formerly the world's largest floating semi-submersible oil platform, suffered two explosions resulting in the deaths of 11 workers and the sinking of the rig.

4.86 Major revisions of Brazil's regulatory regime took place in the wake of this and came into force in 2007. Brazil issued the Technical Regulation of Operational Safety Management System for Maritime Drilling Installations and Oil and Natural Gas Production20. In addition to this another key piece of legislation is Federal Law No. 9.966, which regulates prevention, control and supervision of pollution caused by discharge of oil and other harmful substances.

20 Resolution ANP No. 43

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Regulation of Brazilian Operators – The ANP 4.87 Brazil's main regulatory body in respect of offshore work is the National

Petroleum Agency (ANP). However, Det Norske Veritas (DNV), the private Norwegian classification society, has assisted in overseeing the implementation of the new regulations in Brazil's offshore operations21.

4.88 The new regime requires operators to implement a full safety management system, setting out 17 management practices which are divided into the following three groups:

(a) Management practices relating to safety culture offshore, management responsibility, the work environment, consideration of human factors, performance monitoring, and incident investigation.

(b) Management practices in respect of installations and technology covering mechanical integrity, critical elements for operational safety, identification of risk analysis and emergency planning.

(c) Management practices with regard to operational procedures covering safe work practices and control procedures.

4.89 The new regulations are prescriptive but require operators to self regulate and audit their own procedures in respect of safety, health, and the environment. Operators are also required to monitor the main risks which they face, using qualitative measures set out in the regulations.

4.90 The new regulations do not contain prescriptive provisions regarding the use of specific equipment, but impose management instruments and rules on corporate governance to be adopted by the operator. The thinking is that a corporate culture of safety comes from the top.

4.91 Beyond this, the regulations apply mainly to the situation where a pollution incident has occurred and sets out the actions required of an operator in response.

4.92 The sanctions applicable to violation of these regulations include fines and the possible retention of a vessel.

4.93 Outside of ANP's regulatory regime, more stringent technical requirements are increasingly being included in the environmental guidelines within drilling licences which are issued by Brazil's environmental protection agencies.

4.94 For example, licences are increasingly requiring, as a precondition or as a condition to be achieved within a given deadline, the purchase and installation of filters, additional wellhead safety equipment and secondary safety systems by licensee/operators.

4.95 The impact of the regulations aside, as concerns the technical standards which are being applied in practice within the Brazilian offshore industry, in all Petrobras operations, BOPs can be remotely activated if both the automatic and locking system fail.

21 DNV has been supporting numerous companies in Brazil with gap analyses and technical safety studies to align their safety management systems to the new requirements.

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4.96 Petrobras has also taken the lead from the Norwegians in requiring all BOPs to have an acoustic control. This allows the BOP to be controlled remotely from a supply vessel, a rig or another location.

4.97 Following the Deepwater Horizon disaster, Brazil has reportedly been paying close attention to the ongoing inquiry. Speaking on the subject, Jose Pontes, DNV’s Energy Director of Operations in South America stated that “already offshore safety levels have been raised in Brazil and I foresee more to come.”22

Australia 4.98 Australia's regulatory regime is performance based, and has very recently

been revised in the wake of the Montara blow-out incident in 2009.

4.99 On 15 September 2011, the Offshore Petroleum and Greenhouse Gas Storage Amendment (National Regulator) Bill 2011 (OPGGSA) was passed. The Act gave effect to reforms resulting in the establishment of two national regulators for the offshore oil and gas industry, namely the National Offshore Petroleum Safety and Environment Management Authority (NOPSEMA), and the National Offshore Petroleum Titles Administrator (NOPTA).

4.100 The current regulations in place under OPGGSA are the Offshore Petroleum (Safety) Regulations 2009, which came into effect on 1 January 2012.

4.101 As its name suggests, NOPSEMA is the safety regulator. It has jurisdiction in state and territorial waters and is the regulator for all offshore petroleum activities conducted more than three nautical miles from the territorial sea baseline.

4.102 To ensure that the focus of NOPSEMA is clearly on the safety, integrity, and environmental performance of the offshore industry, title administration and related activities are managed separately by NOPTA. This is like the division between HSE and DECC in the UK.

4.103 As concerns the background to the current system, during the 1990s Australia adopted the recommendations of the Piper Alpha Cullen Report and moved to a 'safety case' approach with active worker involvement in safety culture. The policies and practices of NOPSEMA are modelled closely on those of the UK's HSE (see above).

4.104 As in the U.K., all facilities, including individual drilling ships, MODUs, and platforms, must have a safety case.

4.105 The safety case is characterized by an acceptance that the direct responsibility for the ongoing management of safety on facilities is the responsibility of those best placed to manage the risks: the operators. The role of the regulator is not to tell the operator how to operate safely but to provide robust challenge and oversight.

4.106 Prior to drilling taking place, operators are required to submit a Well Operations Management Plan for NOPSEMA's approval. In addition,

22 http://www.dnv.com/industry/oil_gas/publications/offshore_update/2011/01_2011/brazilsregulatoryandsafetyevolution.asp

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operators are required to submit an Environmental Plan, addressing environmental issues relevant to the proposed well activity, and an Oil Spill Contingency Plan (OSCP) outlining how they will manage an oil spill event.

4.107 Before the Montara incident, the predecessor to NOPSEMA, NOPSA, was not engaged in the safety review process until after the production design plans under the safety case had been developed. That was the responsibility of individual state authorities. For example, in the case of Montara, the authorities of the Northern Territory were responsible for the review of the well design and operator’s safety case. However, following the official inquiry into the Montara incident, the safety regulators' functions have been extended to include structural integrity of facilities, wells, and well-related equipment.

4.108 Although OPGGSA 2006 requires the holder of a petroleum title to maintain adequate insurance against expenses or liabilities arising from its activities (including expenses relating to clean-up or other remedying of the effects of the escape of oil), the amount and terms required for any such insurance are as may be prescribed from time to time by the designated authority or as may be included as conditions in the licence on a case by case basis.

4.109 With regard to the enforcement of regulations, OPGGSA sets out methods for monitoring compliance with legislative obligations. These include the appointment of inspectors with monitoring and investigative powers, who will determine whether parties have complied with their legislative obligations.

4.110 With regard to well control measures employed in Australia's offshore operations, operators are not required to ensure that BOPs adhere to any rigid technical specifications. However, operators are required to work towards preventing well blowouts using the technology and the management practices which are most effective. In practice, the BOPs which Australian operators now use are triggered remotely, using a hydraulic, electronic or acoustic signals. In addition, some new drilling rigs incorporate a system through which BOPs can be switched on automatically, i.e. with no need for a worker to activate it using a switch.

Sanctions under the OPGGS Act and Regulations 4.111 There are currently only criminal sanctions under the regime; no civil

penalties are currently provided for.

4.112 The criminal sanctions currently range from imprisonment to the application of fines, which aim to ensure that parties comply with their legislative obligations.

4.113 The maximum sanction for failure to comply with a direction given by the 'Designated Authority' is 100 penalty units (equivalent to $11,000 for an individual or $55,000 for a corporation). The maximum sanction that can be applied for a breach of an operator’s duty of care for occupational health and safety at or near a facility is 1000 penalty units (equivalent to $110,000 for an individual or $550,000 for a corporation).

4.114 The sanction amounts are therefore proportionally very small in the context of the costs of an oil/gas exploration and production operation, despite the extent of the potential safety, resource and environmental damage that may result from a breach of these requirements.

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4.115 Sanctions are also possible in cases where an operator fails to have a adequate safety regime in place in respect of each rig. However, the incentive lies not in the financial penalties for non-compliance but in the potential for withdrawal of the acceptance of the safety case. If the safety case acceptance is withdrawn, the operator must shut down the facility.

Proposals for EU wide regulation

4.116 On 7 July 2010, in the wake of Macondo, European Commissioner Oettinger called for an EU moratorium on deep water drilling. He also called for European oversight of regulators, suggesting he would "not hesitate to propose a European framework for 'controlling the controllers' if need be".

4.117 A Commission Communication in October 2010 looked at ways of increasing the safety of oil and gas offshore drilling. The UK's DECC responded to the question of a European moratorium by saying: "We are not aware of any current provision within EU law which would enable any EU body to require a moratorium on deep water drilling [...] But HMG remain of the firm view that these are matters which are properly left to individual member states."

4.118 Several commentators have doubted the EU’s ability to oversee offshore drilling given its lack of experience, and that they would want other jurisdictions to reach UK and Norwegian standards rather than there being any 'watering down' by EU law. The UK government has rejected calls for increased regulatory oversight by the Commission. It feels that countries without a North Sea coastline should not be involved in offshore regulation on the UKCS.

4.119 After a public consultation in Spring 2011 and European Parliamentary debate in plenary on 8 September 2011, the European Commission published draft proposals for an EU wide Regulation in October 2011, setting common EU standards for prevention and response to major accidents in offshore oil and gas explorations. Licensed operators would be required to produce a ‘major hazard report’, environmental risk assessment and emergency response plans to national authorities, and would be fully liable for any environmental damage caused by their activities. Within a year, Member States would have to set up ‘national competent authorities’ to assess and grant licences. The Commission’s proposals would apply to the North Sea only, but the EU considered itself well placed to help strengthen regimes globally.

4.120 Following the successful evacuation of personnel because of the Elgin platform gas leak on 25 March 2012, Oil & Gas UK, the UK's principal oil and gas industry representative body said: "While Oil & Gas UK will always support proper moves to improve safety standards, the Commission’s proposal to dismantle the UK’s exemplary safety regime is likely to have exactly the opposite effect. Moving overall responsibility for offshore safety to the EU, which has absolutely no experience or competence in the regulation of safety in the offshore oil and gas industry is, in our view, totally lacking in sense or balance. Offshore oil and gas safety will not be best served by the blanket ‘one size fits all’ regulatory approach now being advanced by the Commission."

4.121 In the UK the EU Commission’s proposals were considered by the UK Parliament's European Scrutiny Committee on 14 December 2011. It was noted that the Government remains concerned by the proposals. Although

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they are largely modelled on the UK/Norwegian model, they might still affect the administration of the UK’s mature and sophisticated regime. The proposals were considered in the EU Energy Council in June 2012 and reporting back, the then UK Minister of State for Energy, Charles Hendry MP, said: "On the regulation on the safety of offshore oil and gas, the Commission acknowledged the high safety standards applied by the UK and Norway in the North sea and signalled that it could be flexible on the legal form of the proposal. I welcomed this flexibility, with the support of several other member states."

Prescription v Performance

4.122 It is mistaken to regard the two approaches as mutually exclusive. Certain types of equipment with a particular specification will be an sine qua non requirement for safe operation. For example, a BOP with a particular number of shear rams and remote operation. A number of the performance based systems have prescriptive elements in relation to such equipment. Furthermore, where there two or more valid engineering approaches to the same issue, a prescriptive approach can give the operator the choice about which one is adopted. However, prescription may not be so effective in relation to those elements of the operation which are concerned with human behaviour, i.e. training, oversight, chain of command lines and so on. These things do not have a free-standing value; their purpose is to generate specific responses to specific situations. The desired behavioural responses can be prescribed. However, there may well not be one 'right' system that needs to be put in place to achieve those responses. Furthermore, a prescriptive approach may have a tendency to encourage an unthinking tick-box type approach by both the operator and the compliance and enforcement agency.

4.123 Whether a prescriptive or performance based approach is taken, it is axiomatic that what matters ultimately is not the words which make up the regulation but the quality of the people whose job is to monitor compliance with them. The regulations are only useful to the extent that they are implemented. We consider at the end of this paper the ingredients of an effective operational safety regulatory regime.

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5 DAMAGES, PENALTIES AND FINES FOR POLLUTION

INCIDENTS: OVERVIEW

5.1 On the basis of the location of existing deepwater production and exploration sites, the jurisdictions that are likely to be relevant are:

(a) The United States (Federal and State law)

(b) Brazil

(c) UK

(d) Norway

(e) Nigeria

(f) China

5.2 Before considering the detail of the individual legal regimes, it is worthwhile to make some general observations about how any given jurisdiction will respond to a pollution incident and also to consider the type and size of liabilities that have been sought to be imposed upon operators and contractors for pollution incidents in the very recent past.

5.3 Broadly speaking, a person who is legally responsible for a pollution incident could, in any given jurisdiction, face the following liabilities:

(a) The costs of cleaning up the oil that has contaminated the sea and state-owned land, i.e. the shoreline. This liability will tend to be governed by specific statutory law (although it does not need to be).

(b) The costs of restoring the natural resources that have been damaged or destroyed by the oil. Again this liability will tend to be governed by specific statutory law (although it does not need to be).

(c) The costs of repairing or replacing privately owned real and personal property. This may be governed by specific statute law that imposes strict liability but will, in tandem, also be governed by the law of tort which most of the above jurisdictions possess, whether it is a

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common law/case law based jurisdiction or a civil code based jurisdiction.

(d) Compensating private persons for the economic loss they suffer in consequence of the pollution. In most of the above jurisdictions, the recoverability of economic loss will tend to be governed by the law tort.

(e) Punitive damages recoverable by private individuals on top of compensatory damages awarded to them.

(f) Administrative penalties and/or criminal fines to punish the polluter for his polluting behaviour payable to the state.

5.4 To expand on some of the above points.

5.5 First, there is no truly international convention governing damage caused by pollution from offshore oil and gas facilities. In other words, there is no 'international' piece of legislation23 that a state or private individual can invoke to bring a claim in its own domestic or an 'international' court seeking compensation for loss and damage, whether to property or to economic interests, caused by a pollution incident. Whether such a piece of legislation is necessary, desirable or even feasible will be considered later. The only truly international piece of legislation governing pollution damage applies to pollution from oil tankers (the 1969 and 1992 Civil Liability Conventions in respect of civil liability for oil pollution, which are not discussed in this paper). However, the considerations that led to the creation of that legislation do not tend to apply in the case of deepwater offshore oil spills which tend to be the responsibility of well capitalised international oil companies.

5.6 Second, whatever specific legislation (i.e. statute law) may exist, a third party claim (i.e. a private individual or company) against an offshore facility operator or contractor will invariably be available in tort in any jurisdiction, whether it is a common law jurisdiction like England or a codified/Romano Germanic law jurisdiction like Brazil (which is based on Portuguese law). Broadly, tort law protects third party property interests and will compensate the injured party, whether a private individual or company, in respect of his repair/replacement costs of property in which he has an ownership interest (that is, he owns or leases it). The essence of most tort law is the existence of a duty of care on the part of one person towards the property or other interests of another person.

5.7 The major issue in tort law in any given jurisdiction tends to be whether it will compensate a third party in respect of his pure economic losses, that is loss of revenue that is caused by the wrongdoer's conduct whether or not that loss of revenue flows from damage to property. For example, a restaurant in a seaside town that is heavily dependent on trade from tourists might experience a significant downturn in consequence of an offshore pollution incident, not because its premises have been physically damaged by the pollution but because the seaside town has become a less attractive destination for tourists in view of the pollution that has affected or is perceived to have affected the coastal waters. A jurisprudential debate has gone on in many jurisdictions for many years over whether such loss should

23 Meaning a piece of legislation developed jointly by two or more countries that can be invoked by private parties in each of those countries to bring a claim against an alleged wrongdoing polluter.

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in principle be recoverable in tort and, generally, the answer has been 'no'. The principle reasons why tort law has traditionally not permitted the recovery of economic loss are:

(a) Economic interests tend to be more numerous and so cumulatively greater in amount than pure property ownership interests. Accordingly, the economic loss caused by a wrong could be massive and out of all proportion to the seriousness of the wrong committed. In other words a trivial mistake could lead to billions of dollars of liability and not only is it perceived to be unfair to visit upon a particular wrongdoer all the economic consequences of a wrong he has committed, especially where that wrong was trivial and committed without intent, but the imposition of such massive liability could drive economically beneficial entities out of business and the prospect of such massive liability could discourage economically beneficial activities.

(b) Unlike property damage where something is actually destroyed, economic loss is not a true social cost in the sense that the wealth of society as a whole is not diminished since it really involves the redistribution of wealth between entities, e.g. money in a restaurant transaction money is redistributed between the customer and restaurant but if the customer does not go to the restaurant that money is not 'lost' to society but spent elsewhere.

(c) There are perceived to more efficient mechanisms for compensating economic loss, such as business interruption insurance. In other words, if a victim really values a stream of income he will insure it.

5.8 However, third, some jurisdictions, in particular the USA have specific legislation that permits recovery by private individuals for pure economic loss that has been proximately caused by a pollution incident. As previously mentioned, this is sometimes the subject of a liability cap dependent upon the character of wrongdoer's conduct, i.e. whether it was just negligent or grossly negligent or wilful or in violation of a particular safety regulation.

5.9 Fourth, most jurisdictions have in place domestic statute law that governs the question of liability for clean-up costs that are incurred by the state. A very large component of the damage caused by a major pollution incident will not be damage to private property; it will be the cost of cleaning up and safely disposing of the oil that has contaminated the sea or state-owned land. In the Deepwater Horizon incident, 48,000 people were involved in the clean-up operation and at one stage there were 6,500 vessels on the water engaged in that operation.

5.10 Fifth, in some jurisdictions (such as the USA and Brazil) punitive damages can form a very large component of the financial liability that a polluter faces. Punitive damages are claimed by and awarded to the victim of the wrong but they are designed not to compensate him for damage (i.e. to restore him to the position he was in before the wrong was committed) but rather to exact retribution on the wilful or reckless wrongdoer and to deter future wrongful conduct by him and other potential wrongdoers. As discussed later, there is a very serious issue in some jurisdictions (in particular the USA) as to whether a liability for punitive damages can be passed from one wrongdoer to another through contractual indemnities. This has profound implications for the issue of who, in practice, bears the

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financial burden of paying for pollution incidents in particular as between oil companies and their contractors.

5.11 Sixth, virtually all of the above jurisdictions have statutory law that impose administrative or civil penalties or criminal fines on individuals and/or corporations for conduct that results in pollution. Such liability is over and above the liability to private entities for the types of compensation that have been discussed above. The level of fines and penalties are also likely to be adjustable depending on whether the wrongdoer is guilty of morally reprehensible behaviour.

5.12 Seventh, what ultimately matters is whether the polluter has sufficient assets to meet its liability. As discussed earlier, this is for two reasons. First, basic economic theory says that the liability regime will only act as a real deterrent to inadequate behaviour if the polluter has significant assets at stake to make it want to invest in safety measures to avoid losing those assets. The US Oil Pollution Act 1990 deals with this by requiring the operator to demonstrate Oil Spill Financial Responsibility or OSFR. This means that the operator has to demonstrate that it has assets up to certain value available to meet its liabilities. The current maximum is $150 million (which many observers say is far too low given the size of the liabilities generated by the Deepwater Horizon spill). The second, obvious, reason is so that victims of the pollution spill can be properly compensated for their loss.

5.13 However, eighth, in a Deepwater Horizon type situation, as the evolving litigation is demonstrating, the issue is not so much whether there are adequate funds to compensate those who have genuinely suffered damage from the pollution but rather who as between the potentially responsible parties, i.e.. the operator(s), the contractors and the insurance companies is ultimately going to take the 'hit' to their balance sheets. This is probably the most complex issue of all since it depends upon a combination of the enforceability in particular jurisdictions of the mutual contractual indemnities that operators and contractors give to one another (as discussed above), the law on contribution as between tortfeasors in cases of joint and several liability and the enforceability of insurance in respect of liability arising from certain types of conduct and for punitive damages, penalties and fines. As also mentioned above, the question of who must ultimately pay also has profound implications for the future direction, structure and composition of the energy exploration and production industry.

