A missing piece in the oil transport debate

Climate and Energy

Concerns about the environmental risks from oil transport are a key aspect of the debates about energy infrastructure in Canada. Pipelines pose risks of spills and so do tankers. At the same time, the recent five-year anniversary of the tragic Lac-Mégantic derailment reminded us of the risks that come with transport by rail. Our new report Responsible Risk mostly isn’t about oil transportation, specifically; it takes a broader look at environmental risk. But it does offer a starting point for talking about managing risks around oil transportation. And just maybe that can help open the door to a more productive, less polarizing conversation.

The debate

Debates about resource extraction and energy infrastructure have been intense for a long time in Canada. And as we’re witnessing with the Trans Mountain pipeline debate, oil transportation in particular has become a touchstone.

We’re well aware that many issues are at play in these debates (GHG emissions, Indigenous consent, and economic benefits, to name a few). But risk to the environment, and in particular the risk of oil spills, is an important factor — one where our new research may have something to offer.

The environmental risks of oil transport

Canadian companies move large volumes of oil daily — by pipeline, by rail and by tanker. Most of this transport occurs without incident. But it comes with a risk of environmental damage — if things go wrong, oil can spill into the environment with potentially catastrophic effects. A significant spill can lead to large-scale ecosystem damage. That damage has costs for society, including: taxpayer funded clean-up; polluted air, water and soil; loss of wildlife; health impacts and loss of life; and loss of the value Indigenous Canadians ascribe to their traditional lands.

These kinds of risks can generate strong reactions. At one extreme, there are those who believe that the risks are unacceptable and must be avoided at all costs. At the other extreme, there are those who believe these risks are an unavoidable part of a modern economy that we simply must accept.

At the end of the day, what distinguishes these two perspectives is the relative weight they place on the goals of environmental protection and economic activity. Both goals are legitimate. We care about environmental risk and should seek to reduce it. And we also care about the economic benefits that the extraction and transportation of our natural resources can provide.

The problem is that the debate between the two extreme views can create the (false) impression that we have to make a binary choice.

A false dichotomy

In reality, it’s possible to pursue both serious environmental protection and robust economic activity. That doesn’t mean that there won’t be trade-offs. But it is possible to strike a balance.

We have policy tools we can use to help us strike this balance. We can use regulations to make sure things are done safely and sustainably. And we can use laws to make companies liable for any environmental harm they might cause, giving them an incentive to avoid it. But we can also use an economic tool called financial assurance which puts a price on risk to the environment. Financial assurance complements regulations and liability rules. It harnesses market forces to help us balance our goals.

Financial assurance can add a constructive frame to Canadian debates about oil transport. Not only could it create more space for views that fall in the middle, it might also help those at the extremes have a better, more productive conversation.

Financial assurance explained

So let’s take a step back: what exactly is financial assurance? In essence, financial assurance requires companies to promise or commit funds against their environmental risks. The greater the risk, the more they commit. Cash deposits, insurance coverage, and industry funds are examples of different kinds of financial assurance.

Financial assurance is a powerful tool because it adds an important backstop to the rules and laws that hold companies liable for environmental damage they might cause. These liability rules make it in a company’s economic self-interest to avoid causing environmental harm. But they often come with gaps. For example, when a company that has caused environmental damage goes bankrupt, the costs of this damage can fall to society—even if the company is technically liable for it. This gap can undermine companies’ incentives to reduce environmental risk.

Financial assurance can address the gaps in our liability rules. It can help ensure that companies will be held accountable for any damage they cause. And this in turn provides an economic incentive for them to undertake investments, maintenance, and operating practices to reduce risk. In this way, financial assurance can increase confidence that companies are managing risks responsibly.

Policy-makers understand the importance of financial assurance; it’s why they already use it to address the environmental risks of oil transport. But it’s fair to ask whether we’re applying it in the right way.

Financial assurance by land and by sea

In Canada, companies that transport oil have to provide financial assurance. But it works a bit differently depending on how they transport oil. The differences provide a useful illustration of the available instruments.

For tanker traffic, financial assurance comes mostly from insurance coverage and industry funds. Tanker operators are required to carry a given amount of liability insurance. And they pay into Canadian and international industry funds that cover the costs of any accident that exceeds individual firms’ insurance coverage.

