Shell In the Arctic: Why Ecological Services Valuation Needs to be Part of E & P Investment Analysis

The 2013 New Year’s holiday did not start out smoothly for the oil industry with news that Royal Dutch Shell’s ice-reinforced hull Kulluk oil-drilling ship, which is carrying 150,000 gallons of diesel and about 12,000 gallons of lube oil and hydraulic fluid, had run aground as it was being towed to avoid an Arctic storm of 70 mile per hour winds and swells to 35 feet. The ship had been working in the Beaufort Sea over the summer. The event, which so far has not led to a spill, raises questions anew about the wisdom of Arctic drilling off the fragile Alaska coast and whether the oil industry is really as well versed in managing Arctic conditions as it would like the public and policy makers to believe. The new problem follows major delays last summer for Shell in its Chukchi Sea exploration efforts given problems related to unusually icy summer conditions.

Hopefully, the Kulluk salvage will stay together well enough to prevent oil and chemicals to leak from its reinforced tanks. But the accident highlights the difficulties of operating in the harsh Arctic conditions where ice and storms remain hard to predict and best available ocean ice science was not sufficient for Shell to utilize a supposidly well-planned summer drilling schedule. Were the industry truly equipped to predict and manage icy conditions at will with reasonable risk, Shell’s highly advertised summer Chukchi Sea exploration program should have been easier to see through.

The consequences of an oil spill in an Arctic environment like the Chukchi Sea would be more ecologically damaging and harder to remediate than in some other oil-rich regions, scientific experts argue. The new, wintery problem of the Kulluk salvage rescue should be taken as a renewed warning call about the need to establish scientifically sound, mandated guidelines for the valuation of the ecological services from coast and marine habitats. Ecosystem service valuation is important not only to determine the measurement of damages and compensation in the event of a Macondo and Valdez type of accident; it should also be used more prominently in corporate evaluation of the relative investment risks of green lighting one exploration program versus another.

There might have been a time when the industry could have argued that oil and gas resources were so scarce it might have no choice but to drill in the most sensitive parts of the globe. But now that technology breakthroughs and unconventional resource plays are changing the outlook for the size and breadth exploitable reserves, ecological services valuation should be a much more material part of the decision where to drill.

Senior managers, and not just corporate marine scientists, need to better understand the process by which ecology is assessed. For companies with multiple prospects like Shell, the value of ecosystems they opt to put at risk will increasingly be a major factor in portfolio decision making. Companies whose return-on-capital calculations take into account the size of ecological risks will be safer organizations, leading to better stewardship of sensitive regions. Shareholders should also care, as the detriment to share value after the Macondo accident clearly highlighted. SEC requirements for disclosure of environmental liabilities would also benefit from a clear presentation of the value of ecological services where various public companies operate.

From the point of view of public interest, regulators should also be opening up regions for leasing based on the latest science for risk analysis and ecosystems valuation. It may be that for an individual company a highly valued, highly sensitive region is their best commercial prospect; but for residents who live and work along coastlines, government needs to protect more than just revenues from oil and gas exploitation. Clearer guidelines on best practices for measuring and valuing the trade-offs and conflicts between different uses of coastal and ocean resources would offer multiple benefits, according to UC Davis Professor of Environmental Science and Policy, James N. Sanchirico. Only through advances in the field of understanding the risks and valuation of differing natural environments can the public and policy-makers best assess where is the optimum regions to allow drilling on public lands.