5.14 Before considering the detail of individual regimes it is worthwhile to consider what responses there have been to pollution incidents in some of the key jurisdictions in recent years. Above all else, given the highly political aspect to any pollution incident it could be said that what actually matters is not so much the detail of the theoretical legal position but the practical reality.

5.15 In the last 2 years the authorities in the US, Brazil, China and Nigeria have all sought to impose massive financial liabilities on operators and contractors for oil spills. In at least some of those cases, there would appear to be something of a disproportionality between the size of the financial liabilities sought to be imposed upon the operators and/or contractors and the scale of the spill and the physical damage done. This is not to mean that one should just ignore what the particular country's laws say but that one should be cautious about placing too much reliance upon the letter of

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the law contained in the country's statute books and exactly what form the liability could take (whether compensatory damages, a penalty or a fine) because what is sought to be imposed could, in practice, be something very different.

Nigeria (Bonga) 20 December 2011

5.16 This arose out of an spill of about 40,000 barrels of oil on 20 December 2011 at Shell's Bonga oil field located at license block OPL 212 which is approximately 120 km offshore Nigeria24. An export line linking the Bonga FPSO to the tanker was apparently identified as the source of the discharge25.

Bonga FPSO

5.17 On 17 July 2012, Nigeria's National Oil Spill Detection and Response Agency (NOSDRA) announced that it had imposed an "administrative penalty" of $5bn on Shell. In explaining the penalty, NOSDRA said26 that:

(a) Although the spill was actually contained offshore (i.e. had not reached land) it reflected the large quantity of crude oil discharged into the environment and the impact of the impact on the water and aquatic life. In particular, NOSDRA said “The spilled 40,000 barrels impacted approximately on 950 square kilometres of water surface; affected a great number of sensitive environmental resources across the impacted area and has direct social impact on the livelihood of people in the riverine areas whose primary occupation is fishing." Further, “It also potentially caused a number of physiological effects on aquatic lives while surviving aquatic species around the spill site would migrate to a farther distance to situate new habitat thereby forcing coastal communities to move deeper into the sea to carry out fishing activities.”

(b) The penalty was not the same as compensation since compensation could only be demanded from a polluting company after a proper post impact assessment has been conducted and scientific evidence of impact established.

(c) The penalty was consistent with what was obtainable in other oil producing countries such as Venezuela, Brazil and the United States of America.

24 http://en.wikipedia.org/wiki/Bonga_Field 25 http://www.upstreamonline.com/live/article295190.ece 26 http://www.vanguardngr.com/2012/07/bonga-oil-field-spill-fg-fines-shell-5bn/

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5.18 To paraphrase NOSDRA's explanation, the $5bn was a penalty that was informed by the extent of the impact on the fishing industry even though that had not yet been assessed.

5.19 In August 2012, Shell published a response to the suggestion of a US$5bn fine stating that: "SNEPCo (Shell Nigeria Exploration and Production Co) does not believe there is any basis in law for such a fine. Neither do we believe that SNEPCo has committed any infraction of Nigerian law to warrant such a fine."27

5.20 To date the situation is unresolved.

Nigeria (Funiwa Deep 1A Gas Well): 16 January 2012

5.21 The background to this was a blow-out and explosion at the Funiwa Deep 1A gas well on 16 January 2012 on board the KS Endeavour Drilling rig. This was located 6 miles off the south eastern coast of Nigeria. The explosion and subsequent 46 day fire caused the loss of the drilling rig, a lift boat MV MAKO and the loss of two lives.

Explosion and fire on KS Endeavour Drilling Rig, Funiwa Deep 1A, Nigeria

5.22 On 14 August 2012 NOSDRA stated that Chevron should pay a $3 billion penalty28. Chevron maintain that no oil was spilled as a result of the fire not least because the well was a gas well.29

5.23 Once again, the NOSDRA Director General stated that “Having looked at the relevant literature and what happens in other countries, we recommended a fine of $3 billion for Chevron.”30

5.24 In addition, a number of civil claims have been brought by private individuals claiming to represent those local communities that are alleged to have been affected by pollution. One of those claims is seeking in excess of $10 billion in damages31.

5.25 To date this situation remains unresolved.

27 http://www.shell.com.ng/environment-society/our-response/bonga-hor-response.html 28 http://www.punchng.com/business/business-economy/rig-explosion-nosdra-recommends-n465bn-fine-for-chevron/ 29 http://nationalmirroronline.net/index.php/business/energy/43522.html 30 http://www.bloomberg.com/news/2012-08-14/nigeria-agency-wants-chevron-to-pay-3-billion-for-fire.html 31 King Diete Spiff & Ors v. NNPC, CNL & Chevron Corporation

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Brazil (Frade Field), November 2011 and March 2012

5.26 This arose out of a leak of 3,600 barrels of crude at Chevron/Petrobras' Frade Field northeast of Rio De Janeiro in November 2011 and also a smaller seepage in March 2012. Apparently no oil reached land. This incident gave rise to:

(a) A $17.3m fine against Chevron for the November 2011 leak, which Chevron paid in late September 2012.

(b) Two civil lawsuits against Chevron and Transocean (the owner of the rig at the Frade Field) totalling $20bn brought by the Brazilian Federal Prosecutor for the 'incalculable' damages inflicted upon the environment and Brazil's natural resources.

(c) A claim for various injunction against Chevron and Transocean including preventing them from conducting further operations in Brazilian waters (Transocean has 10 rigs under contract with Petrobras in Brazil).

(d) Criminal charges against executives of Chevron and Transocean seeking prison sentences of up to 31 years (which were dismissed on 20 February 2013).

Frade Field oil spill

5.27 It was reported at the end of December 2012 that Chevron was close to an agreement to pay around USD$150 million to settle the civil lawsuits32. USD$43 million of the payment would be for "environmental damages" and the rest of the settlement would be to pay for equipment and measures to prevent future spills.

5.28 It will be observed that the expected settlement amount is a tiny fraction of the nearly $20 billion in damages sought by the original public prosecutor. The second public prosecutor who took over the case in 2012 is reported to have said of the revised claim: "The amount is reasonable, and I don't think I could get a judge to sign off on more." He added that the previous prosecutor "asked for too much and asked for it before investigations of the spill were even complete."

32 http://finance.yahoo.com/news/chevron-brazil-nearing-settlement-153900858.html

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China (Bohai Bay, Penglai 19-3 field), June 2011

5.29 In June 2011, separate blowout and seepage incidents resulted in a total of 723 barrels of oil being released into the Bohai Sea off China. 33 In January 2012, ConocoPhillips and China National Offshore Oil Corp (CNOOC) reached a settlement with the Chinese government to settle compensation claims relating to the oil spill34. The total amount that the two oil companies are paying in respect of that 723 barrels oil spill in total is $481 million. $223m of that $481m purports to be justified by a fishing industry and aquatic life impact studies carried out by the Ministry of Agriculture. The balance of $258m has not been justified by anything in particular except that it is supposedly for 'compensation'.

Bohai Bay Oil Spill

US (Deepwater Horizon), 20 April 2010

5.30 The potential liability of the persons involved in the Macondo blow-out (principally BP, Transocean and Halliburton) is discussed in detail later. However, it is worthwhile to say something at this point about the level of financial liability that has so far been imposed (through settlement agreements with the US Department of Justice) on those involved.

5.31 As discussed later, the two principal sources of liability in the U.S. for oil pollution are the Oil Pollution Act 1990 ('OPA') and the Clean Water Act 1972 ('CWA'). Under the CWA the 'standard' civil penalty is $1,100 per barrel of oil spilled. However this would increase to $4,300 per barrel of oil if BP was found to have been grossly negligent, resulting in a total fine in the region of $20 billion to be paid on top of whatever damages are awarded against it.

5.32 BP, Transocean and Halliburton face trial on 25 February 2013, which will determine if BP is guilty of gross negligence. BP has set aside around $40 billion to deal with its liabilities, which may not be enough if BP is found grossly negligent and subject to the higher penalties under the CWA.

5.33 Any liability under the OPA and any liability to pay the above per barrel penalty under the CWA are regarded as being civil matters. However, under the CWA and other legislation (such as the Migratory Birds Act) there is also provision for the imposition of criminal fines. These can be imposed in addition to the civil penalties.

33 http://www.conocophillips.com.cn/EN/Response/Pages/default.aspx. 34 http://online.wsj.com/article/SB10001424052970203718504577181743807960180.html

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5.34 On 15 November 2012 BP admitted guilt in relation to 14 criminal charges relating to manslaughter of the 11 people who died on board the drilling rig and various breaches of the CWA and Migratory Birds Act. BP agreed to pay a total of $4.5bn of criminal fines35.

5.35 On 3 January 2013, Transocean, which owned the Deepwater Horizon drilling rig, entered into a settlement with the US government and agreed to pay $400m in criminal fines and $1bn in civil penalties after pleading guilty to one a single misdemeanor violation of the CWA for negligent discharge of oil into the Gulf of Mexico36. This violation pertains to well monitoring in connection with specific operations during the temporary abandonment procedure on 20 April 2010. Pursuant to the agreement, Transocean will pay a fine in the amount of $100 million within 60 days of the agreement receiving U.S. federal court approval.

5.36 In addition, Transocean will pay $150 million to the National Academy of Sciences (NAS) over a five-year period, and $150 million to the National Fish and Wildlife Foundation (NFWF) over a three-year period. The funds paid to the NAS will be for the purposes of oil spill prevention and response in the Gulf of Mexico; the funds paid to the NFWF will be directed to natural resource restoration projects and coastal habitat restoration, including restoration of the barrier islands off the coast of Louisiana and diversion projects on the Mississippi and Atchafalaya Rivers.

5.37 In relation to the Government's pending civil claims under the CWA, Transocean has agreed to pay $1 billion in CWA civil penalties over a period of three years. Additionally, the company has agreed to implement certain measures to prevent a recurrence of an uncontrolled discharge of hydrocarbons. Transocean has agreed to consult with the United States in preparing a performance plan for these improvement measures, which must be submitted for the government's approval within 120 days of this agreement taking effect.

5.38 Any potential claims associated with the Natural Resources Damage Assessment (NRDA) process are excluded from the agreement with the Department of Justice. However, the district court previously held that Transocean is not liable under the Oil Pollution Act for damages caused by subsurface discharge from the Macondo well. Assuming that this ruling is upheld on appeal, Transocean's NRDA liability would be limited to any such damages arising from the above-surface discharge.

5.39 The Department of Justice has agreed that it will not pursue further prosecution of Transocean Ltd. and certain of its subsidiaries for any conduct regarding any matters under investigation by the Deepwater Horizon Task Force relating to or arising out of the Macondo well blowout, explosion, spill or response. Transocean has agreed to continue to operate with the Deepwater Horizon Task Force in any ongoing investigation related to or arising from the accident. The civil and criminal agreements are subject to court approval and, in the case of the civil agreement, public notice and comment.

5.40 In the next section, we describe in greater detail the liability regimes that exist in key deepwater jurisdictions.

35 http://www.bbc.co.uk/news/business-20336898 36 http://finance.yahoo.com/news/agreement-reached-u-department-justice-172601505.html

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6 THE UNITED STATES POLLUTION LIABILITY REGIME

6.1 In the United States there are three main types of law that govern liability in respect of a pollution incident.

(a) The Oil Pollution Act 1990;

(b) State developed common law tort and statutory law;

(c) The Clean Water Act 1972 (as amended).

The Oil Pollution Act

6.2 The Oil Pollution Act 1990 (OPA) was enacted in the wake of Exxon Valdez catastrophe which happened on 24 March 1989. That supertanker ran aground on Blight Reed off the Alaskan coast spilling 260,000 barrels of crude oil into Prince Williams Sound. Exxon spent $2.1 billion on the clean up effort. The cause of the accident was that the Master, a relapsed alcoholic, was drunk and left the bridge during a difficult manoeuvre leaving his unqualified crew in charge of the vessel.

6.3 The OPA provides that "each responsible party for a vessel or a facility from which oil is discharged…into or upon the navigable waters or adjoining shorelines or the exclusive economic zone is liable for the removal costs and damages…that result from such incident". The exclusive economic zone extends to a distance of 200 nautical miles from the baseline from which the territorial sea is measured.

6.4 In essence, the OPA creates a strict liability cause of action enforceable by the government/state and/or private parties against 'the polluter' to

(a) recover removal/clean up costs of the oil spill. That amount of clean up costs that can be recovered depends upon the 'thing' that gave rise to the pollution. Where the source of the pollution is a tanker, the liability for clean up costs is limited to $23.5 million37. Where the source of the pollution is an offshore facility, such a well infrastructure, the liability for clean up costs is unlimited.

(b) recover compensation for damage to natural resources, property and economic interests caused by a pollution incident up to a particular monetary limit. In the case of an offshore facility the maximum limit is $75 million.

6.5 The target of the OPA is the "responsible party".

37 For a vessel of more than 3,000 gross tons. Indeed, in the case of an tanker owner, its liability for both clean up costs and for damages is limited to $23.5 million in the aggregate. However, in the case of offshore facilities the legislature considered that the liability for removal costs should be unlimited in light of the potential for, an uncontrollable offshore well, to be catastrophic.

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(a) In the case of a vessel, the "responsible party" is the owner, operator or demise charterer of the vessel.

(b) In the case of an offshore facility, the "responsible party" is "the lessee or permittee of the area in which the facility is located or the holder of a right of use and easements granted under applicable State law or the Outer Continental Shelfs Lands Act….for the area in which the facility is located".

6.6 There may be one or more "responsible parties" (e.g. field lessee who will be an oil company and the owner/operator of the drilling rig who will be a contractor), in which case their liability is joint and several. In such a case there may be the potential for contribution claims as between the various "responsible parties".

6.7 The limits of liability for removal costs and damages in the OPA override the general Shipowners' Limitation of Liability Act. In other words, a vessel owner will not be able to invoke a lower limit of liability than prescribed by the OPA.

6.8 Conversely, the OPA limits for removal/clean up costs cannot by usurped by a claim under any other statutory or common law claim. In other words, the State cannot bring a separate claim in public nuisance to recover the entirety of removal costs over and above the OPA limit (to the extent it applies).

6.9 The responsible party(s) is strictly liable unless it can show that the oil spill was caused solely38 by (1) an act of God, (2) an act of war or (3) an act or omission of a third party other than an employee, agent or contracting party of the responsible party.

6.10 Each of these defences will be rarely open to the responsible party:

(a) The OPA defines an "act of God" very narrowly as an unanticipated grave natural disaster or phenomenon the effects of which could not have been avoided by the excise of due care or foresight. Given the state of modern technology most weather events will not qualify. However, an earthquake probably would qualify.

(b) As concerns the third party defence, this has to be the act or omission of a true third party (such as the captain of pleasure craft). The act of someone with whom the responsible party is in a contractual relationship will not qualify for the defence.

6.11 The limits of liability prescribed by the OPA for removal costs and damages will be disapplied, inter alia, in the event that its gross negligence, wilful misconduct or violation of an applicable safety, construction or operating regulation has proximately caused the incident. The same is true if the misconduct causing the incident is that of a party with whom the responsible party is in a contractual relationship. In other words, the responsible party can be liable by association. This is an important consideration when considering the need, if any, to lift or remove limits the $75 million liability of liability for damages (which some have called for).

6.12 Applying this scheme to the Deepwater Horizon incident:

38 Which means that the slightest causal contribution from the responsible party's conduct negates the availability of the defence.

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(a) The relevant well, which is located at Macondo Prospect, is 41 miles off the southeast coast of Louisiana and so within the US EEZ.

(b) BP is a responsible party being the lessee of the Macondo Prospect area.

(c) BP's partners in the Macondo Prospect, Anadarko Petroleum (with a 25% interest) and Mitsui (with a 10% interest) are also responsible parties.

(d) Transocean who is the owner and operator of the drilling rig, the Deepwater Horizon (which was a mobile offshore drilling unit or MODU) is also responsible party because that rig is both a component of an offshore facility and a vessel.

(e) If BP or any of its contracting parties is found to have committed an act of gross negligence or wilful misconduct or to have violated an applicable federal safety or operation regulation the limits of liability prescribed by the OPA will not apply (leaving aside the fact that BP has waived the right to limit in any event).

6.12.2 As stated above, the "responsible party" has a liability for (a) removal costs and (b) damages.

6.12.3 'Removal costs' are the costs of removing the discharged oil or the costs of mitigating oil pollution which is threatened. Vessels and facilities covered by the OPA are required to have oil spill response plans and arrangements with oil spill response contractors so that if a discharge occurs, intervention can be immediate. Often the responsible party will engage the contractors to carry up the clean up exercise and foot the bill. However, the government will monitor the exercise and is entitled to reimbursement of its monitoring activities.

6.12.4 The OPA sets out six categories of recoverable damages. Three categories of damages are recoverable exclusively by government entitles.

(a) Harm to natural resources, namely the cost of restoring or rehabilitating the environment and the diminution in value of natural resources pending restoration. Such damages are recoverable by the federal, state, Indian tribunal and foreign trustees.

(b) Injury to real or personal property including consequential economic loss (recoverable by the owner or lessee of the property). Such damages are recoverable by state and private party claimants.

(c) Loss of subsistence use of natural resources. These are recoverable by private party claimants, particularly fishermen etc.

(d) Loss of taxes, royalties, rents, fees or net profit shares. These are recoverable by the United States or a particular state.

(e) Loss of profits or impairment of earning capacity due to an injury to property or natural resources. These are recoverable by private party claimants.

(f) Costs of providing public services during or after removal activities. These are recoverable by federal or state entities.

6.13 The OPA does not cover compensation for personal injuries.

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6.14 The two categories of loss that deserve special consideration are (a) natural resources restoration costs recoverable by particular public body trustees and (b) loss of profits recoverable by private party claimants.

6.15 The first category of loss, namely the cost of restoring natural resources, gives rise to very difficult issues of quantification especially where (a) the resources have no particular commercial market value or (b) it is not physically possible restore the natural resources.

6.16 For example, in the case of the Deepwater Horizon spill there may be species of fish that are adversely affected but which are not the object of commercial fishing. How is the damage to the stock of such fish to be quantified? Furthermore, unless accurate records of the historic stocks of such fish exist, it is going to be difficult to accurately assess the diminution in such stocks and, indeed, whether any diminution has been caused by the oil spill rather than something else.

6.17 So far as restoring natural resources is concerned, where some land which provides amenity to the public, e.g. a beauty spot, has been damaged by pollution and thereby rendered inaccessible or unattractive and cannot be restored any faster than nature permits, damages may be assessed according to the cost of creating an equivalent beauty spot elsewhere.

6.18 Nevertheless, one can anticipate that this head of damage will give rise to controversy, not least in relation to the question whether particular land or water has actually suffered harm because of the pollution in relation to which there are competing scientific analyses.

6.19 The loss of profits category of damages has already proved to be controversial in the Deepwater Horizon case. On its face it embraces economic losses caused by damage to property not belonging to the claimant (which physical damage has been caused by the pollution). In other words, the rule against the recovery of pure economic loss embodied in the Robins Dry Dock case has been statutorily overridden and pure economic loss is recoverable. However, the critical question is the scope and extent of those economic losses that are recoverable.

6.20 As indicated earlier, there are many types of economic loss. Indeed, one can conceive of a type of pyramid of economic interests which, at each stage, become increasing removed from the actual property damage.

(a) At the first level is economic loss that is tied directly to damage to the claimant's own property. For example, a beach bar gets covered in oil and the bar owner loses revenue whilst his beach bar is being cleaned up (and beyond).

(b) One step removed from this is the beach bar is not itself damaged but the beach immediately in front of it is polluted. The beach is not actually owned or leased by the bar. However, the beach bar has a licence from the municipal authority to put tables and chairs on it. The bar experiences a down-turn in trade.

