Transocean Ruling May Limit Oil Spill Liability

Nov.22.11 | About: Transocean Ltd. (RIG)

While Chevron's (NYSE:CVX) minor oil spill last week drew the spotlight just off the coast of Brazil, a federal judge's ruling on BP's (NYSE:BP) suit for insurance money from last year's Deepwater Horizon will create greater waves. U.S. District Judge Carl Barbier rejected BP's claim to Transocean's (NYSE:RIG) insurance coverage, with his full ruling suggesting the courts will agree with Transocean that it has no liability for the March 2010 oil spill.

This ruling was narrow. BP sued several of Transocean's insurers of the Deepwater Horizon, including Lloyd's of London and Ranger Insurance, for up to $750 million in coverage across different policies. BP argued that it should be named an "additional insured" on Transocean's policies and therefore be eligible for the $750 million coverage. Judge Barbier's ruling was based on the drilling contract in which Transocean assumed liability for all above-surface oil spills, regardless of negligence and BP assumed liability for all pollution liabilities not expressly assumed by Transocean, regardless of negligence. Since the Deepwater Horizon spill was a subsurface spill, the court ruled that this liability belonged to BP. The ruling reads:

The Court finds that BP, under the Drilling Contract, assumed responsibility for Macondo well oil release pollution liabilities. BP’s assumption of pollution responsibility is found in Article 24.2, in which BP assumes pollution liabilities not assumed by Transocean in Article 24.1. Article 24.1 allocates to Transocean liabilities for pollution originating on or above the surface of the water. The Deepwater Horizon Incident entailed a subsurface release; thus, Transocean did not assume pollution liabilities arising from the Incident. Further, because Transocean did not assume these liabilities under Article 24.1 of the Drilling Contract, BP assumed them under Article 24.2’s catch- all provision: responsibility for pollution arising out of or connected with operations under the contract and not assumed by Transocean in Article 24.1. Because Transocean did not assume these liabilities, there is no additional insurance obligation in favor of BP for these liabilities.

Analysts have been overly caught up in assigning blame rather than determining liability. I make no claim as to which party was responsible. This court decision affirms that in determining the financial liability of BP and Transocean regarding the oil spill, it doesn't matter who was responsible for the oil spill. BP and Transocean signed a contract allocating potential liability, and this contract determines the financial liability.

To clarify, I suggest the following analogy. If I take out a car insurance policy that specifically covers me even in the case of negligence and then cause a car accident that is completely my fault, the insurance policy covers me. This is exactly the same situation as the BP and Transocean contract. Transocean indemnified BP for all above-surface oil spills, regardless of negligence of any parties. BP indemnified Transocean for all subsurface oil spills, regardless of negligence. In this case, since the oil spill occurred below the water's surface, the entirely liability belongs to BP.

This case does not immediately affect Transocean, as BP in this case sought money from Transocean's insurers. However, the judge's reasoning bodes well for Transocean in future legal rulings. This is especially true because Judge Barbier is overseeing the many different suits that have been rolled into the court case In re: Oil Spill by the Oil Rig "Deepwater Horizon" in the Gulf of Mexico on April 20, 2010, MDL-2179, U.S. District Court, Eastern District of Louisiana. This ruling shows that Transocean's contract with BP can stand up in court, as it has in this case. As a result, the cloud hanging over Transocean as a stock may begin to dissipate as investors realize that the courts have begun to back Transocean's claims regarding their contract with BP.

Disclosure: I am long RIG.