For pipelines, governments tend to rely more on financial assurance that operators provide themselves, from “harder” assurance that can’t fluctuate in value (e.g., a bond or cash deposit), to “softer” types, such as a guarantee from an operator’s parent company. Operators also have the option to meet part of their obligation using an industry fund.

Similar to tanker operators, railway firms must carry liability insurance up to a defined threshold. Previously, this was the only policy requirement in place. But in the wake of the Lac-Mégantic derailment, the Safe and Accountable Rail Act (2015) also created an industry fund to cover any costs that exceed insurance coverage.

What requiring financial assurance for oil transport is getting us

Each of the financial assurance instruments used in these three areas has strengths and weaknesses. Some are better at providing risk reduction incentives, others at ensuring that society doesn’t bear the costs associated with remediating a spill, and still others at minimizing the cost to businesses (for more on available financial assurance instruments as well as the trade-offs they present, see this infographic.)

As is often the case, the devil can be in the details: how these instruments are implemented matters a lot (we’ll come back to this below).

But at the same time, Canada’s financial assurance policies for oil transport have some important general features that are worth highlighting:

  • They create incentives to reduce risk. Take the example of insurance coverage for transport by rail. The more that a company can demonstrate strong safety practices (and therefore lower risk), the less it will pay for insurance. This financial benefit creates incentives for rail companies to find new ways to make rail transport safer.
  • They screen out excessively risky activity. Financial assurance means that posing risk to the environment carries a cost. A pipeline operator with a bad safety record might have a harder time finding a lender willing to issue a bond for them. In this way, particularly high-risk operators or projects can get priced out of the market.
  • They avoid taxpayers getting stuck with the bill. Financial assurance means that funds are available for clean-up and compensation regardless of what becomes of the company that caused the damage. For example, the fact that tanker companies pay into an industry fund means that private funds will be available even if a spill bankrupts the responsible company.
  • They help reduce the costs of addressing risk. Financial assurance provides firms with flexibility in how they reduce risk and gives them incentives to innovate. This helps reduce the costs of risk reduction, minimizing impacts on production and investment.

Some open questions

While we can say financial assurance helps us balance the risks of oil transport against the benefits, it remains an open question as to whether we’re striking the right balance. For example:

  • For tankers, the use of industry funds helps ensure compensation for spills. But because they pool risk across companies, they provide less incentive for individual companies to avoid risky behaviour than other types of instruments. Should tanker companies have to provide more assurance themselves (i.e., before the pool kicks in)?
  • Pipeline operators’ financial assurance requirements are based on a pipeline’s “risk value,” which is calculated based on things like diameter, operating pressure, and daily capacity. Should this formula also reflect the ecological sensitivity of the terrain that pipelines cross? And should operators’ potential liability extend past the $1 billion maximum currently laid out in the law?
  • The industry fund in the rail sector is supported by per-tonne levies on crude oil shipped. But this model does not distinguish operations based on their risk. Should their contributions to the fund be risk-weighted (e.g., by requiring smaller payments from early adopters of safer rail tanker car technology), in order to make them fairer and to provide stronger risk-reduction incentives?

These questions, while only a sample, show us how important — and complex — the details of financial assurance can be. The design choices that we make in financial assurance policies have important implications for operators’ costs, for possible social costs, and for risk to the environment.

A better conversation

There isn’t one right answer to any of the above questions, since answering them requires balancing trade-offs. But when it comes to financial assurance for oil transport, asking whether we can do better is a legitimate question.

Shifting the debate to how we manage environmental risk using financial assurance could help us have a more productive conversation. And, if we price environmental risk correctly, we can be more confident in letting market forces determine whether and how we transport oil (and other products), since under the right policies, higher risk will mean higher costs.

Of course, financial assurance has its limits. It cannot substitute for environmental assessments (which weigh environmental risk and other factors like local and national benefits, GHG emissions, and Indigenous consent). Whether a risk is acceptable or not is a bigger question. But for those risks that we do decide to take, financial assurance can offer us a way of creating incentives that ensure companies take them responsibly.

By shifting the debate to who pays for environmental risk, how they pay for it, and what they pay, we might be able to have a more constructive conversation on how to better balance the risks and benefits of energy transport.

On its own, financial assurance can’t resolve our ongoing debates about energy infrastructure in Canada. But it’s one piece of the puzzle.

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