(c) The next step removed from that is that the beach bar has no legal right to use the polluted beach but people like to buy a drink from the bar and sit on the beach. Again, the bar experiences a down-turn in trade.

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(d) The next step removed from this is a drinks wholesaler who makes a great deal of money from its long-standing contract with the beach bar. The bar buys less drink from the drinks supplier than before whilst the beach in front of it is polluted.

(e) The next step removed from this is the drinks manufacturer who ends up selling less product to the wholesaler because the wholesaler is selling less product to the beach bar and similar businesses.

(f) The next step removed from this is employees of the drinks manufacturer who are laid off because demand for the drinks manufacturers' products declines.

6.21 What the OPA does is specify the need for a causal connection between the lost profits and property damage. The causal connection that is posited is a "due to" causal connection. However, this does not take one much further. As a matter of plain language, it does not connote a requirement for any form of legal interest in the property that is damaged39. The reality is that all of the entities that populate the pyramid illustrated above suffer a down-turn in trade because of property damage. All other things being equal, the property damage is the 'but for', indeed the root cause, of the economic loss suffered by each entity in the pyramid. The only difference between the various layers is the interface between the property damage and the economic loss becomes increasingly less immediate either in terms of physical proximity to the polluted beach or because of the existence of one or more transactional layers between them and beach bar. However, that physical or transactional distance does not make one claimant less morally deserving of compensation than the next. All the economic loss that each layer of the pyramid suffers can be traced directly back to the property damage. The causal link between property damage and economic loss is, factually, unbroken. In each case when one asks why the business is making less money the answer is that oil that ruined the beach front of this and similar beach bars. Where one draws the line in terms of where recovery is no longer permitted in law is a morally arbitrary decision so far as the victims are concerned. It is decision informed by the desire not to annihilate defendants, discourage economically beneficial activity and overwhelm the system with litigation.

6.22 The sort of claim that ought not to qualify for recovery is where the link between property damage and loss is factually doubtful. For example, a claim by a petrol station that sold BP products which suffered a down-turn in trade because the public boycotted BP products as a demonstration of their disapproval of BP's conduct in being responsible for the spill.

6.23 Where the OPA liability cap applies and is insufficient to satisfy the full amount of qualifying claims, the victims can make a claim for the unsatisfied

39 The report of Professor John CP Goldberg of Harvard Law School on "Economic Loss in Connection with the Deepwater Horizon Spill" 6 (2010) concludes that claims for lost profits claimants should be limited to "those economic loss claimants who can prove they have suffered economic loss because a spill has damaged, destroyed or otherwise rendered physically unavailable to them property or resources that they had a right to put to commercial use". However, the assertion of a need to demonstrate a "right" to use the property that has been damaged effectively reintroduces the previous rule barring recovery except in those cases where the claimant owns or leases the land. It expands it only to the extent that the claimant can show it had a licence to use the land, being the only other legally recognised species of legally protected 'right' in real or personal property. That is not what the statute on its face says nor is it likely that that very limited expansion of the traditional bar on the recovery of economic loss was the intention of the legislature.

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balance against the Oil Spill Liability Trust Fund which can pay up to $1 billion per incident (although up to $500 million may be used to pay for repairing damage done to natural resources and removal costs). The Fund is financed principally from an 8 cent per barrel tax levied on crude oil and crude oil products imported into or exported from the United States. In the wake of Macondo, there have been calls within Congress (which have been rejected) to increase the value of the Fund to between $5 billion and $10 billion by increasing the levy and to increase the amount of the per incident payout.

6.24 A 'responsible party' may itself seek reimbursement from the Fund of amounts it pays in excess of the statutory limit or full reimbursement where a complete defence to liability applies.

6.25 So far as the availability of punitive damages over and above compensatory damages is concerned, the OPA states that "[e]xcept as otherwise provided in this Act, this Act does not affect admiralty and maritime law". A wrongdoer's potential liability for punitive damages is not mentioned by the OPA and is therefore arguably preserved.

6.26 Another very important aspect of the OPA is its requirement that 'responsible parties' maintain evidence of Oil Spill Financial Responsibility (OSFR). The evidence of financial responsibility must be sufficient to meet a specified amount which depends upon what the responsible party is responsible for. In the case of offshore facilities that amount is between $10 million and $150 million depending on the relative operational, environmental, human heath and other risks posed by the quantity of oil. The amount of OSFR that must be posted is premised upon a worst case scenario that involves a maximum of 4 days' uncontrolled flow of oil from the well. In other words, it is assumed that the worst spill will last 4 days. If the worst case spill, based upon this calculation, is between 1,000 and 35,000 barrels of oil, the OSFR that needs to be posted is $35 million. For any volume greater than 105,000 barrels, the required financial responsibility is $150 million. This ceiling is imposed by the statute and cannot be adjusted by regulation. Macondo and Montara (and indeed IXTOC 1 before them) have demonstrated the inadequacy of this calculation. The question of the adequacy of OSFR is discussed further in the final section of this paper40.

6.27 Permitted methods for establishing financial responsibility include evidence of insurance, surety bond, guarantee, letter of credit or qualification as a self-insurer or 'other evidence of financial responsibility'. If a responsible party seeks to self insure, it must submit audited financial statements showing that it has assets net of liabilities equal to at least ten times the required amount of financial responsibility. If a responsible party seeks to establish financial responsibility by indemnification agreement, only a parent corporation or an affiliate of the responsible party may act as an indemnifier. If a responsible party wishes to demonstrate financial responsibility by obtaining insurance it must submit a certificate of insurance. The certificate must be from one or more insurance carriers each of which have received 'secure' ratings from a recognised ratings agency.

40 See also Deepwater Drilling: Law, Policy and Economics of Firm Organization and Safety, Cohen et al (2011) at http://www.rff.org/documents/RFF-DP-10-65.pdf

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6.28 The other key point is that the OPA does not merely require responsible parties to maintain evidence of financial responsibility but allows claimants to assert claims for removal costs and damages directly against any guarantor who provides evidence of financial responsibility for a responsible party to the extent that the responsible party has denied or failed to pay a claim on the basis of insolvency or filed a petition for bankruptcy or the claim is asserted by the United States government for removal costs and damages or for compensation paid by the Fund.

6.29 The other important point to note is that where an insurer guarantor would not be liable to indemnify the responsible party under the terms of the particular contract of insurance for all or part of the responsible party's liability (for example, there is an exclusion for a liability to pay damages for harm to natural resources or an express limit upon removal costs) and yet is still required to pay the OPA claimant(s) in full, the guarantor can bring a claim against the Fund for that contractually excluded or limited element of its pay out.

State Law: common law and legislation

6.30 There are two potentially applicable sources of State law. The first is general maritime law tort claim. This will require the victim to show that the wrongdoer owed him a duty of care which the wrongdoer breached and caused the victim damage. A cause of action in the general maritime tort of nuisance will tend to be available which is a tort concerned with the remedying the effects of dangerous substances. However, the problem with a common law tort cause of action, including in nuisance, is that generally only damage to property owned or leased by the victim is recoverable loss. Pure economic loss tends not to be recoverable.

6.31 The second source of applicable State law is specific pollution legislation. Most coastal states, including those Mexican Gulf states, possess oil pollution legislation with strict, often uncapped, liability provisions. However, State legislation varies with respect to recoverable losses (in particular, whether pure economic loss is recoverable), liability caps and defences.

6.32 As concerns the interrelationship between the OPA and State law:

(a) As previously mentioned, the OPA supersedes any State or federal law on liability for the costs of removal. In other words, the relevant state cannot 'bust the limit' of liability for removal costs (to the extent there is one – which is not the case with regard to offshore drilling operations) by bringing an additional or alternative claim to recover the balance of the removal costs incurred excess of the OPA limit.

(b) Public or private claimants can bring a general maritime law tort and/or a State statutory claim for damages including in an amount in excess of the applicable OPA limit. In other words a responsible party can be liable under both the OPA and under State law (common law and State legislation) and for an amount in excess of the OPA limit. This could be said to call into question the purpose of the OPA damages liability caps, which in principle, exist to save an entity from ruin. Furthermore, where the responsible party is guilty of gross negligence or wilful misconduct and the liability cap in respect of compensatory damages (including for pure economic loss) under the OPA does not apply, the responsible party could also be liable for

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punitive damages. In other words, the responsible party could be liable for:

(i) Unlimited clean up costs payable to the state/government under the OPA;

(ii) Unlimited damages for harm to property interests and pure economic loss under the OPA and/or State common or statutory law; and

(iii) punitive damages under State law.

6.33 So far as the US States around the Gulf are concerned (that is, Florida, Alabama, Mississippi, Louisiana and Texas) only Louisiana (whch is the jurisdiction for the Macondo litigation) has capped damages liability legislation. In all the other states, the damages that are available in principle are unlimited and in the case of Florida and Texas, liability is strict (i.e. negligence does need to be proved by the claimant).

6.34 As previously mentioned, punitive damages are non-compensatory. They are not intended to restore the victim to the position he was in before the wrong was committed but rather they are aimed at retribution and deterrence of morally reprehensible behaviour. So far as the victim is concerned, when he is awarded punitive damages he receives a windfall. The amount of punitive damages that can be awarded against a wrongdoer who is guilty of 'merely' reckless conduct is subject to some degree of control based upon their ratio to the level of compensatory damages awarded as informed by considerations of proportionality, fairness and predictability. Where the wrongdoer has behaved wilfully (that is deliberately with the intent to injure) the punitive damages that can be awarded are not limited in this way.

6.35 The objection to the award of punitive damages is that they are not consistent with the general aim of tort law which is to compensate victims for the actual loss they have suffered, i.e. to restore them to the position they were in before the tort was committed. Furthermore, prior to the enactment of the OPA which has codified the availability of damages for economic loss, a somewhat unsatisfactory state of affairs existed whereby a significant number of victims could be denied compensation altogether because of the general bar on the recoverability of economic loss whilst certain victims were over-compensated because the wrongdoer happened to behave in a morally unacceptable way. It has been observed by several commentators that it would be more fair and just if the wrongdoer's bad behaviour triggered a liability to pay compensation to a broader range of victims, especially those who suffer pure economic loss, than a liability to overcompensate particular victims. The OPA has addressed the problem of economic loss not being recoverable at all and also created a morally coherent system of more victims having access to more compensation where the wrongdoer has behaved badly by removing the cap on the damages liability in such circumstances. However, the grossly negligent wrongdoer now faces the risk of 'double jeopardy' meaning an unlimited liability to compensate victims for their economic losses plus a liability to pay them punitive damages (perhaps being a multiple of the compensatory damages) on top.

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Liability for administrative, civil and criminal fines: The Federal Water Pollution Control Act

6.36 So far as fines and penalties for oil pollution are concerned, the Federal Water Pollution Control Act or FWPCA (as amended by Clean Water Act or CWA) provides for administrative, civil and criminal fines and penalties against the owner, operator or person in charge of a vessel or facility that discharges a prohibited amount into or upon the navigable waters of the United States, adjoining shorelines, or the waters of the contiguous zone.

6.37 The key point about the FWCPA is that it provides recovery for government incurred cleanup and restoration costs but no remedy for private losses.

6.38 In summary:

(a) There is criminal liability for negligently or knowingly polluting the water. There is potentially a question about the standard of negligence required for the crime to have been committed, whether it is the civil standard of failing to take reasonable care or a standard that requires some degree of moral culpability, i.e. gross negligence or worse.. A negligent violation attracts a fine of not more than $25,000 per day of violation or imprisonment of not more than one year or both. A knowing violation attracts a fine of not more than $50,000 per day or a prison sentence of not more than 3 years or both.

(b) There is a liability for administrative penalties. The liability is strict and does not depend upon the character of the conduct that led to the spill. All that matters is whether a spill has taken place in an amount that is deemed to be harmful. The maximum amount of the administrative penalty is $190,000 (i.e. not a great deal).

(c) Alternatively, there is a potential liability to pay civil penalties that are imposed judicially. These can be very considerable and are dealt with below.

6.39 An action to impose a civil penalty can be brought in the district court of the United State for the district in which the defendant is located, resides or is doing business. The defendant will be the owner, operator or person in charge of the relevant vessel or facility. A defendant cannot be liable for both administrative and civil penalties. The amount of the civil penalty can be up to $37,500 per day of violation or an amount of up to $1,100 per barrel of oil discharged.

6.40 In determining the amount of the civil penalty the court must consider, amongst other things, the seriousness of the violation, the degree of culpability exhibited by the wrongdoer, any history of prior violations, the success of an efforts made by the wrongdoer to mitigate the effects of the spill and the economic impact of the penalty on the wrongdoer.

6.41 Where the spill is the result of gross negligence of wilful misconduct the owner, operator or person in charge is subject to a civil penalty of not more than $4,300 per barrel of oil discharged, i.e. almost four times the maximum primary measure. Accordingly, in the case of the Deepwater Horizon incident where 4.9 million barrels of oil were spilled BP faces a potential liability of $21 billion in respect of FWCPA civil penalties in addition to its OPA and State law liability.

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6.42 The concepts of 'gross negligence' and 'wilful misconduct' are discussed later on in this paper in relation to the question of the enforceability of the contractual cross-indemnities that the operator gives the contractors and vice versa.

Other potentially relevant federal statutes imposing fines and penalties

6.43 Several other federal statutes are potentially available to prosecutors to pursue criminal penalties against a party responsible for an oil spill including the Act to Prevent Pollution from Ships, the Refuse Act and the Migratory Bird Treaty. However, as previously discussed, the OPA prevails insofar as the removal costs are concerned.

The 1851 Limitation Act

6.44 The Shipowner's Limitation of Liability Act 1851 limits the liability of a vessel owner that causes pollution to the post-incident value of the vessel plus pending freight. However, it only applies to non-OPA claims such as claims for economic loss that are not contingent upon property damage.

Summary of applicable US remedial law

6.45 An operator of an offshore facility whose gross negligence has given rise a pollution incident is, in theory, exposed the following forms of liability as a matter of US federal and state statutory and common law law:

(a) Unlimited liability for the removal/clean-up costs under the OPA;

(b) Unlimited liability for environmental harm restoration costs under the OPA;

(c) Unlimited liability to private parties for compensatory damages for property damage and property damage related economic loss under the OPA;

(d) Punitive damages to the victims of property damage or economic loss under State statute or common law tort (including private nuisance) law.

(e) FWCPA civil penalties up to $4,300 per barrel of oil spilled.

(f) Criminal penalties and/or prison sentences under the FWCPA and some other statutes.

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7 THE UNITED KINGDOM POLLUTION LIABILITY REGIME

7.1 As concerns a pollution incident that affects United Kingdom territory, the following forms of legal redress are potentially available:

(a) A claim under the Offshore Pollution Liability Agreement 1974 ("OPOL") by the State and/or private parties for clean up costs and loss and damage caused by the pollution.

(b) A claim for clean up costs by the State under the Environmental Damage (Prevention and Remediation) Regulations 2009;

(c) A claim in tort (negligence and/or nuisance) by the State and/or private parties for clean up costs and damage caused by the pollution.

7.2 Under the Petroleum Act 1998, exploration and production of oil and gas in the United Kingdom and the UK sector of the North Sea can only be undertaken in accordance with the conditions of a licence issued by the UK Government. The Secretary of State, on behalf of the UK Government, issues licences though annual licensing rounds.

7.3 The Department of Energy and Climate Change is the department responsible for the regulation of all oil and gas licensing within the United Kingdom., its territorial sea and on the UK Continental Shelf. The conditions of the licences that are issued are prescribed in a series of model clauses that are set out in regulations that are in force at the time when the licence is granted. Licences issued after 6 April 2008 have model clauses a set out in the schedule to the Petroleum Licensing (Production)(Seaward Areas) Regulations 2008.

7.4 The model clauses require all licensees to:

(a) Operate in accordance with the methods customarily used in good oilfield practice;

(b) Take 'all steps practicable' to prevent the escape of oil in the licensed area.

(c) Licensees are required to have sufficient funds available to discharge any liability that they may incur for damage caused by any oil pollution.

(d) Licensees must keep the Secretary of State and the Department of Energy and Climate Change fully indemnified against all claims that may be brought by third parties in connection with the licence.

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OPOL

7.5 The grant of a licence to explore or produce oil on the United Kingdom Continental Shelf is conditional upon the operator being party to OPOL

7.6 OPOL is not a piece of legislation but a voluntary industry compensation agreement scheme. It came into effect on 1 May 1975. The scheme is administered by an English company, the Offshore Oil Pollution Liability Association Ltd, and is funded by the parties to OPOL, which are oil companies operating, or intending to operate, offshore facilities in connection with exploration for or production of oil and gas in jurisdictions designated by the agreement.

7.7 OPOL covers escapes and discharges of oil from offshore facilities within the jurisdiction of any State that is specified in the agreement. Those states include the Coastal States of the European Community, Norway, the Isle of Man and the Faroe Islands.

7.8 OPOL covers offshore facilities such as wells, drilling units, platforms, sub-sea infrastructure, offshore storage, production and loading systems and pipelines. It does not cover abandoned wells, installations or pipelines.

7.9 Governments, public bodies or authorities (municipal, local or otherwise) may claim in respect of reasonable remedial measures taken by them to prevent, mitigate or eliminate pollution damage or to remove or neutralise oil following an escape or discharge.

7.10 Any private person or entity may claim compensation for pollution damage resulting from an oil spill.

7.11 Pollution damage is defined as direct loss or damage by contamination which results from a discharge of oil.

7.12 Claims must be reasonable, quantifiable and justifiable. They can be submitted directly to operators for compensation. Admissible claim would include:

(a) clean up operations on shore or at sea,

(b) property damage,

(c) disposal costs of collected material,

(d) other losses which must be quantifiable and which must result directly from the contamination itself.

7.13 The key point about OPOL is that the operators who are party to it undertake to bear strict liability (with a limited number of exceptions) to third parties for any claims for pollution damage, or costs of remedial measures, caused by any offshore facility operated by them. OPOL is intended to encourage prompt remedial action by operators of offshore facilities in the event of spill without recourse to the courts and avoiding complicated and lengthy jurisdictional problems.

7.14 OPOL does not take away a claimant's right to seek redress through the Courts for losses which exceed the maximum recoverable under the Agreement or those beyond the scope of the Agreement.

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7.15 It will be observed that the requirement that losses must "directly result from the contamination" could potentially exclude some forms of economic loss, such as loss of revenue experienced by businesses because of the 'blight' on the general area caused by the pollution incident.

7.16 Furthermore, the 'quantifiable' requirement may well preclude compensation for 'harm to natural resources' that is claimable under the OPA.

7.17 Compensation payable under the scheme is subject to a limit of US$250 million per incident, sub-divided into two separate limits: first, a maximum of US$125 million in respect of remedial measure undertaken by public authorities, and second, a maximum of US$125 million in respect of other types of claim (by any party including private parties) for loss and damage (including claims for pure economic loss) caused by the pollution.

7.18 Operators who are parties to the scheme must provide evidence of financial responsibility (in the form of insurance or other security) for an amount of not less than US$250 million for any one incident. They also agree to contribute proportionally to the payment of claims due from a party in default.

7.19 Any compensation paid under the scheme is funded entirely by operators or their insurers not by the State. Allocation of risk between operators and contractors is left to individual contracts, rather than apportioned within the scheme itself.

7.20 Whilst the scheme provides no guarantee that claimants will not choose to litigate, in practice it should normally provide them with a simpler and more favourable source of compensation than legal remedies. Litigation is more likely if the incident is sufficiently catastrophic to generate claims above the US$250m limit. In such a case there is nothing to stop claimants suing contractors, or any other parties potentially at fault, as well as the operator.

