Andarko Gets Caught For Kerr-McGee Subterfuge

Kerr-McGee was founded in 1929 as an exploration and production company.  Over time, it diversified into a number of other extractive industries, such as its 1952 entry into uranium mining and milling.  At a time when the Cold War had the U.S. and Russia in an all out nuclear arms race, this probably seemed like a good business to enter. Uranium mining and processing operations were carried out at multiple locations, including on tribal lands of the Navajo nation.

In 1963, Kerr entered into a creosote business for treating lumber, and in 1967 it acquired American Potash and Chemical Company in Henderson, NV which produced perchlorate ("perc") for use in rocket fuel, targeting demand from government space programs and Defense department projects.

Over time, investors grew disenchanted with the conglomerate or portfolio approach to creating public companies. "Focus" became the mantra, partly because it made investor valuation easier and, the story goes, leads to higher multiples without the conglomerate discount.

Lehman Brothers, as Kerr-McGee's banker, encouraged the company to slim itself down into an E+P company, the original business, and a titanium dioxide business, the critical commodity for all manner of residential and industrial paints.   By 2005, Kerr-McGee had reinvented itself, but court documents note that exploration and production produced $1 billion in income in that year, while the Ti02 business generated a little over $100 million in income.

As early as 2002, Andarko Petroleum had taken a hard look at Kerr-McGee but it clearly had no interest in the peripheral businesses, and Andarko wanted to stay away from the large legacy environmental liabilities from businesses like creosote and uranium mining, among others.

So, the bankers came up with the classic, cookie cutter strategy of creating a corporate entity into which to deposit all the legacy liabilities.  In itself, this is neither new nor inherently sinister strategy, provided that the new entity, called Tronox Worldwide, LLC had adequate funding and prospects for financial viability. This structure has been used successfully for asbestos, lead paint, and other long-tailed, costly liabilities.

Andarko acquired Kerr-Mcgee in 2006, a few weeks after the Kerr had divested the legacy environmental liabilities via Tronox becoming an independent company.  When I first read about the liabilities coming back to Andarko, I wondered if regulators had once again overreached arbitrarily into structures that had been used before in the normal course of business.

Reading the court documents, this is clearly not a case of regulatory overreach, although the suit was based on the theory of fraudulent conveyance in the assignment of liabilities to Tronox, including pension obligations. Kerr also raided the cash coffers of the former subsidiaries.  Bondholders of the old KM didn't protest, because they got some special protections, since their indentures specifically prohibited this kind of financial 'three card Monte.'

The executives at the old Kerr-McGee ran an organization whose normal industrial safety and environmental policies were woefully deficient.  They also had the temerity to suggest that the creation of Tronox had nothing to do with offloading the liabilities and weren't motivated by thoughts of a transaction.  Given the record, and common sense, this is laughable.

Prior to cutting Tronox loose as an independent company, the old Kerr-McGee stripped out 83% of the revenue and 113% of corporate income, according to the court documents. Lehman Brothers had looked for other options for Tronox, including spin-off, but they clearly knew that it was a dog, or in the parlance of the financial crisis, a "piece of ***t."

So, the argument of fraudulent conveyance, ex post, proved to be an easy case to make.  Andarko seems to be able to deal with the now, much larger environmental liabilities and associated fallout from the Tronox bankruptcy.

This unfortunately is an example of agency problems with the interests of executive management as agents lying with the creation of Tronox, either in ignorance or of a cynical assessment that the day of reckoning would be down the road after they were all gone.  So it goes.

Chinese Air Pollution and Public Health

www.weather.com

                      Since January, the world press has been forced to acknowledge that urban air quality in China is no longer a red herring issue of economic growth, but a national and international public health menace.  Japanese researchers are looking into potential effects of pollution from China on old arboreal forests in Japan. The long-term costs won't be known for decades, when it may be possible to publish results long term studies of effects on coronary and pulmonary health and mortality.  Children, like the little girl in the photo, who are growing up exposed to the toxic soup would be ideal study candidates.

"Let’s start with the gloom. China’s air quality is already dismal, thanks to an ever-growing number of coal-fired power plants, factories and automobiles. The annual average levels of small particulate pollution, PM2.5, in cities is at 75 micrograms per cubic meter, three times as high as what the World Health Organization considers safe. (And that’s an average — in January, Beijing’s pollution levels soared past 900 µg/m3.)"  Source: Washington Post. 

It's macabre to think that the U.S. Embassy sensors in Beijing only go up to a maximum of  500 µg/m3, a level that would have been viewed as unthinkable.  Middle class Chinese executives and professionals are already sending their children out of the country to private schools abroad to spare them from the air pollution scourge. The parents are soon following when they can work out visa arrangements for the U.S. and Europe. Expatriates are turning down Chinese assignments because of the public health concerns for their families.  

Organizations like Greenpeace, which get exercised about minutiae and non-problems in the U.S., are totally neutered pussy cats in China, where they should be shouting from the roof tops.  India's legendary air quality in Calcutta and Delhi puts it in China's club. It's only a matter of relative sizes of the economies as to how bad both economies are in terms of contributing to global pollution and public health problems.  

What's being done?  Nothing of any import or substance.  Believe it or not, there is a Chinese "cash for clunkers" program.  Public health issues are simply not in the economic calculus of China's national leaders and the system of inefficient public companies and favored enterprises which together have generated the enviable GDP growth and burgeoning reserve balances.  Greenpeace and others await the publication of Chinese CAFE standards for automobiles.  

