Exxon Valdez: Valuation with Contingencies

Exxon Valdez: Valuation with Contingencies

Pascal Schirato

July 13, 1995

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1. FOREWORD 1

2. INTRODUCTION 2

3. THE COMPANY 3

4. THE EXXON VALUATION AS REPORTED 5

5. THE VALDEZ PROVISION AS A FORM OF FINANCING 5

6. CONCLUSION 6

1. Foreword

The present essay was originally an attempt to explore the significance of unexpected environmental liabilities on company valuation. Specifically, the idea was to evaluate the financial significance for Royal Dutch/Shell after it gave up its attempt to sink the Brent Spar oil tank into the North Sea on June 21, 1995. To this end we needed the initial cost and the operating costs of the Brent Spar, as well as the quantity of oil that flew through during its useful life. Unfortunately we have not received sufficient material from Shell(UK) to perform that study.

The Exxon Valdez presented also an interesting case of sudden environmental liability. Again, we have not been able to collect enough data to build a consistent image of Exxon since the late �80s. In the end too much time was spent attempting to distentangle the two Annual Reports on which the present report focuses, leaving the analysis superficial and not anywhere near the degree of involvement anticipated. What looked at first as a mind-jogging exercise turned into a straining chase for evidence, resulting in frustrating few results.

Nevertheless, we have attempted to sketch the point that unexpected environmental liabilities such as the Valdez provision should not be accounted for as operating costs, but treated in a similar way as financing activities, although with a very distinctive meaning. The proposed treatment should apply in this case because the Valdez provision was a hopefully one time expense that was to be incurred over a few years, that was going to harm somewhat the financial results of the company, but that wasn’t expected to harm its operation. Whether the treatment is correct or not is of course debatable, the point is that it leads to a valuation of the company that follows better its ongoing market value than the earnings as presented in the Annual Report 1989.

2. Introduction

Thursday, March 23, 1989, 9:15 p.m., a tanker moving 1.26 mbbl of crude oil left Valdez Terminal, Alaska. It was a 3 years old Maersk Navigator, on its way to California. It had costed $125m.

Friday, 12:04 a.m., less than three hours later, the Exxon Valdez failed to adjust its course and struck a reef near Bligh Island. Another three hours later, Coast Guards reported 138000 bbl of crude oil that had leaked from the vessel. Saturday, March 25, 1989, 9:45 p.m., Exxon Corporation assumed financial responsibility and cleanup coordination .

By April 1993, Exxon had already spent some $3.5b in legal and cleanup costs . In June 1994, a federal jury opened the company to an additional $16b in punitive damages . Exxon stock declined nearly 5% that week (June 13-17). Sept. 16, 1994, the Federal Jury awarded Exxon $5b in punitive damages . Exxon’s stock dropped from a 52-week high of 67 down to 60. By october 1994, Exxon had already spent in legal settlement and cleanup costs some $3.9b, or $2.5b after tax, or $2 per share . Since, Exxon declared it will appeal that verdict .

Exhibit 1

Exhibit 1 shows Exxon’s stock price during the period 1989-1995. Between the time of Valdez spill and of the Federal Jury verdict, the Gulf war has had its influence too on the stock price. We notice the following characteristics:

• Exxon’s stock price kept growing less than S&P500,

• Exxon’s stock price follows similar patterns as S&P500,

• Bad news such as the Valdez spill or the Federal Jury verdict seem to depress somewhat Exxon’s stock price.

As a result, and although the stock market certainly doesn’t welcome bad news, no definite conclusion can be drawn from the above Figure as to the effect of anticipated environmental and legal expenditures. Indeed, news kept flowing