7.21 As OPOL has never been replaced by any statutory remedies it remains in force, having been updated on a number of occasions, most recently in October 2010, when the liability limits were increased to their current level.

Environmental Damage (Prevention and Remediation) Regulations 2009

7.22 These regulations implement the EC Environmental Liability Directive. It applies only to activities onshore and in territorial waters up to 12 miles out. It relates only to prevention and clean up costs. It does not create a right to claim damages for any private third parties.

Claims in tort

7.23 A private individual or entity may have a claim in nuisance and/or the principle in Rylands v Fletcher in respect of pollution damage to property in which it has a proprietary interest. See the Buncefield litigation case (2009). Damages would be unlimited in principle but confined to compensation in respect of damage to property in which the claimant has a proprietary interest and economic loss flowing directly from such property damage. Pure economic loss is not recoverable in principle.

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8 NORWEGIAN POLLUTION LIABILITY REGIME

8.1 Norway's Petroleum Activities Act was passed in November 1996 and was and amended in June 2009. Chapter 7 of the Petroleum Activities Act assigns liability for pollution damage.

8.2 In essence, it is a strict liability regime that requires the licensee of the well to pay compensation to parties who have suffered damage because of pollution quickly and directly. Although the act specifically protects the economic interests of fishermen, it is unclear what other pure economic interests qualify for compensation. There are no monetary limits on the level of compensation that can be claimed.

8.3 Section 7-2 defines the scope of the law, making pollution damage that “occurs in Norway or inside the outer limits of the Norwegian continental shelf or affects a Norwegian vessel, Norwegian hunting or catching equipment or Norwegian facility in adjacent sea areas” the subject of liability under the Act. The Act also applies to pollution damage “from facilities used in petroleum activities” defined under the Act “when the damage occurs in onshore or offshore territory belonging to a state which has acceded to the Nordic Convention on Environment Protection.”

8.4 Section 7-3 of the Act makes the licensee “liable for pollution damage without regard to fault.”

8.5 This liability can be “reduced to the extent it is reasonable” if “an inevitable event of nature, act of war, exercise of public authority or similar force majeure event has contributed to a considerable degree to the damage.” It will be noted that this is the same type of limited defence available under the OPA.

8.6 Section 7-4 allows a victim of pollution damage to recover from the party that caused the spill only if the licensee “fails to pay within the time limit stipulated by the judgment.”

8.7 Section 7-8 sets the venue for legal claims as the courts in the “district where the effluence or discharge of petroleum has taken place or where damage has been caused.” However, the Ministry of Industry and Energy decides the venue if the damage was caused outside of any court district, its unclear in what court district the discharge or damage occurred, the discharge occurred in one court district but caused damage in another court district, or if the damage is caused in multiple court districts.

8.8 Chapter 8 of the Act provides special rules for the compensation of Norwegian fisherman. Section 8-3 makes the licensee liable, regardless of fault, to fishermen whom are affected by oil pollution for “the cost of reasonable measures to avert or limit such damage or such loss, including damage or loss as a result of such measures” including “damage and

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inconvenience due to pollution and waste.” Chapter 8 claims are made to a special commission set up by the King of Norway, and the decision of the commission may be appealed to a court of law.

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9 CHINESE POLLUTION LIABILITY REGIME

9.1 In China, the State Oceanic Administration (SOA) is the national authority vested with responsibility for the investigation, monitoring, observation, appraisal and scientific research of the marine environment.

9.2 The SOA is the competent authority with oversight of the Administrative Regulations on Environmental Protection on Ocean Exploration and Exploitation (REPOE) which were promulgated on 29 December 1983 and apply to enterprises, institutions, and individuals engaged in ocean oil exploration and exploitation within the seas under China’s administration, as well as fixed platforms, movable platforms and other related facilities.

9.3 As far as offshore pollution incidents are concerned, the key substantive laws consist of the PRC Marine Environment Protection Law (the "MEPL"), enacted in 1982 and amended in 1999, and the PRC Tortious Liability Law (the "TLL"), enacted in 2009.

9.4 In addition to these there is also a regulatory regime which is contained in the Regulations on Exploitation (1982), the Regulations on Environmental Protection (1983), the Implementing Rules on the Regulations on Environmental Protection (1990) and the Regulations on Prevention of Pollution and Damage (2006).

9.5 There is no primary legislation in China which deals exclusively with environmental protection in the specific context of exploration and exploitation of offshore petroleum. There are specific regulations dealing with those matters such as those set out above. However these were first promulgated in the 1980s and are now considered to be largely obsolete.

9.6 The MEPL provides a framework for the management and supervision of the China's marine environment by certain state authorities. Pursuant to Article 5 of the MEPL, there are five different governmental departments which are vested with the power to conduct various actions relevant to the supervision and administration of the marine environment. These authorities are as follows:

(a) The PRC's Ministry of Environmental Protection.

(b) The PRC's State Oceanic Administration (the "SOA").

(c) The PRC's Maritime Safety Administration.

(d) The PRC's Ministry of Agriculture (the "MOA").

(e) The environmental protection department of the Armed Forces, which is mainly responsible for pollution caused by warships.

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9.7 The MEPL also provides for the imposition of fines and/or penalties on any parties who are found liable fir having caused pollution to the marine environment. Rule 15 and rule 85 of the MEPL allows for a fine of up to RMB 200,000 ($32,000) per incident to be levied upon those entities which are found liable. This in itself does not represent a significant level of exposure when compared to that which is faced by those operating offshore in other jurisdictions.

9.8 However, the greatest exposure which a polluting party might face is likely to arise as a result of the broad powers which have been granted to the Chinese authorities for the recovery of "compensation" in the event of a pollution incident. The broad spectrum of losses in respect of which such compensation can potentially be recovered further increases a party's potential exposure. In this regard, the MEPL provides as follows:

(a) Whoever causes pollution damage to the marine environment shall remove the pollution and make compensation; in case of pollution damage to the marine environment resulting entirely from the intentional act or fault of a third party, that third party shall remove the pollution and be liable for the compensation (Article 90.1).

(b) For damage to marine ecosystems, marine fishery resources and marine protected areas which cause heavy losses to the State, the department invested with power by the provisions of this law to conduct marine environment supervisions and administration shall, on behalf of the State, put forward compensation demands to those held responsible for the damages (Article 90.2).

9.9 Under the law of the PRC, the authorities identified above are permitted to pursue claims for compensation in respect of losses which are deemed to have been incurred by the public at large (i.e. by the PRC or the state). The legislation which provides for this is Article 55 of the recently updated Civil Procedural Law, which states as follows:

"The relevant authorities and organisations invested with power by law could file claims before the competent People's Courts for actions which have damaged social public benefits, including actions which have resulted in environmental pollution and damage to numerous consumers."

9.10 By way of an example, China National Offshore Oil Corporation ("CNOOC") and Conoco Philips China ("COPC") are joint venture partners in respect of an oil field in Bohai Bay offshore China. As previously mentioned, a result of two pollution incidents which took place in 2011, a relatively small quantity of oil appeared to have been spilt into the bay (approximately 100 cubic meters). However, the parties were subsequently required to pay compensation of approximately RMB 3bn ($480m) to the Chinese authorities. The largest part of what was seemingly a disproportionate amount of compensation was recovered for "the public benefit" (i.e. for the state), in respect of losses which were said to have been suffered by the surrounding marine environment.

9.11 The two authorities which sought the compensation were the SOA, which is entitled to file claims in respect of "marine ecological damage", and the MOA, which is entitled to file claims in respect of "losses to natural fishery resources".

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9.12 It is also worth noting that, with regard to individuals and/or entities affected by pollution incidents, the law of the PRC provides for the authorities to recover compensation on their behalf. A fund is then set up, and the individuals and/or entities are compensated by the state in order to circumvent any requirement for them to pursue their own claims through the courts. As a result of the Bohai Bay incidents, RMB 731.5m ($116) worth of compensation was recovered through this mechanism in respect of losses incurred by Chinese fishermen who had been affected by the incidents.

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10 BRAZILIAN POLLUTION LIABILITY REGIME

10.1 Like most other countries the legal regime in Brazil involves three main elements namely criminal, administrative and civil liability. Criminal and administrative liability can be cumulative.

10.2 So far as criminal liability is concerned, Law 9.605/1998 ("Law of Environmental Crimes") establishes fines for criminal acts to the environment, including pollution, as provided under Art. 54. Decree 6.514/2008 is a secondary piece of legislation which deals, amongst other things, with the different fines and breaches created by the Law of Environmental Crimes. R$50m is the maximum fine applicable to pollution under Decree 6.514/2008, as provided under Art. 61.

10.3 So far as administrative liability is concerned, the relevant instrument is Law 9.966/2000 (the "Oil Law"). The Oil Law is concerned with the prevention, control and inspection of pollution caused by the spill of oil and other substances into Brazilian jurisdictional waters. R$50m is the maximum fine as provided under Art. 25,§2.The Oil Law expressly provides, under Art. 25,§3, that other fines can apply additionally and cumulatively.

10.4 Federal, state or municipal governments and governmental agencies can levy administrative penalties (pursuant to the Law of Environmental Crimes) and administrative fines (pursuant to the Oil Law) on the polluter. The Brazilian Environmental Agency, IBAMA, is in charge of clean up and the administrative enquiry/process and is particularly powerful.

10.5 Turning to civil liability (i.e. liability to pay damages to private parties), two pieces of law are relevant or potentially relevant.

(a) Article 225 of the Brazilian Constitution under which there is a duty on a wrongdoer to pay compensation in respect of environmental damage on a strict liability basis.

(b) Article 927 of the Brazilian Civil Code, under which there is a duty on a wrongdoer to pay compensation in respect of damage he causes.

10.6 In the case of the Frade spill, Chevron have been fined and pursued for civil damages. So far as the fines are concerned, Chevron were fined (a) R$50 million in November 2011 by IBAMA for the oil spill, (b) R$10 million in December 2011 by IBAMA for breach of safety measures and (c) R$35.1 million in September 2012 by ANP (the Brazilian Oil Regulatory Agency) for various breaches of safety regulations.

10.7 So far as the civil claims totalling $20 billion against Chevron and Transocean are concerned, these claims were principally based upon Article 225 of the Brazilian Constitution and Article 927 of the Brazilian Civil

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Code. As previously discussed, they have been significantly reduced in amount by the second public prosecutor who took over the cases.

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11 NIGERIAN POLLUTION LIABILITY REGIME

11.1 The regulation and licensing of oil operations offshore Nigeria falls under the aegis of the Ministry of Petroleum Resources.

11.2 Technical administration of offshore licensing is the province of the Department of Petroleum Resources, a department within the Ministry of Petroleum Resources.

11.3 Licences are managed pursuant to a production sharing contract (PSC) between the Nigerian National Petroleum Corporation and the relevant operator (typically a large multinational oil company) and the other joint venture participants. The Deep Offshore and Inland Basin Production Sharing Contracts Act No. 9 1999 governs PSCs in Nigeria and sets out the general framework for the operation of PSCs, including the applicable royalties, tax regimes, and the manner in which costs and profits are allocated between the parties.

11.4 The National Oil Spill Contingency Plan is Nigeria’s action plan for imposing liabilities in spill situations pursuant to Nigeria’s adoption of the International Convention on Oil Pollution Preparedness, Response and Co-operation 1990.

11.5 Other environmental protection legislation includes the Oil in Navigable Waters Act, the National Environmental Standards and Regulations Enforcement Agency Act (which repealed the Federal Environmental Protection Agency Act) (now the Federal Ministry of Environment), the Environmental Impact Assessment Act, the National Oil Spill Detection and Response Agency (NOSDRA) Act 2005, the Harmful Wastes (Special Criminal Provisions) Act of 1988 (Harmful Wastes Act), the Oil Terminal Dues Act, the Federal Environmental Protect Act and the Environmental Guidelines and Standards for the Petroleum Industry in Nigeria published by the Department of Petroleum Resources

11.6 So far as a liability for criminal fines is concerned, the Oil in Navigable Waters Act provides that if oil or mixture containing oil is discharged into waters to which the Act applies from any vessel or from any place on land, or from any apparatus used for transferring oil from or to any vessel (whether to or from a place on land or to or from another vessel), a fine of only N2,000 can be imposed upon the person responsible for the pollution. However, this very small fine can only be imposed after a trial and conviction of the polluter.

11.7 There is a draft law before the Senate to be known as "National Oil Spill Detection & Response Agency (Amendment) Act", which seeks to impose much higher fines. For example, for an offshore facility (except a deep water port) the total of all removal costs could be imposed upon the polluter plus N5bn (US3.3m).

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11.8 In addition, the Federal Environmental Protection Agency Act prohibits the discharge of any hazardous waste into the air, upon land and the waters of Nigeria and provides for criminal liability of a life imprisonment upon conviction.

11.9 This patchwork of legislation purports to adopt the ‘polluter pays’ principle and creates a strict regime prohibiting the discharge in harmful quantities of any hazardous substances to the environment, except where permitted or authorised by law, and to render the party responsible for the pollution liable to remediate any contamination of the environment and to compensate those who suffer loss and damage as a result of any pollution.

11.10 Although these laws exist, they are typically not enforced in practice. Instead, claims tend to be based upon common law remedies such as the torts of nuisance, trespass, negligence or the rule in Rylands v Fletcher rather than by the application of the statutory remedies provided under the relevant statutes.

11.11 Alternatively, the authorities have taken to asserting very large fines against oil companies. The National Oil Spill Detection and Response Agency (NOSDRA) has been taking the lead on seeking to impose financial liabilities on alleged polluters. The $5bn that has been imposed upon Shell for the Bonga incident and the $3bn fine that has been imposed upon Chevron for the Funiwa incident have been mentioned earlier. It is notable that NOSDRA has not suggested that the imposition of these fines is justified by reference to any existing Nigerian legislation. NOSDRA appears to be taking a more 'practical' approach of asserting a fine and then getting political support for it on the basis that the oil company will have no practical choice to pay at least something if it wants to continue getting the co-operation of the Nigerian state for its exploration and production activities.

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12 THE ARCTIC

12.1 It is estimated that the Arctic holds up to 25% of the world's hydrocarbon reserves. Many of the world's international oil companies are interested in exploiting those reserves. Although there has been some significant exploration activity over the last 50 years, the region is largely unexplored and, so far, production has, essentially, been limited to onshore oil production on the North Slope of Alaska (which has been going on since the 1970s).

12.2 This will inevitably change with:

(a) Long-term high oil and gas prices making costly exploration activities economically worthwhile.

(b) The warming of the region making more of it more accessible for more of the year than was previously the case.

(c) Technological advances.

(d) The desire of the West to reduce its dependence on the Middle East for oil and gas;

(e) The economic/political ambitions of Russia in particular, its desire to sell oil and gas to China.

12.3 The Arctic region is controlled by eight states: Canada, Denmark (including Greenland and the Faroe Islands), Finland, Iceland, Norway, Russia, Sweden and the United States. All eight states are members of the Arctic Council which is a high level intergovernmental forum which provides a means for promoting cooperation, coordination and interaction among the Arctic States, with the involvement of the Arctic Indigenous communities and other Arctic inhabitants on common Arctic issues, in particular issues of sustainable development and environmental protection in the Arctic41.

12.4 Most exploration and production activity will tend to take place, for the foreseeable future at least, in territory that clearly belongs to one or other of these eight states. Accordingly, the licensing, regulation and liability regime that applies to a particular operation should be readily discernible in the short to medium term; it will be that one of the eight states.

41 See http://www.arctic-council.org/index.php/en/about-us

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12.5 At present Gazprom, Total, BP, Rosneft, Exxon are engaged in exploration in the Russian sector. Statoil are engaged in some gas production and oil and gas exploration activities in the Norway's Arctic fields and the Barents Sea. There is ongoing onshore oil production on the North Slope of Alaska and Shell has been given federal approval for six exploratory wells offshore Alaska. Cairn Energy is undertaking exploration in Greenland.

A drilling rig in the Arctic being towed into position

12.6 Broadly speaking, the licensing, regulation and liability regimes of all eight of these states are sophisticated. The regimes in the United States and Norway have already been discussed.

12.7 There are five main issues with hydrocarbon exploration and production in the Arctic from a pollution perspective.

(a) The harshness and instability of the operating environment which will tend to cause mistakes and equipment failures to happen more frequently than in a normal environment.

(b) Ensuring rigorous adherence to safety regimes and transparent reporting of incidents to ensure an effective response. This may be easier in some territories than others.

(c) Incomplete understanding of what pollution containment techniques are effective in the Arctic.

(d) Lack of infrastructure to support an effective containment operation when there is a spill in the Arctic.

(e) Incomplete understanding about the environmental impact of an oil spill in the Arctic.

12.8 The lack of infrastructure to deal with a pollution incident is illustrated by the resources that were available and were used to deal with the Macondo spill.

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According to BP's website: "At its peak, the response [to Macondo] involved the mobilization of approximately 48,000 people, the coordination of approximately 6,500 vessels and the deployment of approximately 2,500 miles of boom to contain or absorb the oil. BP employees and retirees brought their expertise from all parts of the business, from around the world to the response effort"42

12.9 Below is a map which shows the number of airports and coastguard facilities within a 500 mile radius of the Deepwater Horizon incident.

Infrastructure within a 500 radius of the Deepwater Horizon spill

12.10 By contrast, in the Arctic, there is essentially no real infrastructure to speak of. It would simply be impossible to mobilise anything approaching the number of craft and personnel to deal with a serious spill in the Arctic. For example, the response fleet for the Shell exploration venture in Alaskan waters consists of less than 10 vessels and a capping device to deal with a 'worst case scenario' 43. This is not to suggest that the fleet is bound to be ineffective. However, it demonstrates what is economically and physically possible. If the Deepwater Horizon is a 'worst case scenario' and required tens of thousands of personnel and thousands of vessels to bring it under control, it is perhaps questionable whether, had it occurred in the Arctic, it would ever be brought under control.

42 http://www.bp.com/sectiongenericarticle800.do?categoryId=9036585&contentId=7067606 43 http://www.youtube.com/watch?v=LnWlBZJP9HU

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The Nanuq – Shell's principal response vessel in the event of a spill in the Arctic

12.11 As anywhere, but particularly the Arctic, the focus has to be on safety and minimising the risks of a spill. It would only take one major incident for exploration and production to be put in jeopardy forever. Given the potential for catastrophic environmental damage, it makes sense for the Arctic states jointly to develop and enforce uniform standards of minimum best practice. It is important that knowledge is shared and there is transparency between the Arctic states. The Arctic Council is critical to this happening. What has to be avoided is one state trying to gain advantage over the others by permitting lax operating standards or dealing inadequately with, or worse, covering up environmental damage.

12.12 Adherence to standards of best practice can also be encouraged by Insurers who can impose terms requiring adherence to those standards as a condition of the insurance cover responding in the event of a loss. Although insurers may not be exposed to pollution liability per se they will be exposed to some of the causes of pollution liability, i.e. physical loss of or damage to machinery and equipment that can give rise to pollution. It is obviously important that underwriters have a proper technical understanding of the underlying engineering so that the conditions they impose are specific, clear and relevant. Furthermore, it would make sense for compliance with those conditions to be monitored in real time by a representative of the Insurer who understands the information provided to them, i.e. a marine warranty surveyor (MWS). In short, Insurers are third parties who have a powerful incentive to ensure that best practice is actually followed and whom the operator has a powerful incentive to accommodate (if he wants to have effective first property damage cover). This is an important theme in the context of mitigation pollution risks generally and is discussed at the end of this paper.