It's a shame because the Chinese citizenry both in cities and in the countryside deserve so much better from their leaders.  

Hyrdraulic Fracturing and Groundwater: A Connection

Engineers and scientists at Duke University and Cal State (Pomona) have published a paper in the Proceedings of the National Academy of Sciences which confirms my long-stated belief that the industry certainly doesn't know everything about the effects of hydraulic fracturing of deep shale gas formations and possible impacts on shallow, drinking water aquifers.

This paper is not a smoking gun for condemning the burgeoning shale gas industry.  What is its value?  It shows that there is a mechanism for hydraulic connectivity between shallow drinking water aquifers and deep-lying shale gas formations.  The researchers found evidence of a "strong geochemical footprint" in salinized water in the Alluvium, Catskill and Lock Haven aquifers in northeastern Pennsylvania. The salts are chlorides of the s-block elements, alkali metals and alkaline earth metals. 

They speculate about the conditions that might provide a pathway for the salinization of the aquifers, but it is an educated supposition.  Shale formations with extraordinary hydrodynamic pressures and a natural pathway might cause migration into the lower pressure areas of the aquifers.  Where, how, and why this occurs at some locations and not others is unknown.

Results on methane gas migration are sketchy in this sample.

The authors conclude,"The occurrences of saline water do not correlate with the location of shale-gas wells and are consistent with reported data before rapid shale-gas development in the region." 

The research is in this paper definitely shows that continuing research is needed, and that industry and regulators should work together with conservatism and caution in well head designs, drilling techniques, and documentation of geological characteristics of the formations, integrated with existing data about the aquifers.  There is indeed a way in which methane and brines could migrate into drinking water supplies. 

Because such damage would be prohibitive to mitigate, the industry should make sure that the shale gas boom is not a California gold rush or a replay of early wildcatting of oil wells in Western Pennsylvania.  Meanwhile, this paper is a small beginning and far from the last word.

Natural Gas versus Coal for Power Generation

Here's information, somewhat dated, on the subject from an EPA website:
"At the power plant, the burning of natural gas produces nitrogen oxides and carbon dioxide, but in lower quantities than burning coal or oil. Methane, a primary component of natural gas and a greenhouse gas, can also be emitted into the air when natural gas is not burned completely. Similarly, methane can be emitted as the result of leaks and losses during transportation. Emissions of sulfur dioxide and mercury compounds from burning natural gas are negligible.

The average emissions rates in the United States from natural gas-fired generation are: 1135 lbs/MWh of carbon dioxide, 0.1 lbs/MWh of sulfur dioxide, and 1.7 lbs/MWh of nitrogen oxides.1 Compared to the average air emissions from coal-fired generation, natural gas produces half as much carbon dioxide, less than a third as much nitrogen oxides, and one percent as much sulfur oxides at the power plant."

With interest rates at historical lows, construction costs cyclically lower and generationally low gas prices, one wonders why the power generation industry doesn't convert significant portion of its fleet of older, coal fired electricity plants into gas fired capacity.  While there has been progress made in burning coal differently and better, this switchover isn't progressing quickly either. According to the Union of Concerned Scientists, we still have 600 coal-fired plants producing 54% of our electricity.  If hydraulic fracturing raises environmental concerns, carbon capture/sequestration is probably even more complex. 

Since electric utilities are so heavily regulated, I'd argue that we have a regulatory failure here.  What kind of regulatory regime do we need to incentivize utilities to rapidly switch more power generation capacity to widely available, cheaper and more environmentally friendly fuels?  Lack of clarity in  the government's regulatory stance may be what's holding back  investment in conversion.

And, while we're at that, what about a Marshall Plan for building the next generation power grid? 

EU Intransigence May Turn Airbus into Airbust

From today's Wall Street Journal:

"BRUSSELS—China's ambassador to the European Union said it "makes sense" for Chinese airlines to shun Europe's Airbus planes in favor of competing American models from Boeing Co. in response to the EU's new levies on aviation greenhouse emissions.


Wu Hailong's comments are among the first by a senior Chinese official linking Beijing's displeasure with the EU's emissions trading system, or ETS, to jetliner sales by the Airbus unit of European Aeronautic Defence & Space Co.

EADS chief executive Louis Gallois on Thursday said that the Chinese government is withholding final approval on contracts for 45 Airbus jetliners with a catalog value of $12 billion because of ETS.

Mr. Wu said that when the EU includes a Chinese airline in the ETS, "it makes sense for them to go to Boeing."

Under the EU program, any airline operating at an EU airport must hold special credits to offset its carbon dioxide emissions since the start of this year. Airlines have said their inclusion in the ETS, which already covered many EU industries, will cost them billions of dollars annually.

Airbus warned last spring of the risk of foreign backlash against the EU plan, as China and others had threatened action if their airlines were forced to comply.

Governments outside the EU, including China, the U.S., Russia and India, have accused the 27-country bloc of exerting extraterritorial authority by levying fees on emissions that occur outside EU airspace."


The final arrogance of the EU is their unilateral imposition of these wacky standards without any consultation, as the Chinese have rightly pointed out.

If international flights aren't allowed to even fly over European airspace, this will be much more disruptive to global economies than any realistic possibilities attached to the Strait of Hormuz blockade.  Someone is going to have to blink on this one, and let's hope that the Eurocrats come to their senses, but it's not guaranteed.