12.13 So far as the remedial regime (i.e. fines, penalties and damages) is concerned, although the laws of the eight regimes differ, there is no gaping deficiency in any of them. It will be apparent that it is mainly the world's major oil companies that are going to be engaged in Arctic exploration and production in the foreseeable future. As has been previously mentioned, these are amongst the best capitalised entities in the world. A major incident in the Arctic would generate massive adverse publicity and the entity responsible would be put under huge political pressure to make available such funds as were required to sort out the problem, regardless of

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the application of the statutory limit of liability (if there was one). The real problem is whether the capital base of one or more major international oil companies would actually be sufficient to deal with the costs of sorting out an environmental disaster in the Arctic. If Macondo costs BP $40-$60 billion, a similar disaster in the Arctic could cost a multiple of that. However, a clean up cost of, say, $100 billion would destroy most companies on the planet and it is likely to be economically possible to 'tie up' that amount of money in anticipation of it being needed. In short, one would hope that the risk of financial annihilation that exists as a matter of political reality is probably sufficient to encourage good and responsible behaviour and deter bad behaviour without the need to draft laws specially for the Arctic promising the same consequences. To reiterate, what is critical is ensuring that standards of best practice are followed and that is best achieved not by promulgating legislation that punishes heavily after the event but by further massive investment in technology, recruitment, training and supervision. Once the stage of actually applying the remedial or punitive laws is reached, the system has failed.

A controlled experiment at burning an oil spill in the Arctic

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13 WHO PAYS?

13.1 The question of who ultimately stands to bear the costs of a pollution incident is complex. The following questions need to be separately considered:

(a) Who is primarily liable to pay clean up costs, damages and fines to the State and to private parties?

(b) An operator or contractor having paid out clean-up costs, damages and/or fines to the State and/or to private parties, can he pass that liability onto another party through a contractual indemnity or a civil liability contribution claim?

(c) Can the operator or contractor recover its remaining liability (indemnities and contribution claims having been exhausted) from its insurers?

13.2 The issue of who pays is important for a number of obvious reasons. First and foremost, it is important to ensure that the person who is responsible for paying has the means to do so. Second, what are the consequences for the offshore contracting industry if the standard indemnities are challenged and do not work? Third, does the consumer or taxpayer ultimately pay with higher oil prices and, if so, how is that consistent with aims of the regulatory and civil and criminal liability regimes?

13.3 The section deals with the topic of 'who pays' under three headings:

(a) Primary liability for loss and damage caused by a pollution incident.

(b) The terms of and enforceability of contractual Indemnities between operators and contractors;

(c) Scope and quantum of insurance coverage

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(a) Primary Liability

13.4 The party who is primarily liable to third parties and the State for loss and damage caused by a pollution incident depends upon the legal regime that applies to the incident.

13.5 As previously discussed, where US law and, in particular, the OPA applies, it is the 'responsible parties' who are primarily liable. Specifically, in the case of an offshore discharge:

(a) Where a discharge is from a vessel, any person who owns, operates or demise charters the vessel is the responsible party.

(b) Where the discharge is from an offshore facility (other than a pipeline), the responsible party is the lessee or permitee of the area in which the facility is located.

13.6 In cases involving multiple responsible parties, their liability under the OPA is joint and several.

13.7 The US courts have construed the OPA's definition of 'responsible party' broadly. Following the Deepwater Horizon incident the United States Cost Guard designated BP Exploration & Production Inc (the lessee of the field in which the Macondo well was located) and Transocean Holdings Incorporated (the owner of the Deepwater Horizon drilling rig) as responsible parties.

13.8 So far as fines for oil pollution in the US are concerned under the FWPCA, the owner, operator or person in charge of a vessel or facility that discharges the pollution may be liable.

13.9 Turning to the UK and the OPOL regime, it is the relevant operator who is party to the OPOL agreement who, alone, is liable under OPOL, regardless of the culpable contribution of any other party. However, it is important to remember that OPOL is not a statute. It is an agreement to which the operator is party as a condition of its licence to explore for and produce oil under which it contractually agrees to assume responsibility to bear clean up costs and pay compensation to affected third parties.

13.10 So far as tortious nuisance type claims are concerned under any particular system of law, the primarily liable party will tend to be the operator, since it is the operator who has overall responsibility for the activity that has given rise to the pollution.

13.11 So far as tortious negligence type claims under any particular system of law are concerned, it is the party or parties whose failure to take reasonable care has caused the pollution incident who will be primarily liable. Depending upon the facts, this could be the operator, the drilling contractor, the cement manufacturer, the BOP manufacturer or owner or a combination of them.

13.12 Accordingly, it will be observed that depending on the facts, it may not just be the operator who is liable to pay damages (including punitive damages), clean-up costs and fines. One or more contractors may also be liable.

13.13 As previously mentioned, the potential liability of contractors for a pollution incident, especially to pay penalties and fines, disrupts the economic assumptions upon which contractors participate in an offshore ventures.

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The industry assumption has been that it will be the operator who is principally exposed to third party clean-up costs and will be entity that Governmental agencies will pursue for clean-up costs, penalties and fines. However, the litigation that has arisen out of the Deepwater Horizon incident has falsified that assumption and this has profound implications for the future of the industry.

13.14 The Deepwater Horizon incident has also brought into sharp focus the efficacy of the indemnity regime that is such a key feature of offshore exploration contractual arrangements, specifically the efficacy of the indemnity provided by the operator to the contractors in respect of the liability they may incur in respect of a subsea pollution incident. This is considered in the next section.

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(b) Contractual indemnities

13.15 As previously mentioned, in a typical exploration project the contracts between the operator and contractors will contain a provision whereby the operator promises to indemnify the contractors for any third party liability they may incur arising out of a subsea pollution incident regardless of whether that pollution incident has been caused by a breach of contract or negligence (including gross negligence) of the contractor. The forms of liability usually covered include a liability to pay compensatory or punitive damages and fines and penalties imposed by the Government.

13.16 By way of example, the pollution liability indemnity given by the operator to the contractor in the LOGIC General Condition of Contract for Mobile Drilling Rigs provides at clause 18.3 as follows:

"…the COMPANY [operator] shall save, indemnify, defend and hold harmless the CONTRACTOR GROUP [drilling rig contractor] from and against any claim of whatever nature arising from pollution and/or contamination including without limitation such pollution and/or contamination emanating from the reservoir or from the property of the COMPANY GROUP including oil based muds or similar materials used on the instruction of the COMPANY…"

13.17 The LOGIC contract goes on to provide at Clause 18.8 that "All…indemnities given under this Clause…shall apply irrespective of cause notwithstanding the negligence, breach of duty (whether statutory or otherwise) or other failure of any nature of the indemnified party or any other entity or party and shall apply irrespective of any claim in tort, under contract or otherwise at law".

13.18 Accordingly, if a blowout is caused by the negligence of the drilling rig contractor and that blowout results in a major pollution incident which in turn results in the drilling rig contractor being found liable to pay damages to private parties and the Government and fined, that liability should, pursuant to the plain words used in these provision, be indemnified and borne wholly by the Operator.

13.19 However, the Deepwater Horizon litigation has put that basic proposition into doubt.

13.20 Clause 24.2 of the Drilling contract between BP and Transocean in respect of the Macondo well provided as follows: "[BP] shall assume full responsibility for and shall protect, release, defend, indemnify and hold [Transocean] harmless from and against any loss, damage, expense, claim, fine, penalty, demand or liability for pollution or contamination…specially without regard for whether the pollution or contamination is caused in whole or part by the negligence or fault of [Transocean]".

Wilful misconduct not capable of being subject of an indemnity

13.21 Most legal systems will generally not permit an indemnity to given by one party to another in respect of the other's wilful misconduct (whether it gives rise to third party liability or otherwise). Wilful misconduct is conduct that is deliberately calculated to cause harm and damage. So far as insurance is concerned, it offends the 'fortuity' principle. In other words, it is not possible in principle to provide an indemnity for loss that the an assured deliberately incurs. Wilful misconduct involves a subjective inquiry into the state of mind

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of the wrongdoer to establish whether he or she intended to cause harm. The meaning of 'wilful misconduct' and how it differs from 'gross' negligence is discussed later.

13.22 However, it is common to find that the contract will define precisely whose conduct counts to qualify as the wilful misconduct of the corporate entity, for example 'senior supervisory personnel' rather than a deckhand (for example).

13.23 Accordingly, where a contractor's low level employee has committed an act of wilful misconduct, such as sabotaging the well, that has given rise to a pollution incident that, in turn, has given rise to third party liability on the part of the contractor, the indemnity should still be effective so long as it does not exclude any act of wilful misconduct regardless of at what level within the organisation it is committed.

13.24 An act of wilful misconduct committed at a high level within the organisation such that it could be said to be committed by the directing mind and will of the company is, under most systems of law, incapable of being the subject of an indemnity whether or not it is expressly excluded. This is for the straightforward public policy reason that an act of wilful misconduct will invariably also be a crime and the concepts of crime and punishment would be undermined if it were possible to transfer the burden of meeting society's response to such conduct to a third party.

13.25 This is precisely the same policy consideration that underlies the prohibition in most jurisdictions on insurance cover for the consequences of engaging in criminal conduct, e.g. the cost of having to engage a driver if you are banned from driving a vehicle for a drink driving offence. If a party is able to insulate itself from the consequences of its criminal conduct through insurance (which is a contract of indemnity) the deterrent effect of the prospect of punishment will be eroded and the tendency for crime to be committed may be increased.

Indemnity for gross negligence is enforceable as a matter of Louisiana law

13.26 However, in the Deepwater Horizon case, BP went beyond obtaining confirmation of the position in relation to wilful misconduct. They were seeking to argue that the indemnity did not cover the situation whether the pollution had been caused by morally less culpable behaviour than wilful misconduct, specifically Transocean's gross negligence (in distinction to normal negligence) even though the indemnity did not expressly exclude Transocean's gross negligence.

13.27 BP argued that an indemnity given by one party in respect of another's gross negligence was void as a matter of public and also pointed to Louisiana case law that stood for the proposition that a contractual waiver given by party A to party B in respect of party B's gross negligence causing party A harm is void as a matter of public policy. However, the judge held that a release was not the same as an indemnity because an indemnity was concerned with liabilities to third party as opposed to the position inter se. The distinction is apparently justified on the basis that it is unobjectionable for a party to agree to bear another's liability to a third party, even where that liability has been generated by the indemnitee's gross negligence. On the other hand, it is objectionable as a matter of public policy for a party to agree to deprive itself of a claim and a remedy where it has been injured or damaged by another party's gross negligence.

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13.28 This distinction is not entirely convincing because gross negligence on the part of a contractor which renders it liable in law to a third party is also likely to be an actionable wrong as against the operator which causes the operator loss and damage as well. Yet it would be an odd result if, notwithstanding the indemnity, the operator could nevertheless sue the contractor. For example, if the drilling contractor's gross negligence causes a blowout which leads to a pollution incident which in turn leads to a third party bringing a claim against both the operator and the contractor and they are both found jointly and severally liable for the same loss and damage, the contractor's conduct will likely be in breach of duty to the operator as well as the third party and that breach will have caused the operator loss and damage by rendering it liable to the third party. However, it would be inconsistent with the indemnity if the operator was able to bring a claim against the contractor to recover its liability to the third party.

13.29 If this is not the correct analysis, it rather calls into question the efficacy of the whole indemnity regime in the sense that despite being obliged to indemnify the contractor in respect of its liability to the third party, the operator could get around that by paying the third claim in full itself and then bringing a claim against the contractor to recover that loss.

13.30 Nevertheless, despite the rather fragile distinction between a waiver and an indemnity, as matters stand in the Deepwater Horizon litigation, an indemnity (as opposed to a waiver) for gross negligence is valid and enforceable as a matter of Louisiana state law.

Indemnity in respect of punitive damages and fines not enforceable

13.31 However, the Deepwater Horizon litigation has established that what is not enforceable is an indemnity in respect of either punitive damages or fines and penalties. This is because they are sanctions and intended 'to punish culpable individuals and deter future violations, not just to extract compensation or restore the status quo'. Indeed, a 'penalty requires a Court to consider factors such as the seriousness of the violation, the defendant's culpability, and the economic impact the penalty will have on the defendant'. Moreover, 'the penalty becomes somewhat 'tailored" to the specific defendant and situation; and amount appropriate for one defendant might be ineffective (or grossly excessive) for another'.

13.32 In short, punitive damages and fines need to be 'felt' by the party on whom they are imposed in order to promote their retributive and deterrent purpose. That purpose would be undermined if the burden of paying them is shifted to someone else.

Indemnity for removal costs enforceable

13.33 On the other hand, removal costs are capable of being the subject of an indemnity because they are 'intended to restore the status quo; they are remedial in nature'. In other words, it is not purpose of compensatory damages to teach the wrongdoer a lesson and so there is nothing objectionable about it shifting the burden of paying them to another party.

13.34 Accordingly, the position so far as Louisiana state law is concerned is that:

(a) An indemnity in respect of a liability of a private party to pay the Government compensatory damages is enforceable even if the

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conduct giving rise to that liability is in the nature of gross negligence (except where gross negligence is expressly excluded).

(b) However, a waiver by one party of a claim it may have against the other arising out of other's gross negligence is not enforceable as a matter of public policy.

(c) An indemnity in respect of a liability to pay any form of damages or fines that are intended to punish that party is not enforceable.

13.35 However, it should be noted that there are some states of the United States that do not permit indemnities in respect of gross negligence (including where the indemnity is express). This has led some operators to carve out gross negligence from the standard form indemnity.

Gross negligence carve out – what is 'gross' negligence?

13.36 Where gross negligence is expressly carved out of the indemnity, alternatively not permitted to be the subject of an indemnity as a matter of the governing law of the contract, the question arises what is meant by 'gross negligence'.

13.37 There are two aspects to this inquiry. The first is the quality of the conduct which makes it 'gross' rather than 'normal' negligence. The second is the position within the organisation of the person who has committed the act of gross negligence; an entity may be vicariously liable to a third party for the gross negligent acts of its most junior employees. However, vicarious liability is not the same thing as saying that the entity itself has committed the act of gross negligence. This involves identifying exactly which human being(s) is the company for the purposes of the particular activity in question.

13.38 As concerns the question of what quality of conduct constitutes 'gross' negligence, the concept may sometimes be defined by the contract or it may require to be construed according to the governing law of the contract.

13.39 However, whether the concept is defined by the contract or is left open, it still needs be applied to the particular context. Accordingly, the most substantial part of the inquiry will always tend to be applying the 'abstract' standard (which, despite some differences in definition is broadly the same under many legal systems, namely a serious disregard for an obvious risk) to the real world and the specific industrial context, here offshore exploration and production.

13.40 We shall consider first how English, US and Canadian courts have defined the concept of 'gross negligence' in the abstract. We shall then consider a contractual definition of gross negligence that may appear in an offshore exploration contract..

13.41 First, English law. In Tradigrain S.A. v Intertek [2007] EWCA Civ 154, the Court of Appeal said that the term “gross negligence” although often found in commercial documents has never been accepted by English civil law as a concept distinct from simple negligence. There is just the tort of negligence, which is a failure to take reasonable care. The liability of the tortfeasor is not enhanced or increased because the negligence was particularly culpable.

13.42 However, it is unlikely that an English Court if asked to apply the 'gross negligence' carve-out as a matter of English law would hold that since gross

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negligence is legally the same thing as normal negligence as a matter of tort law, the carve-out has the effect of excluding negligence of whatever character altogether from the indemnity, alternatively not excluding negligence at all. The parties have identified 'gross' negligence as not qualifying for an indemnity as distinct from 'simple' negligence. The reason why the law does not (and does not need to) distinguish between simple and gross negligence in the context of a third party claim should not govern the approach to the proper application of the contractual indemnity. That would be dogmatic and obviously to disregard the parties' intentions.

13.43 In Armitage v Nurse [1998] Ch 241, the Court of Appeal suggested that English law does accept that there is a difference in degree between simple negligence and gross negligence, and that parties can exclude liability for gross negligence.

13.44 There is also the judgment of Mance J in The Hellespont Ardent [1997] 2 Lloyd’s Rep. 547. in which he decided that as a matter of English Law, gross negligence is intended to represent something more fundamental than a failure to exercise proper skill and/or care. He said that as a matter of ordinary language and general impression the concept of gross negligence is capable of embracing not only conduct undertaken with actual appreciation of the risks involved but also serious disregard of or indifference to an obvious risk. In that case, one of the contracts which contained the relevant gross negligence provision was governed by New York law. Mance J said that whether United States or English principles were applied, the concept of gross negligence did not involve, necessarily, any subjective mental element of appreciation of risk. It may include conduct which a reasonable person would perceive to entail a high degree of risk of injury to others, coupled with heedlessness or indifference to or disregard of the consequences. In other words, an objective test. There did not need to be conscious indifference or disregard judged subjectively.

13.45 Mance J concluded that whether one looked at the American authorities or to the simple meaning of the words without attributing to them any special meaning under New York law, the concept of gross negligence embraces serious negligence amounting to reckless disregard. The type of reckless conduct which was required to found gross negligence could either be:

(a) where the actor knows, or has reason to know, of facts which create a high degree of risk of physical harm to another and deliberately proceeds to act, or to fail to act, in conscious disregard of, or indifference to, that risk; or

(b) where the actor has such knowledge, or reason to know, of the facts, but does not realise or appreciate the high degree of risk involved, although a reasonable man in his position would do so.

13.46 However, for either type of conduct, to be reckless it must not only be unreasonable, but it must involve a risk of harm to others substantially in excess of that necessary to make the conduct negligent. It must involve an easily perceptible danger of death or substantial physical harm, and the probability that it will so result must be substantially greater than is required for ordinary negligence. Mance J pointed out that factors which went to the crassness or blatancy of a defendant’s conduct were relevant, and these would include (a) the seriousness or otherwise of any injury which might arise; (b) the degree of likelihood of its arising and (c) the extent to which

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someone takes any care at all. He also added that if obvious steps had been completely omitted to guard against or cater for a risk that could have very serious consequences, then the fact that in many or most cases the risk was not likely to materialize would not automatically defeat a charge of gross negligence. All the circumstances have to be weighed and balanced.

13.47 Under New York State law, gross negligence "differs in kind, not only degree, from claims of ordinary negligence. It is conduct that evinces a reckless disregard for the rights of others or smacks of intentional wrongdoing." Colnaghi, U.S.A v. Jewelers Protection Servs.. 81 N.Y.2d 821, 823-4 (N.Y. 1993). "Stated differently, a party is grossly negligent when it fails to exercise even slight care or slight diligence." Ryan v. IM Kapco, Inc., 930 N.Y.S.2d 627, 629 (App. Div. 2d Dep't 2011).

13.48 Federal case law on gross negligence in the context of vessel classification inspections states that gross negligence requires that the "defendant has not only acted carelessly in making a mistake, but that it was so extremely careless that it was equivalent to recklessness. . . an indifference to present legal duty and utter forgetfulness of legal obligations, so far as other persons may be affected." 1992 A.M.C. 2946, 2968-9 (S.D.N.Y. 1992).

13.49 Turning to Canadian law, the Newfoundland Supreme Court said this in a 1960 case: 'What exactly is meant by "gross negligence"? Now, courts have repeatedly declined to give any general, or abstract, definition of the expression: whether conduct is negligent at all, or grossly negligent, must depend upon the circumstances of each case. What all the authorities seem to agree upon is that the words connote something going beyond ordinary actionable negligence. Some judges translate them as "great negligence"; others, as "very great negligence". Without joining in the dispute at all, I will only give it as my opinion, having regard to all the arguments I have advanced above, that the best view is that . . . the word gross, which seems to have become a term of reproach and usually to suggest something opprobrious, is used in its simple and original sense of denoting something large.' See Drake v Power (1960), 46 M.P.R. 91 at 104, 105.

13.50 That said, in 1942, the Supreme Court of Canada said: "All these phrases, gross negligence, wilful misconduct, wanton misconduct, imply conduct in which, if there is not conscious wrong doing, there is a very marked departure from the standards by which responsible and competent people in charge of motor cars habitually govern themselves." See McCulloch v Murray [1942] 1 S.C.R. 141 at 145 per Duff CJ.

13.51 The most recent judicial pronouncement came from the Ontario Court of Appeal in 1972 in Jackson v Millar [1973] 1 O.R. 399 at 40: "Sedgewick J in City of Kingston v Drennan, defined gross negligence as "very great negligence". This paraphrase has generally been accepted and while it is probably not too satisfactory, it clearly indicates that in any given case the factual situation, in order to form a basis for gross negligence, must indicate conduct that is a marked departure from the standard by which ordinary responsible persons govern themselves."

13.52 Turning to the situation where 'gross negligence' is defined by the contract, an example is as follows:

“An intentional and conscious or reckless disregard of good and prudent oil and gas field practice and/or of any of the terms of this

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Contract in utter disregard of avoidable and harmful consequences but shall not include any act, omission or error of judgment or mistake made in the exercise in good faith of any function, authority or discretion which in the exercise of such good faith is justifiable by special circumstances, including but not limited to safeguarding of life, property or the environment and other emergencies.”

13.53 It will be observed that this accords with the language used by the English and US Courts when defining gross negligence. The difficult part of the exercise is applying the abstract concept to the particular context. This is will require establishing

(a) exactly what 'good and prudent oil and gas field practice' is. Of course, in some situations this will be obvious. In others it will not and there may be competing schools of thought.

(b) to what extent the good practice was disregarded and whether it was "utter".

13.54 Whether or not the concept of gross negligence is defined by the contract or not, the perception of whether an act is merely negligent or grossly negligent depends not only on the character of the act but its consequences. As has been eloquently put by Patrick H Martin in a very thoughtful article in the Louisiana Law Review [Vol.71, 2011] entitled 'The BP Spill and the Meaning of "Gross Negligence or Wilful Misconduct',

"In the mind, the degree of negligence is linked to magnitude of the injury. A negligent extinguishment of a campfire or shooting of fireworks will be deemed minor when the injury is limited to a few feet of brush next to the fire. The same act of shooting a firework is more likely to be characterized as "gross negligence" when it takes place on a dry day and the resulting fire destroys several thousand acres of property. A reading of even a small number of the thousands of cases that take up and apply gross negligence as a standard readily confirms that "gross negligence" is not no much a description as it is a conclusion, one that merges the actor's act(s), the actor's state of mind and the insured's injury. The term "gross negligence" in these cases identifies both the action of the wrongdoer and the effects of that action. Thus the degree of negligence and magnitude of risk are closely connected…To paraphrase: the greater the degree of potential (or actual) harm, the greater the degree of negligence".

13.55 As is apparent from its title, the purpose of this article is to assess the chances of the US Court characterising BP's behaviour in the run up to the Macondo blow-out as 'grossly negligent' under the OPA and the FWCPA thereby greatly increasing BP's liability for damages and fines it faces.

Wilful Misconduct

13.56 As stated earlier, wilful misconduct will not be covered by the indemnity. However, where 'gross' negligence has not been carved out there may be an interesting question as to the difference between 'gross' negligence (which will be covered by the indemnity) and wilful misconduct which will not be.

13.57 In Horabin v British Overseas Airways Corporation [1952] 2 Lloyd’s Rep. 450, a case concerned with the Carriage by Air Act 1932, Barry J defined

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wilful misconduct as occurring when the person who did the act knew that he was doing something wrong, and knew it at the time, and yet did it just the same, or alternatively that the person who did the act did it quite recklessly not caring whether he was doing the right or the wrong thing, quite regardless of the effect of what he was doing upon the safety (in that case) of the aircraft and the passengers for which and for whom he was responsible. However, the wilful misconduct had to be the direct or immediate cause of the accident.

13.58 In the context of the Criminal Damage Act 1971, the House of Lords held in R v G [2004] 1 AC 1034, that it had to be shown that the defendant’s state of mind was culpable in that he acted recklessly in respect of a circumstance if he was aware of a risk which did or would exist, or in respect of a result if he was aware of a risk that it would occur.

13.59 New York courts have held that the existence of wilful misconduct depends on the facts of the particular case and that "there must be . . . a conscious intent to do or to omit doing the act from which harm results to another, or an intentional omission of a manifest duty. There must be a realization of the probability of injury from the conduct, and a disregard of the probable consequences of such conduct." Goepp v. American Overseas Airlines, Inc., 117 N.Y.S.2d 276, 281 (App. Div. 1st Dep't 1952).

13.60 Federal courts that have attempted to formulate a definition for wilful misconduct in marine cases have had to borrow from other contexts due to the lack of case law on the subject. In specific context of oil spill pollution, the Second Circuit looked to case law relating to aviation and the Warsaw Convention in holding that wilful misconduct is: "an act, intentionally done, with knowledge that the performance will probably result in injury, or done in such a way as to allow an inference of a reckless disregard of the probable consequences. If the harm results from an omission, the omission must be intentional, and the actor must either know the omission will result in damage or the circumstances surrounding the failure to act must allow an implication of a reckless disregard of the probable consequences. The knowledge required for a finding of willful misconduct is that there must be either actual knowledge that the act, or the failure to act, is necessary in order to avoid danger, or if there is no actual knowledge, then the probability of harm must be so great that failure to take the required action constitutes recklessness." Tug Ocean Prince, Inc. v. United States, 584 F.2d 1151 (2d Cir. 1978).

13.61 The Tug Ocean Prince case involved an effort by a tug owner to limit its liability for costs of oil pollution cleanup. The statute that would permit the owner to limit its liability provided for an exception in cases where the oil discharge was the result of wilful misconduct or wilful negligence. The Second Circuit held that the tug owner showed wilful misconduct, noting that the owner knowingly: (1) dispatched the tug without telling one of its pilots that the other pilot was unfamiliar with the river; (2) failed to appoint a captain for the vessel; and (3) failed to require a lookout.

13.62 As with gross negligence, the offshore contract may define what conduct amounts to wilful misconduct. It may specify that the relevant wilful misconduct must occur at a very senior managerial level, and can further define wilful misconduct as being (for example) an intentional, conscious or reckless disregard of any contractual provision or of good and prudent

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oil/gas field management practice. In such circumstances, for the relevant senior management to be guilty of wilful misconduct:

(a) There would have to have been an intentional or conscious disregard at a very senior management level of either a contractual provision or of good and prudent oil (or gas) field management practice (breach of which could obviously cause mischief), and the relevant person must have known at the time that his conduct was wrong and serious mischief would result from his conduct, or alternatively, if he must have known at the time that what he was doing or omitting to do could cause serious mischief, and he wilfully persisted, careless of whether the mischief would occur or not. His actions must also have been causative.

(b) Alternatively, there would have to have been, at a very senior managerial level, an obvious disregard of either a contractual provision or of good and prudent oil (or gas) field management (breach of which could obviously cause mischief), with the relevant person not caring at the time whether their conduct was wrongful or not, and not caring what the results of their carelessness might be and whether serious mischief would or would not result from it. Again the person’s actions must have been causative.

(c) However, if the relevant person genuinely did not appreciate or foresee the mischief involved in his actions, then the requisite mental element will not be established.

13.63 A related ‘real world’ point is that in the event of a negligent act by a contractor causing massive pollution and massive loss the operator may have a powerful incentive to characterise negligent behaviour as wilful misconduct. The practical reality is that when there is a disaster, something specific tends to have gone wrong in order to make the disaster happen. For example, a cement job has been badly executed, data has been overlooked or the BOP stack has not worked as it ought. With the benefit of hindsight that failing may appear obvious. The operator may have a powerful incentive to avoid liability and the litigation process is such that an innocent failure may be portrayed as deeply culpable. In other words, the power of ‘spin’ (and, indeed, witnesses breaking down) in a highly charged litigation environment is something that needs to be taken into account when assessing the risk of a finding of wilful misconduct.

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(c) Insurance

13.64 As matters stand and as discussed in more detail below, commercial insurance coverage for pollution liability is fairly limited. The default position for most energy insurance products is a more or less blanket exclusion for pollution liability emanating from wells with scope to 'buy-back' some cover on an individually negotiated basis. This has its rationale in (a) the division of responsibility discussed earlier and (b) the general unwillingness of insurers to assume pollution liabilities in the light of heavy underwriting losses during the 80s and 90s in respect of long-tail environmental risks.

13.65 So far as an offshore oil and gas facility is concerned there are three main phases in its existence where pollution may occur and where insurance cover may (or may not) respond, namely

(a) the exploration phase,

(b) the construction phase; and

(c) the production/operational phase.

13.66 There are standard market forms of cover that can be bought for those three phases.

The Exploration Phase

EED 8/86

13.67 First, the exploration phase. This is the subject of Operator's Extra Expense insurance cover. The standard market wording is Energy Exploration ad Development (EED) 8/86. It will be taken out by the operator alone on the basis that the burden of well-related incidents will borne by the operator pursuant to the waiver and indemnity regime in the contracts between the operator and the contractors.

13.68 In essence EED 8/86 covers:

(a) Section A: The costs of regaining or attempting to regain control of an out of control well. A well is out of control when there is an unintended flow of drilling fluid, oil, gas or water above the surface of the ground or water bottom which cannot be promptly stopped (i.e. a blowout)

(b) Section B: The costs incurred to restore or redrill the well which has been lost or damaged as a result of the blowout.

(c) Section C: Clean up costs and third party liability incurred in respect of pollution arising from an insured well.

13.69 It is the third section of the cover which is considered here. To paraphrase, Section C provides an indemnity for:

(a) Liability to state and private parties for remedial measures, personal injury, property damage and loss of use of property caused directly by the seepage or pollution;

(b) Clean up costs;

(c) The cost of defending third party claims resulting from actual or alleged pollution and any liability to pay the third party's litigation.

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13.70 On the face of it there is no indemnity for:

(a) A liability for fines and penalties;

(b) Liability for pure economic loss unrelated to loss of use of property.

13.71 So far as concerns fines and penalties, it would seem that as a matter of US federal and state law it is very doubtful that such an indemnity is valid and enforceable in any event. Fines and penalties are criminal and civil sanctions whose essential purpose is to punish the wrongdoer and to discourage future bad behaviour. As discussed in the context of the enforceability of contractual indemnities between the operator and the contractor, it is said that that purpose would be undermined if the wrongdoer could pass on its liability to its insurers or anyone else.

13.72 Whether fines and penalties are recoverable as a matter of English law depends upon whether the Assured is guilty of morally reprehensible conduct at the 'directing mind and will' level of the organisation. This will tend to be a function of the particular statute. In the case of a criminal statute it will define whose knowledge and conduct counts. If the statute is engaged and the fine is payable this will, by definition, tend to mean that the assured itself has been guilty of morally reprehensible conduct.

13.73 So far as a liability for damages for pure economic loss is concerned, there are, as has been discussed, few relevant jurisdictions that permit the recovery of pure economic loss. So far as liability under OPA in the US concerned, it will be recalled that the economic loss must be "due to" property damage. Accordingly, there ought to be some cover under EED 8/86 for some economic loss claims made under the OPA. However, there are other liabilities that may be incurred under the OPA, such as damages for harm to natural resources, that are probably not covered by EED 8/86.

13.74 Similarly an operator who is party to OPOL may incur liabilities that are not necessarily covered by EED 8/86.

13.75 To deal with the potential mismatch between the standard EED 8/86 cover and the types of liabilities which the operator may incur under the OPA or OPOL as the case may be and the need to satisfy financial responsibility requirements under both, OPOL and/or OPA liability endorsements can be purchased. This is clearly what an operator ought to do (and will do) when he is exposed to these types of liability.

13.76 So far as the quantum of cover is concerned for a pollution incident, Control of Well policies are normally subject to a combined single limit in respect of the policy's response under the three sections. The combined single limit that is purchased by the Assured is normally intended to cover its financial responsibility obligations under OPOL or OPA. To ensure that the cover is not diminished beyond the minimum permissible by OPOL and OPA, the policy may contain a provision that gives precedence to OPOL or OPA liabilities before it is available to meet losses under other sections of the Policy. The limit under a Control of Well policy is generally no higher than three to four times the drilling costs of the most expensive well in the portfolio.

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The Construction Phase

WELCAR

13.77 The primary policy in force during the construction phase of a project, i.e. when the production platform or vessel and off-take arrangements etc are being assembled and installed is the Construction All Risks policy which is invariably on the WELCAR 2001 form or a variant of it.

13.78 WELCAR provides very limited cover for pollution liability. There is a general exclusion for "Bodily Injury or Property Damage directly or indirectly caused by or arising out of seepage, pollution or contamination however caused whenever or wherever happening". However, this is subject to a carve-out for cover where:

(a) The pollution was caused by an event;

(b) The event first commenced on an identified specific date during the Policy period;

(c) The event was first discovered by the Assured within 14 days of the commencement of the event;

(d) Underwriters received written notification f the event from the Assured within 60 days of the Assured's first discovery of the event;

(e) The event did not result from the Assured's intentional violation of any statute, rule, ordinance or regulation.

13.79 However, even where these conditions are satisfied: there is no cover for actual or alleged liability:

(a) for monitoring or cleaning up pollution to the extent that such liability arises solely from any obligations imposed by any statute, rule, ordinance or imposed by contract.

It will be immediately noted that a liability can only exist because of a legal obligation and there is only cover for liabilities expenses that are voluntarily assumed. Accordingly, this exclusion means there is no cover for any clean up costs that are incurred, which will be the major portion of any exposure.

(b) to abate or investigate any threat of pollution or contamination of the property of a third party.

(c) for pollution or contamination of property in which the Assured has a legal interest or which is in its care, custody or control.

(d) arising directly out of the transportation by the Assured of oil by watercraft.

(e) arising directly or indirectly from pollution or contamination which was intended by the Assured or a person acting on its behalf.

13.80 There are also free-standing exclusions for:

(a) The costs incurred in bringing a well under control (Exclusion 14)

(b) "loss of …subsurface oil [or] gas…or for the cost or expense of reducing to physical possession above the surface of the earth any oil

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[or] gas…or for the cost or expense incurred or rendered necessary to prevent or minimise such loss or damage" (Exclusion 18).

(c) Fines, penalties, punitive or exemplary damages, including treble damages or any other damages resulting from multiplication of compensatory damages (Exclusion 19).

13.81 Last but not least, there is the Due Diligence clause in the General Terms and Conditions (Clause 10) which provides that: "It is a condition of the Policy that the Assureds shall exercise due care and diligence in the conduct of all operations covered under the Policy, utilising all safety practices and equipment generally considered prudent for such operations". In other words, it is strongly arguable on the basis of this term that there is no cover whatever for a liability incurred in circumstances where it has been caused by the negligence (let alone gross negligence) of one or more of the Assureds at senior decision making level within the organisation.

13.82 In short, pollution liability cover under WELCAR is very limited indeed and, in reality, probably non-existent. At best, there is cover for liability for pollution damage to or loss of use of third party property to the extent that it is not a clean up cost.

13.83 This means that a party who faces liability for pollution during the construction phase will need to have recourse to the contractual indemnities available to it or its other insurance covers. If that party is a contractor, it will look to its contractual indemnity from the Operator. Failing that, it will look to its P&I Club cover (if it is the owner of, say, an FPSO responsible for a pollution incident) Comprehensive General (Third Party) Liability (or CGL) Cover. If it is an operator it will look to its CGL Cover and/or its cover with OIL and/or its captive insurance arrangements and/or, ultimately, its balance sheet. Cover under OIL is discussed below. CGL cover, P&I Club cover and self insurance / captive insurance company cover are discussed in the next section.

OIL

13.84 OIL is a mutual insurance company. The insured members of OIL / OCIL are companies that are engaged in exploration, production, transportation, refining storage and marketing of crude oil and gas, i.e. oil companies, and have assets of at least $1bn. The operator in a major exploration or construction project will tend to be one or more oil companies and so they will tend to have OIL cover.

13.85 OIL's basic coverage consists of (1) property damage cover (2) sue and labour, control of well and removal of debris and (3) seepage, pollution and contamination cover.

13.86 The limit of cover is US$300 million any one incident. OIL cover sits in excess of any more specific insurance available to the Assured, such as a CGL or P&I cover.

13.87 Cover in respect of a pollution incident is triggered by an 'occurrence' that causes "….personal injury or bodily injury, including death, or loss of or damage to, including loss of use thereof, property of any kind or description, other than insured property…".

13.88 The cover specifically includes a liability to pay punitive damages. As discussed above, there is serious doubt that such cover would enforceable

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in the United States. There is, however, an exclusion in respect of liability for governmental fines and penalties imposed under the laws of any State.

13.89 The Assured must become aware of the pollution incident within 40 days of it commencing and provide notice of the incident to OIL within 120 days of it commencing.

13.90 The Condition section of the OIL cover provides that there is cover in respect of "reasonable and necessary expenses incurred, liability to any governmental entity for clean-up and removal costs and expenses or liability for costs and expenses for governmental action, in each case to the extent reasonable and necessary to minimise or remediate, or prevent further injuries to persons or loss or damage to property…"

13.91 There is also cover for "…any other liability to any governmental entity resulting from an occurrence that has taken place and is covered."

13.92 In short, the cover is available for:

(a) Reasonable and necessary clean up and repair costs that have been voluntarily incurred.

(b) Legal liability to the state for clean up and removal costs;

(c) Legal liability to the state and private entities for damages and other costs (such as those for which it may be liable under the OPA).

(d) Legal liability under a contractual indemnity to indemnify, say, a contractor in respect of its third party pollution-related liability.

13.93 Cover only applies to liabilities arising from damage to third party property. Pollution damage to the Assured's own property is not covered.

The production/operational phase

13.94 OIL cover is likely to be relevant where the alleged polluter is an Oil company. This has been discussed above.

CGL cover

13.95 A Comprehensive General Liability is the cover that an operator will tend to resort to first in respect of its third party liability for pollution.

13.96 The principal form of cover is the Excess Liability Claims Made Policy LSW 244. However, the difficulty with the standard form cover is that it contains an exclusion in very similar terms to that which is contained in WELCAR. In other words, there is no cover for liability for clean up costs "to the extent that such liability arises solely from any obligations imposed by any statute, rule, ordinance, regulation or imposed by contract". There is also no cover for abating threatened contamination or pollution of third party property. Further still, there is no cover in respect of "seepage, pollution or contamination which is directly caused by or arises out of drilling of, production from, servicing of, operation of, ownership of or participation in wells or holes".

13.97 In other words, LSW 244 in standard form arguably provides no meaningful cover whether in respect of clean-up costs of liability to third parties in respect of property damage arising out of a well out of control pollution incident.

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13.98 If the Assured wants to have cover it will need to purchase an endorsement 'buy back' the exclusion and providing pollution liability cover. This will tend to be the subject of individual negotiation.

13.99 If the Assured is relying upon his CGL policy to satisfy the financial responsibility requirements under OPOL or OPA it will likewise be necessary to necessary to amend the standard form so as to nullify the effect of the general exclusion and 'bolt on' cover which respond to those liabilities (which, as previously discussed include, amongst other things, a liability to pay 'natural resources damages').

P&I Club Cover

13.100 The owners of Mobile Offshore Production Units such as FPSOs and FSUs may have pollution liability cover as part of their P&I Club insurance cover. Such vessels may have substantial storage capacity and may be involved in processing of oil that makes them potentially the source of pollution.

13.101 P&I Club cover in respect of pollution liability is fairly broad. It covers liability for damage caused to third party property caused by accidental pollution and liability for clean up costs. A liability includes not only a liability to pay damages but also a liability to pay fines and penalties. However, there is only cover in respect of pollution emanating from the vessel/floating production unit including any additional equipment, such as flowlines, that are part of the unit. Liability for pollution emanating from the well is excluded. Furthermore, there may be an exclusion applied in respect of pollution liability arising from a spill occurring in particular jurisdictions such as the US Exclusive Economic Zone, particularly in light of BP's experience.

Captive Insurance / self-Insurance

13.102 Most large international oil companies will substantially self-insure their liability risks. This means that they will set up a captive insurance company which, in principle, is an 'at arms length' separate entity that will be paid premium to accept liability (including for pollution) and other risks to which the operating companies in the group are exposed. The captive may or may not cede a portion of the risk into the commercial reinsurance market.

13.103 Like any insurance company, the obligation and ability of the captive to pay will depend upon (a) the terms of the policy and (b) its assets. Once the captive insurance is exhausted, the relevant oil company will need to resort to its own or group company assets to pay its liabilities.

Discussion on Insurance

13.104 It will be observed from the above review, that even though there may, at first blush, appear to be cover in respect of pollution liability the true scope of that cover may be very limited indeed. The technique of a policy generally excluding and then reinstating cover is confused and confusing. It is really only where a specific endorsement has been purchased by the Assured to cover the specific types of liability that may be incurred by an Assured under a specific regime, e.g. OPA or OPOL, can it have any real confidence that its insurance will respond to the types of liability it may face.

13.105 Apart from P&I Club cover, most policies exclude cover for fines and penalties and most exclude cover for punitive damages. Insurance cover in respect of such liabilities is unlikely to be enforceable in many jurisdictions in any event. Furthermore, an Insured who is fined or adjudged liable to pay

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punitive damages in the US may be prohibited from recovering that liability from its Insurers, wherever they may be located and regardless of what law governs the insurance contract, on the grounds that it would undermine the punitive purpose of that liability.

13.106 At bottom, as previously mentioned, the limited extent of cover under the standard forms, whether under EED, WELCAR, LSW 244 or P&I Club rules in respect of third party liability for a pollution incident arising out of an out of control well incident is explicable on the basis that traditionally it is the operator who assumes responsibility for meeting such liability regardless of whether incident has been caused by the negligence including gross negligence of one or more of the contractors. In the context of a major offshore project, the operator will tend to be a major oil company. Although the oil company may purchase some commercial insurance for third party liability it will be relying principally upon its captive insurance and its balance sheet.

13.107 So far as the contractors are concerned, in the event of a major pollution incident emanating from a well, so long as the Government and private parties pursue the operator primarily and so long as the operator honours its promise to indemnify the contractors in respect of any liability they may incur in respect of the pollution incident, they do not need to be especially concerned to purchase insurance cover for that risk – they are not running it. However, serious problems occur if:

(a) The Government and/or third parties pursue the contractors as well as the operator;

(b) There has been gross negligence by the contractors and they incur substantial liabilities for economic loss flowing from damage to non-owned property, liability for natural resources damage, punitive damages, fines or penalties;

(c) The operator challenges the enforceability of its indemnity promise to the contractors;

In such a case, the contractors could be exposed to making substantial payments many of which will not be covered by the standard form insurances.

13.108 The question of whether the Insurance market should be making more cover for pollution liability available to operators and contractors is discussed in the final section, Reform.

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14 REFORM

14.1 The most important characteristics of any regime governing the risk of and consequences of pollution are as follows:

(a) It results in industry participants actively seeking out and adopting the most effective preventative measures that exist so as to minimise the risk of a major pollution happening in the first place.

(b) There are sufficient financial resources immediately available to deal with the consequences of a pollution incident when it occurs.

(c) So far as third parties who are affected by the pollution are concerned, there is an effective liability regime and they are compensated quickly and efficiently in respect of their genuine losses in order to avoid them going out of business or otherwise being deprived of their interests.

14.2 These objectives are linked; the prospect of liability and financial responsibility are supposed to act as powerful incentives for oil companies to spend money to adopt measures to avoid pollution incidents.

Prevention of pollution

14.3 The regime changes that are likely to be most effective in reducing the risk of major pollution incidents in the future are those which directly improve operating standards, that is quality of equipment deployed in the field and the quality of personnel executing the work and the quality of the supervision of field activities. If equipment works as it ought to work and people do their jobs properly there should be fewer pollution incidents. As discussed, the worst pollution incidents have not tended to happen because something completely unexpected or novel has occurred, e.g. a subsea earthquake. They have happened because basic equipment or practices have failed to work as they should.

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14.4 Although there is a danger of over-simplifying complex activities and offering superficial observations, it is indisputable that the proximate causes of the three most similar offshore blowouts discussed earlier (Deepwater Horizon, IXTOC 1 and Montara) above are very similar.

14.5 It is indisputable that if the BOP stacks in both the Deepwater Horizon and IXTOC 1 incidents had shear rams that could cut through riser collar or had another set of shear rams positioned where there was no riser collar the wells would have been sealed and no, or very little, pollution would have occurred. Accordingly, an obvious way to stop BOP failure related blowouts happening in the future is to make the granting of a drilling licence conditional upon, for example, the use of a BOP stack which has fail-proof shear rams, which may mean having a large amount of redundancy built into the BOP (e.g. land-based radio control). It will be observed from the overview of various jurisdictions' regimes above that the critical importance of the BOP stack is now fully recognised, if it was not previously.

14.6 Similarly, it would seem that there is a need to improve cement technology or at least ensure that those persons who are in charge of taking operational decisions concerning the use of cement in drilling activities have a profound understanding of the technology and are uncompromising in relation to matters of safety. A pool of commercially independent cement experts could be established who are in charge of overseeing all cementing activities on board a drilling rig whether on site or, remotely by way of video, on land.

14.7 The most obvious requirement for achieving these improvements is expenditure of money in research and development of equipment and recruitment and training of personnel.

14.8 However, as previously mentioned, the imperfect relationship which exists between what an organisation should do and what it actually does means that external, third party, supervision and enforcement is also necessary.

14.9 There are two principal forms of external supervision. The first is state supervision. The second is supervision by parties independent of oil and gas companies who have a legitimate interest in the operation because they have capital at stake in it. The most obvious example of such 'independent' third parties is insurers.

14.10 Dealing with state supervision first. One of the key findings from both the Montara and the Deepwater Horizon incidents was that the state regulator did not do its job properly. The rules and regulations already existed to prevent the particular problem that happened from happening but those rules and regulations were not applied properly.

14.11 The essential characteristics of the regulatory systems in the key jurisdictions have been discussed earlier. We would suggest that an effective regulatory system would have, at least, the following qualities44:

44 "The industry needs a robust expertly staffed and well –funded regulator that can keep pace with and augment industry's technical expertise. A competent and nimble regulator will be able to establish and enforce the rules of the road to assure safety without stifling innovation and commercial success". Testimony of Marvin Odium, President, Shell before the National Commission on Deepwater Horizon, 9 November 2010.

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(a) The safety regulator must be independent from the oil and gas revenues regulator. The focus of the safety regulator has to be safety and nothing else.

(b) For the same, reason, the safety regulator must be insulated from political influences.

(c) The safety regulator must be insulated from budgetary constraints that compromise its effectiveness. A solution is for the regulator to be funded by a levy on production.

(d) The staff of the safety regulator must be genuine experts in their fields with a focus on outstanding technical skills and continued rigorous training. They must be remunerated as well, if not better, than their equivalents in the private sector. Ideally, safety inspectors should be the most respected group of people in the industry.

(e) There needs to be a free and transparent flow of key data from the operators to the regulator.

(f) The system needs to force the operators to adopt a corporate safety culture where the initiative to develop the best equipment and techniques and hire the best people comes from within rather than from the regulator. This is the premise of the 'safety case'.

14.12 Also very important is international collaboration between regulators so that there is a free flow of information and high quality personnel between jurisdictions. The emergence since Montara and Macondo of the International Regulators Forum on Global Offshore Safety and its International Committee on Regulatory Authority Research and Development, which is a mechanism for sharing research on health, safety and environmental issues in the oil and gas sector, is a very positive development.

14.13 Of course, ensuring compliance with safety standards is easier said than done. The practical reality is that a drilling rig far out to sea is a physically tough environment in which to work. Mistakes tend to be made more readily than they are on land because people are physically tired and stressed. Furthermore, the type of person who is prepared to make his living on an oil rig may well not be as concerned about adhering to safety procedures as his or her land-based equivalent. This would suggest that all complex drilling operations should be the subject of constant real time, independent land-based oversight. This means installing sensors in the hole and on the rig that transmit key data on a real-time basis to an onshore facility staffed by experienced and independent personnel to reduce the risk of misinterpretation by rig-based personnel who may suffering from fatigue and other distractions. This is the four (or six or eight) eyes principal that is often a key control/safety mechanism in complex, fast-moving environments.

14.14 As concerns supervision by the insurance industry, it has been observed that the insurance industry has the locus, incentive and resources to supervise oil and gas operations effectively. The issue of whether the insurance industry can and should assume more pollution liability risk is considered in the next section. However, even with current levels of exposure to first party property damage that can either cause or be caused by a pollution incident plus the amount of pollution liability risk already

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assumed (e.g. OPA or OPOL liabilities pursuant to OSFR requirements) insurers have more than sufficient interest and incentive rigorously to ensure compliance with safety standards. Insurers can encourage good behaviour on the part of oil companies and contractors in two main ways.

(a) First, the imposition, by way of 'condition precedent to liability' or 'warranty' of specific behaviour (e.g. a maintenance regime) that needs to be observed in order for there to cover at all. The theory is that this acts as deterrent against 'bad' behaviour and an incentive for good behaviour. However, it is important that what is prescribed is precise, relevant and clear.

(b) Second, the need to obtain the express approval of a 'marine warranty surveyor' (MWS) to particular courses of action in order for there to be cover in the event of a loss. This is already a feature of many offshore policies. However, what the MWS is supposed to do and what the Insured is supposed to do is not always clear to either the Insured, the Insurers or MWS. Furthermore, his independence may be compromised by the fact that the Insured often pays his fees. There is also a concern that the quality of warranty surveyors is variable.

14.15 In order that consultation with and clearance by a MWS in respect of a course of action is not regarded as tedious red-tape by the Insured and generally improves the operating environment and reduces the risk of loss (and, in turn, a pollution incident), it is, again, imperative that the MWS is a genuine expert who has the respect of the Insured. The MWS should be paid by the Insurers and paid an amount that reflects his professional standing to attract more good quality people into that particular role. This could well increase the cost of insurance cover for the Insured. However, it is indisputable that the benefit should outweigh the cost in the long-term for both the Insured and the Insurers.

Sufficiency of resources to deal with a pollution incident

14.16 There are two aspects to this. First, the need for the oil company to perceive that it has 'everything to lose' if it does make safety a priority. Second, the need for there to be enough money to sort out the mess when it happens.

14.17 The consensus amongst economists is that oil companies must be (a) capable of paying for all the costs of a pollution incident from their own resources and (b) compelled to pay all the costs. It is posited that anything less than either of these two absolutes will result in an oil company not making safety the priority and, in turn, pollution incidents happening more frequently. This is because the oil company will perceive that it will benefit more from not spending money on safety.

14.18 As concerns financial capability, the prior question is what the costs of a pollution incident are. Before Macondo, and despite IXTOC 1 spilling 3.3 million barrels of oil into the sea, the worst-case scenario in the US system was posited to be a continuous 4 days spill amounting to 100,000 barrels at most, generating a financial responsibility requirement of $150 million. Macondo has demonstrated that this is woefully inadequate. The estimate final cost of Macondo is estimated to be anywhere between $40-$60 billion (although that includes punitive elements). However, is Macondo a worst-case scenario or does it overstate the worst case scenario given the

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improvements that the industry has made since? What is imperative is that the worst-case scenario is properly calculated taking into account all the relevant characteristics of the particular operation rather than using arbitrary formulae.

14.19 Once the worst-case scenario has been calculated, the next question is whether the operator has the financial resources to meet the cost. This will primarily be a function of the operator's balance sheet and how readily realisable its assets are.

14.20 The operator may have bought insurance either to supplement or complement its own asset base. However, where the operator needs insurance to meet its potential liabilities, this arguably weakens its incentive to make safety a priority. To put it simply, it will likely care less about losing someone else's (i.e. the Insurers') assets than its own. This is the rationale for large deductibles in insurance policies. Furthermore, insurance is not a guaranteed, cast-iron 'asset'. It is merely a promise to indemnify and it can be quite a fragile one because of the duty of utmost good faith (which is unique to insurance contract law) and also because of the particular terms that define when it responds (i.e. conditions precedent, warranties, limitations and exclusions). The 'conditional' nature of insurance is often overlooked. However, to the extent that Insurers are required effectively to 'guarantee' the liabilities of the polluter and waive reliance upon any of the sort of defences that would normally be available to them in other commercial insurance contexts, this should be factored into the price charged for the insurance.

14.21 The economic theory ideal is that an oil company has enough assets of its own to meet all the costs of a pollution incident and that it should not be allowed to operate if it is dependent on third party assets, such as insurance, to meet its liability in full. The argument (which the US Congress accepted) that rigid adherence to this principle would drive the smaller companies out of the US Gulf and result in reduced supplies of oil and gas to the US economy, increased dependence on foreign supplies from hostile nations, increased oil and gas prices generally and increased unemployment have been broadly rejected by US economists who have considered the question45. This might suggest that pollution liability insurance is either redundant in terms of promoting policy objectives or an anathema to them; an operator should not need insurance to deal with the consequences of pollution and if it does it should not be operating at all because it is insufficiently incentivised to make safety a priority because it is playing with other people's money.

14.22 However, this view is perhaps rather simplistic.

14.23 First, it is questionable whether an organisation must be capable of internalising all the costs of its mistakes in order to have a legitimate mandate to operate. Classic examples are professional services and information technology firms. Mistakes by them can cause billions of dollar of loss and damage to third parties with whom they are not in a contractual relationship and which their balance sheets are incapable of absorbing. Should such firms not be permitted to operate? Similarly, airlines are dependent upon insurance to meet their liabilities in the event of a worst

45 Nath: Economists Perspectives on Liability Caps and Insurance for the Offshore Oil and Gas Industry in the wake of the Macondo Blowout (2011)

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case scenario accident. The same is also true of bus and rail companies. Should they all not be permitted to operate?

14.24 Second, although an oil company may have sufficient balance sheet assets to meet its worst case scenario liabilities, it may be more economically efficient for it to use insurance capital to meet that exposure, or some of it, than to meet it all using its own assets which it would prefer to 'put to work'.

14.25 Third, insurance money is likely to reach the victims of a pollution incident more quickly than money generated from the realisation of a company's assets. In other words, insurance has the advantage of being able to respond quickly when needed.

14.26 Fourth, and probably most importantly, even if it is not actually needed by an oil company to meet it liabilities, insurance is regarded as a good thing because it provides a legitimate basis for additional third party monitoring and supervision to supplement state monitoring and supervision. An insurer has a powerful incentive to ensure that steps are taken to avoid the loss of its capital. Indeed, the insurer should be able to afford to engage the best and most experienced supervisors (i.e. Marine Warranty Surveyors). This additional 'third party' supervision can play a very useful role in identifying shortcomings in the safety measures (in terms of equipment, procedures and personnel) employed by the operator at a corporate level and any 'agency conflicts' that may be hindering the proper application of otherwise sound safety measures and policies that the company has adopted.

14.27 However, if one accepts the premise that insurance is a good thing because of the opportunity for additional third party monitoring, the following question arise:

(a) How much pollution liability insurance actually needs to be made available?

(b) How will it be provided?

(c) How much should it cost?

(d) How will operators be forced to purchase the insurance in order to make them subject to the safety supervision which is perceived to be its principal value.

14.28 First, the question of how much pollution liability is it necessary for an operator to purchase.

14.29 If no operator actually needs to purchase insurance to absorb the cost of a pollution incident, one answer is that no pollution liability insurance needs to be made available. On the other hand, if an operator needs to purchase insurance to meets its liabilities the obvious answer is the difference between the value of its net assets and the worst case scenario liabilities to which its operations expose it. That obviously depends on a detailed analysis and risk assessment of each of its operations.

14.30 Macondo has generated 'costs' of between $40-$60bn (although a large proportion of that will be penalties which are designed to punish BP not compensate third parties for damage). That is just one company and one well. As matters stand, world-wide commercial insurance capacity for absorbing all energy risks stands at about $3-$4 billion. About $1-$1.5 billion of that capacity is for meeting liability risks including pollution, in other

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words a fraction of the cost of Macondo. However, as concerns deepwater exploration and production activities (as opposed to shallow water activities) it is presently unclear to what extent any operator is exposed to worst case scenario pollution liabilities which are greater than its net assets. Most deepwater operators have a market capitalisation in excess of $100 bn and most are capable of self-insuring the bulk of the pollution risk. They may choose to purchase insurance if it is more cost-efficient than using their own capital. However, in those circumstances there is no obvious answer to the question of how much insurance needs to be made available by the commercial insurance market. The question is really more "how willing are insurers to participate in the pollution liability risk and at what price?"

14.31 Turning to the question of how significant additional pollution liability cover would be provided, in the wake of Macondo, there were calls to increase oil spill financial responsibility requirements to up to $10 billion and for that to be backed by commercial or mutual insurance. On 9 June 2010 Robert Hartwig of the Insurance Information Institute testified before Congress that it would impossible for energy insurers and reinsurers to provide that level of pollution liability insurance coverage because (a) there simply not the capacity to provide that additional cover and (b) rating such a risk was fraught with difficulty. Most informed commentators would not disagree with what Mr Hartwig had to say, but just three months later Munich Re said that it was developing a product that would provide liability cover of $10-$20 billion on a rig-by-rig basis46.

14.32 An increase in capacity to the sorts of levels that have been suggested would require a major influx of capital into the insurance industry. It has been suggested that this could be achieved by a combination of:

(a) pollution liability insurance being provided on a per facility (rather than per company) basis in order to diversify risk for the risk carriers;

(b) making commercial insurance compulsory in order to generate the amount of premium income that would be needed for such risks to be commercially insurable; and

(c) utilising alternative risk transfer vehicles which would be capitalised by the securities market rather than conventional equity47,

14.33 As concerns alternative risk transfer vehicles, such as 'sidecars' and catastrophe bonds, the thinking behind them is that they take advantage of the capital that can be made available by the by the global securities market which is hundreds of times larger than the market for equity capital to be invested in insurers and reinsurers. But however sophisticated may be the risk bearing structure, there is no 'free lunch'. The legal structure of these vehicles does not, of itself, generate value that does not exist in more conventional insurance or reinsurance vehicles. One of the reasons such vehicles are created is that they are less burdened by regulation than conventional vehicles. However, that may be wholly inappropriate in this context. Furthermore, the return on capital that is likely to be demanded by investors in such instruments and vehicles is likely to be very significant, particularly in the wake of Macondo. In other words, 'insurance' capital,

46 http://www.munichreamerica.com/pdf/schadenspiegel_2-2010.pdf. Central to this proposition was (a) a requirement for compulsory insurance up to this level to ensure adequate premium income and (b) the tightening of safety standards to be monitored by independent (non-governmental) experts. 47 http://www.cnie.org/NLE/CRSreports/10Aug/R41320.pdf

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however it is packaged, is likely to be expensive and one can expect the oil majors to make a strong case that they should not have to pay others to bear a risk they are perfectly capable of bearing themselves a lot more cost efficiently.

14.34 Furthermore, what is arguably the principal benefit of insurance in the context of offshore exploration and production, namely the opportunity for high quality third party monitoring of operations, may not happen at all where the capital providers are investors in a commoditised and tradable debt instrument rather than shareholders in a 'living and breathing' insurance company.

14.35 As regards mutual insurance, the major oil companies already participate in Oil Insurance Limited (OIL) which, as previously discussed, provides up to US$300 million per occurrence cover in respect of pollution incidents. Of course, it is conceivable that more cover for pollution liability could be provided by OIL. However, this would presumably be dependent upon the willingness of oil companies to contribute more 'premium'. OIL could also perform a monitoring role. However, given that, as one would expect, the board of directors of OIL is populated by the representatives of major oil companies (who contribute the capital of OIL) such monitoring may not be perceived to be as 'independent' as that which would be conducted by a commercial market insurer.

14.36 As concerns cost, again this is an unknown. One can expect dedicated pollution liability insurance to be, at least in the short term, a lot more expensive than equivalent insurance products in other industrial fields. However, the price will obviously be a function of a variety of things including:

(a) The demand for the product;

(b) The risk that is assessed to exist in relation to a particular operator and its operations;

(c) The amount of competition to provide the product;

(d) Whether its purchase is made compulsory by legislation;

(e) The amount and quality of safety monitoring / supervision which is the principal 'social' value of the insurance.

14.37 As concerns the question of compulsory purchase, it is conceivable that legislation could be passed that required an operator to purchase a certain amount of pollution liability cover. Assuming that safety monitoring was part of the product, all operators would effectively be made subject to that additional third party monitoring, whether they liked it or not. In other words, the state would create, through legislation, the conditions for additional third party monitoring to take place to supplement or complement their own monitoring. In other words, what the state would in substance be doing is requiring operators to purchase third party monitoring plus some insurance. However, where the operator does not need the insurance cover, resents paying for it and is indifferent to whether it responds or not, he may be resistant to the involvement of the insurers' appointed supervisors. Having said that, this of itself could be highly useful information that could be passed to the state regulator who would be able to take appropriate action.

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14.38 How much insurance the operators should be required to purchase is a very difficult question, especially when its primary purpose may not be to make up for a deficiency in assets but to impose supervision. There is a need for there to be some insurance underlying the monitoring. The logic for is that the 'monitor' has to be engaged by and be answerable to someone other than the operator and that someone has to have sufficient 'skin in the game' to really care what is going on.

14.39 Having said all of the above, the insurance and reinsurance industry needs to be very careful. If the consensus amongst leading economists and politicians is that the principal function of insurance in this context is to provide additional third party safety monitoring and supervision, this has to be taken on board by insurers. In other words, insurers must recognise that the corollary of this is that pure state safety supervision is perceived by outside informed observers to be insufficient, which is necessarily relevant to the assessment of the overall risk. If additional third party supervision is really the thing that the State is requiring the operators to purchase by making liability insurance compulsory (rather than additional assets which is what one might think) because they consider their own supervision is not adequate, supervision must be made an absolutely key component of the insurance product and be properly executed as well as being properly priced.

14.40 It is not without good reason that the industry is wary of pollution liability risks generally. No one predicted Macondo would happen and it did. Exploration projects are becoming increasingly challenging leaving aside what is happening in the Arctic. It is naïve to believe that Macondo represents the worst that could happen. The assumption by the insurance industry of significant pollution liability risk could create a game of Russian roulette very similar to the ones the insurance market has played in the past and essentially lost.

14.41 If a pollution event generates cost that exceeds the cost generated by Macondo, additional liability insurance cover, even of the order of $10-$20bn, is unlikely to make much difference to the net cost borne by society from the pollution event.

14.42 Following Macondo there were also attempts in the US Congress to introduce legislation that increased the size of and payouts from the dedicated oil spill compensation fund, the Oil Spill Trust Fund48.

14.43 The creation of larger pollution compensation funds is only necessary to the extent that either it is not a major international oil company that is given the licence/lease to undertake a risky operation and/or the major oil company seeks to hind behind under-capitalised subsidiaries to limit its exposure. Neither of these things should happen if the licensing regulator is doing its job properly. The considerations that apply to the oil tanker trade, which is characterised by one-ship owning offshore companies and which speak for the establishment of large funds to deal with pollution damage when it happens, ought not to apply in this context. The deepwater offshore energy industry is not comprised of untraceable 'uninsured drivers'. Furthermore, the concerns about there being sufficient funds to deal with a future incident are being fuelled, to some extent, by the $40-$60 billion cost figure that is being talked about in respect of BP. However, a very large proportion of

48 The CLEAR Act, the Reid Clean Energy bill and the RESPOND Act or Landrieu bill.

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that 'cost' is not cost in the sense of compensation for damage that has been caused by the spill but 'punishment' visited upon BP in the form of enhanced penalties and fines. In other words, when one is talking about the need to ensure that there is sufficient resource to deal with a pollution incident one needs to be clear that what matters is whether there is enough money in the pot to pay compensation as opposed to satisfying sanctions.

14.44 There were also attempts in Congress in the wake of Macondo to increase Oil Spill Financial Responsibility from $150 million to $300 million (and even higher).

14.45 As a matter of economic analysis, there are good reasons to do this.

(a) First, Macondo demonstrated that $150 million was woefully inadequate. So is $300 million, but it is better than $150 million.

(b) If an operator is incapable of meeting a liability of $300 million, being a fairly modest cost of a spill relative to Macondo, whether with its own assets or with insurance, it should not be operating because it is insufficiently incentivised to prioritise safety over making profits.

14.46 However, like the call to remove the $75 million cap in damages liability, this proposal was rejected on the grounds that it could put the smaller operators out of business and adversely affect employment and security of oil supplies to the US. Those arguments, which won the day in the Congressional debate, have been seriously questioned by leading economists. In essence, economist doubt that any jobs would be lost (employees would simply move to the larger operators), the sites previously operated by the smaller operators would simply be taken over by the larger operators if they were profitable, there would be no reduction in domestic production and the world price of oil (which determines the price paid in the US domestically) would essentially be unaffected.

14.47 Finally, it has been suggested that it would be beneficial to spread pollution liability amongst more entities and make them jointly and severally liable, i.e. not confine it, as the US OPA does, to the responsible party which will tend to be the operator and possibly the owner of a relevant vessel such as a drilling rig. The reason for diversifying liability would be to (a) increase the pot of money available to meet liabilities and (b) incentivise more of the participants in an exploration or production venture to make safety a priority.

14.48 It has also been suggested that the extent of each party's liability could be set in advance by statute.

14.49 Although the idea of making more parties more responsible for taking safety seriously is sound in theory, as discussed earlier it undermines the basis upon which contractors, who are not nearly as well capitalised and profitable as operators, participate in offshore exploration and production activity. Furthermore, in the event of a pollution incident, the prospect of multiple defendants is a recipe for years of litigation leaving aside the difficulties inherent in drafting and then applying a piece of legislation that prescribes in advance how much of the 'blame' each party should take. The industry has tried to avoid precisely this problem by channelling responsibility to the operator and the operator giving an indemnity to the contractors for liability arising from well-sourced pollution. As concerns encouraging contractors to make safety a priority, the operator will have a powerful incentive itself to ensure this happens because it bears the

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consequences of their unsafe, even grossly negligent, behaviour. In short, spreading the burden of pollution liability amongst a diversity of entities is unlikely to improve the final outcome.

Effective liability regimes

14.50 Most jurisdictions have reasonably well developed laws on the recovery of property damage and property damaged related economic loss. This is essentially tort law, a body of which each relevant jurisdiction has. The US OPA goes beyond that by imposing strict liability (subject to very limited defences) and dispensing with the requirement that the party claiming economic loss must show that the loss flows from property in which he has a proprietary interest. Nevertheless, the claimant still needs to show that his economic loss has been caused by property damage (owned by him or not). However, it is not axiomatic that economic loss entirely decoupled from property damage should be recoverable. It is not recoverable in any other similar contexts where the law of tort applies, e.g. a negligent release of a toxic substance from an on-land chemical plant or car being negligently driven into an electricity sub-station.

14.51 Most jurisdictions also have laws which enable the recovery of environmental damage and clean up costs. It is also the case that in most jurisdictions there is no cap on liability for such liability.

14.52 In short, there already exists in most relevant jurisdiction strict liability in an unlimited amount for damages to property and property related economic losses, environmental damage and clean up costs.

14.53 Following the Macondo spill, there was a great deal of focus on the $75 million liability cap for property, economic and environmental damages. The consensus amongst economists was that there no justification for this cap. It was said to discourage safe behaviour because it artificially reduced the oil companies' perception of how much unsafe behaviour leading to pollution would cost it and also act as an unjustified subsidy by society of an oil companies' operations. There were powerful calls for the removal of the cap, which led to bills being proposed in Congress. However, both Republic and Democrat Senators blocked the proposed legislation arguing it could have unintended consequences. The thrust of those counter-arguments were as follows:

(a) The $75 million cap is in respect of no fault strict liability. Generally speaking, most systems of law require some form of moral culpability to be established to justify the imposition of very high levels of liability.

(b) The limits of liability do not apply anyway where there has been a breach or a violation of an applicable safety, construction or operating regulation which has proximately caused the incident. There would tend to be such a breach or violation in the case of most serious pollution incidents.

(c) The limits of liability do not apply to clean up costs in any event, which would tend to be the largest cost.

(d) The limits of liability do not apply to state law based damages claims, which in most cases do not have any damages caps.

(e) Therefore the ‘incremental’ incentive for the properly informed oil company to behave well that is brought about by increasing or

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removing the cap in respect of ‘damages’ would be minimal if anything at all.

(f) Increasing limits of liability would only be effective to the extent that Oil Spill Financial Responsibility (OSFR) requirements were also increased. In other words, someone's assets (whether the operators' or someone else's such as an insurer's) needed to be put at stake to meet the increased liability limits in order for there to be a real incentive to behave better. An increased potential for liability without it really 'hurting' was valueless.

(g) The smaller operators may not be able to afford the Increased OSFR requirements or there might not be the insurance capacity to provide it and so they might cease to participate in offshore exploration and production activity altogether.

(h) Reduced participation of the smaller operators in the exploration and production industry could adversely affect both the supply of oil and jobs.

14.54 Arguments (a) to (e) are unobjectionable. Arguments (f) to (h) are more worrying. As previously discussed, there is powerful school of thought which says there is no place for entities that cannot pay the cost of the damage they cause Nevertheless, leaving all of that aside, by the time that one reaches the stage of having to apply the remedial or punitive laws of a particular jurisdiction, the system has failed. In truth, whether a law is drafted that says the maximum liability that can be imposed on an operator for a pollution incident is $500m, $1bn or $10bn or no limit at all is unlikely to make much, if any, difference to an international oil company's attitude towards mitigating the risk of an incident occurring in the first place, especially in the light of what BP has gone through because of Macondo. Time spent drafting 'tough new laws' that seek to exact massive retribution on oil companies is unlikely to reduce the risk of pollution incidents happening. To reiterate, the principal thing that will actually reduce the frequency of serious pollution incidents is further massive investment in technology and people, rewarding people for prioritising safety over everything else, intelligent regulation and rigorous independent supervision. That appears to be fully recognised by the oil and gas industry and appears to be recognised by most of the relevant jurisdictions, particularly in the wake of Macondo.

14.55 It has been observed that not too much reliance should be placed upon Macondo in terms of reminding people that the damages liability cap in the OPA is illusory because, in time, people will forget what happened. To the extent oil companies fail in their cost/benefit analyses that the $75 million cap on damages liability is illusory and it is liable to skew their assessment of the true cost of unsafe behaviour, then we would advocate the removal of the cap. However, it would be very surprising indeed if oil companies have ever been lulled into a false sense of security by the damages cap per se (as opposed to other factors).

14.56 After the 'pollution event' punishment and retribution (as distinct from compensation) should be secondary concerns (as opposed to sanctions for breach of safety regulations). To put it another way, the cost of making proper compensation to those affected by a major pollution incident will inevitably be very substantial and so ought to have a significant deterrent

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effect upon those who may otherwise be inclined to cut corners even in the absence of additional sanctions such as punitive damages and penalties. The incremental deterrent effect on bad behaviour represented by a liability to pay punitive damages and fines is unlikely to be significant.

14.57 However, what in our opinion does need to be addressed in relation to liability regimes is not so much the laws themselves but how they are applied and by whom. A jurisdiction can have a highly sophisticated liability regime on paper. There are plenty of precedents available to create such a regime. The essence of the OPA, for example, which is the most sophisticated pollution liability regime in the world, can be expressed in a couple of pages. However, if, in reality, what happens is that a governmental or public body picks an astronomical figure out of the air and declaims its determination to recover that amount when either there is no reasonable, scientifically justifiable basis for that figure or the oil company knows that it is just a 'try-on' and will be able to do some back-room deal for a fraction of that amount, or the claim is essentially dropped by the next person to take charge of the case a few months later, this all breeds contempt for the system. The worst thing that any legal regime can be is to be not taken seriously. The respect that is commanded by a legal system is not a function of the words in the statute book, but a function of the quality of the people who operate and enforce it. If respect for the system is lost it is not won back by enacting the equivalent of the US OPA without monetary limits.

14.58 Some commentators have suggested that because the oil and gas exploration and production industry is global and because pollution incidents may well have a wider impact than on the immediate jurisdiction in which they occur, regulation and liability in respect of pollution ought to be promulgated and enforced at an international, rather than a national level. Furthermore, the lack of consistency in and variable quality of how pollution incidents are dealt with from a regulatory and liability standpoint from jurisdiction to jurisdiction does not assist in the achievement of the same high standards of operational behaviour across the globe. For example, it might be suggested that an operator may be more diligent in the Mexican Gulf than he is off the coast of West Africa.

14.59 The problem with any form of international agency or tribunal is that countries do not tend to like giving up sovereignty over things of such national importance as control over their oil and gas industry, including when things go wrong with it. It would be unrealistic to expect 'buy-in' to such a concept. The point about pollution is that it has the potentially to inflict harm on the very fabric of a country. It is probably not very attractive to many governments to devolve responsibility for assessing what that harm is and how it is best remedied to an 'international' body. It would not be a vote-winner.

14.60 What a particular country could do, if it felt it was appropriate and politically feasible, is to refer a particular pollution dispute to an international arbitration tribunal under respected institutional rules such as the ICC or LCIA. This could be achieved by putting an arbitration clause in the licence agreement or agreeing to arbitration once the dispute arose. Furthermore, the substantive law governing the question of liability and quantum need not necessarily be domestic law. It could be agreed that, for example, the US OPA is to be applied mutatis mutandis where domestic law is under-developed. The substantive content of the OPA can be applied anywhere in

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the world. The rationale for this is that questions of liability and quantum could be determined by a tribunal of internationally recognised and respected lawyers and industry experts who could determine the dispute according to a modern and coherent set of legal rules free from the pressures and distractions that the domestic judiciary might experience.

14.61 In terms of the 'loss of sovereignty' objection, this could be partly met by the fact that the state would be able to choose at least one of the arbitrators.

14.62 The other advantages of arbitration is that if the parties dispense with any right to appeal on a point of law they may have under the particular jurisdiction's arbitration law (the equivalent of. s.69 of the UK's Arbitration Act 1996), the award is effectively final, binding and immediately enforceable. Moreover, if the state were to win the arbitration, it would, by virtue of the New York Convention, be able to enforce the award in virtually every country in the world where the operator had assets (leaving aside issues that may arise because of its corporate structure).

14.63 The advantage of this method of dispute resolution for the operator is that it could have, perhaps, more confidence that the matter would be adjudicated upon impartially without political interference and that it would not be as bogged down in the local courts, for years or decades, as it might otherwise be.

14.64 Of course, international arbitration is no panacea.

(a) First, it would not be able to accommodate the claims of private parties unless they agreed to it after the event. In the case of the Bonga and Funiwa incidents in Nigeria there are multiple private claims for billions of dollars. Such claimants might be unwilling to agree to arbitration because of a feeling that they would be giving away an advantage or because of cost (although cost problems could be overcome).

(b) Second, although there is no real conceptual difficulty with an arbitral tribunal imposing civil penalties, the idea of it imposing criminal fines (or even prison sentences) would be very problematic. The consideration and imposition of criminal liability would need to be left to the domestic courts. This could entirely defeat the purpose of referring the matter to arbitration in the first place because there could well be parallel proceedings dealing with precisely the same evidence and issues in the local domestic courts. Furthermore, findings in arbitrations are, in principle, not binding on courts. This could render nugatory the speed advantage of arbitration as well as give rise to problems of inconsistent decisions on the same facts.

(c) Third, having agreed arbitration, there is nothing in practice to stop either the state or the operator challenging the arbitration agreement or any award if one or other party felt it could derive some advantage from that. There are numerous examples of states and private entities making repeated challenges to arbitration agreements and awards (e.g. capacity challenges, jurisdiction challenges, serious irregularity challenges, fairness challenges, bias challenges) that go on for years because they suddenly decide they do not want to arbitrate after all especially when the get the sense that things are not going their way. This could mean everything gets bogged down in the domestic courts

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(or another court somewhere else in the world) and rendered completely uncertain for years anyway.

(d) The very same objections that apply to a state devolving responsibility for dealing with 'state affairs' to an international 'court' apply to an arbitral tribunal. However, arbitration would be on a 'case by case' basis, rather than a wholesale transfer of responsibility.

14.65 Referring pollution disputes to international arbitration is something which should not be dismissed out of hand but it is unlikely to provide a solution to all the short-comings that might exist in a particular domestic legal system.

14.66 In conclusion, the liability regime is already about as aggressive as it can be and, in recent cases, probably over-aggressive. This is counter-productive and in any event is unlikely to be the route that generates the most substantive improvements, which is directly encouraging the spending of more money on prevention.

April 2013

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About the Authors Nigel Chapman

Nigel leads the London marine and energy insurance team. He also chairs the executive committee of the firm's insurance department and has particular responsibility for business development. He joined the firm in 1978 and has been a partner at Clyde & Co since 1983, specialising in marine, energy, engineering (including power generation) and construction. He has profiles in the major directories and is generally recognised as a market leader, particularly for energy work. He acts exclusively for insurers advising on coverage, defence and recoveries. His experience in the energy sector embraces both upstream: control of well, construction and operating, as well as downstream: petrochemicals, power generation and machinery breakdown, including business interruption.

Tim Taylor

Tim Taylor has over 30 years' experience in major international insurance dispute resolution, including marine and war risks, energy, construction all-risks, fraud investigation, reinsurance, political risks and general coverage disputes. Tim is also part of the offshore oil & gas group at the firm. He has also acted in major disaster litigation involving issues of corporate criminal law and is frequently called upon to advise on new insurance wordings. Consistently recognised as a market leader in marine, energy, and insurance in all the major legal directories he has been involved mainly for insurers in many of the major insurance claims over the years

Leigh Williams

Leigh Williams is a partner specialising in all aspects of marine and non-marine insurance and reinsurance including in the offshore energy sector. He qualified as a barrister in 1996 and joined 7 King's Bench Walk, the leading insurance, reinsurance and shipping chambers where he was instructed as junior counsel on a number of high profile cases. Leigh also has wide experience of dealing with charterparty, carriage of goods, sale of goods and ship sale disputes. In addition, he has considerable experience of disputes concerning mergers and acquisitions, joint ventures, bonds, and financial regulation both in court (domestically and abroad) and in international arbitration. Leigh is a joint editor of Reinsurance Practice & The Law

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