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De ep er and ColderThe Impacts and Risks of De epwater and

Arctic Hyd ro c arbon Development

A l b e r t o S e r n a M a r t i nM a r c h 2 0 1 2

Deeper and Colder: The Impacts and Risks of Deepwater and Arct ic Hydrocarbon Development | March 2012 2

Copyr ight 2012 Susta inalyt ics - A l l r ights reserved

Table of Contents

Executive Summary.......................................................................................................3

Introduction..................................................................................................................5

Global Energy Demand and the Shift Toward Unconventional Oil and Gas........6

Oceanic Oil and Gas Development Explained..........................................................6

Defining Deepwater, Ultra-deepwater and Arctic.....................................................6

The Growth of Oceanic Oil and Gas Development....................................................7

Deepwater and Arctic Development Around the World..........................................8

Potential Impact of Oceanic Oil and Gas Development..........................................9

Air....................................................................................................................................9

Habitat Degradation.......................................................................................................9

Employee and Contractor Health and Safety...........................................................10

Investor Risks................................................................................................................11

Regulatory Risk.............................................................................................................11

Litigation Risk...............................................................................................................13

Reputational Risk.........................................................................................................13

Operational Risk..........................................................................................................14

Best Practices................................................................................................................14

Transparency and Disclosure......................................................................................15

Process Changes: Activities to Decrease Impact on Biodiversity..........................15

Process Changes: Practices to Maintain Well Control............................................16

Process Changes: Emergency Management...............................................................17

Process Changes: Precautionary Approach..............................................................17

Process Changes: Decrease Fluid Toxicity................................................................18

Contractor Supervision and Management...............................................................18

Acting on Investor Risks and Opportunities............................................................19

Endnotes.......................................................................................................................21

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Deeper and ColderDespite mounting evidence that climate change requires a shift towards a low carbon economy, hydrocarbon demand is on the rise. Oil and gas producers continue to push offshore projects into unconventional, deeper and colder frontiers, driven primarily by the need to secure future oil and gas reserves in a landscape dominated by national oil companies (NOCs).

Hydrocarbon reserves in deepwater basins are vast, particularly in the Gulf of Mexico, Brazil and West Africa. Arctic reserves are even larger. Unlike oil sands, hydrocarbons produced in deep and Arctic waters are conventional, however, their extraction requires the use of unconventional methods that can cause environmental and social impacts and generate controversy. Moreover, the technological challenges of drilling at sizable depths and managing extreme weather conditions in the Arctic generate significant operational risks. Public concern has mounted following several recent safety incidents resulting in a high number of fatalities on drilling platforms. Company reputation is impacted by hydrocarbon spills that visibly threaten biodiversity and local economies. The recent Deepwater Horizon incident caused a global cascade of regulatory reviews, the results of which will inevitably increase operational costs. Confronted with the possibility of such a scenario in the fragile and unique Arctic environment, oil companies face further mistrust and resistance to operations in that region. Unplanned events, such as spills or injuries, present significant reputational, regulatory and operational risks for individual companies, their investors, and the oil industry as a whole.

Executive Summary




Due to these operational uncertainties, there is still a long way to go to develop and improve existing best practices. To reduce risk investors should encourage their holdings to improve transparency, implement process changes, use less toxic products, and actively manage contractors. Investor risk analysis can be strengthened with company disclosure on reserves owned in deepwater and Arctic offshore basins. Company risk mitigation can be accomplished by implementing best practices such as compiling biodiversity baseline information, enhancing drilling standards that ensure well integrity, and building sufficient emergency response capacity. Ensuring that contractors adhere to company standards is also a major factor in both regulatory compliance and risk avoidance. The industry also has opportunities to develop lower-impact methods and technologies. Innovation will be the key to long-term success in higher-risk basins.

Responsible investors have an important role to play in decreasing the impacts and mitigating the risks associated with deepwater and offshore Arctic hydrocarbon development. Through their numbers and influence investors can engage with oil and gas producers and encourage innovation, and the adoption and ongoing development of best practices.

At the same time, responsible investors should view deepwater and offshore Arctic developments in the context of the broader need to shift our economy away from its dependence on fossil fuels. Oceanic hydrocarbon development, even with best practices in place, does nothing to discourage fuel consumption. Therefore, while pushing for best practices responsible investors should push even harder for investment in renewable and sustainable forms of energy and for regulatory environments that incentivize such investment.




Introduction

All of the incidents outlined above are indicative of a cascading chain of failure in offshore drilling operations. These incidents resulted in regulatory reviews of safety, significant media attention, reputational damage for individual companies as well as for the entire offshore industry, and financial impacts for both the operating companies and their insurers. Despite these risks and the low levels of trust for the offshore oil and gas industry as a whole, companies are pushing into deeper, colder and more dangerous environments in their pursuit of hydrocarbons.

In this report Sustainalytics outlines the impacts and risks of deepwater and Arctic offshore hydrocarbon development. Several examples of leading practises are provided along with an investor initiative and suggestions for shareholder engagement to address risks with their holdings.

In December 2011, 53 crew members of the Kolskaya jack up rig died in the Subarctic Siberian waters of the Sea of Okhotsk. A window

was knocked out during a winter storm; flooding and sinking the rig in less than 20 minutes. Preliminary conclusions of the Investigative

Committee of Russia stated that safety violations and towing without consideration of the weather conditions were believed to be the

causes of the disaster.

In April 2010, 11 oil workers

died during a fire and explosion

that led to the sinking of the

Deepwater Horizon rig in the

Gulf of Mexico. The resulting

three-month-long leak created

the largest accidental oil spill in

the world. The U.S. Presidential

Commission determined that

the Macondo well blowout was

caused by number of separate

risk factors, oversights,

and outright mistakes that

combined to overwhelm the

safeguards meant to prevent

such an event.

In July 1988, 167 oil workers

were killed in the Piper Alpha

disaster in the North Sea. In

1990, the Cullen Inquiry report

concluded that a condensate

leak was the initial cause

of the multiple explosions.

The inquiry made 106

recommendations, including

one that created additional

health and safety oversight.

In August 2009, a spill occurred from the West Atlas rig in the Timor Sea. The Montara oil leak was one

of the worst spills in Australian history, leaking 400 barrels a day for more than 10 weeks. An inquiry

by the Australian government found that safety practices at the well were poor, adding that faulty

cementing of the well led to the blowout that caused the spill.




Global Energy Demand and the Shift Toward Unconventional Oil and Gas

Climate change pressures have resulted in a global call for a reduction in energy demand and a lower-carbon fuel supply. However, this transition will take decades. The current reality is that energy consumption, mainly in non-OECD countries, is on the rise. The International Energy Agency (IEA) projects that by 2035 global energy consumption will increase by 36 per cent above 2008 levels.1 In this scenario fossil fuels will continue to supply the bulk of energy well past 2035. Oil consumption is projected to increase at a rate of one per cent per year, from 85 million barrels a day in 2008 to 99 million barrels a day by 2035.

As demand for fossil fuel continues to grow, many conventional sources are being depleted, and an estimated 87 per cent of known available reserves on the planet today are under the control of national oil companies (NOCs).2 Due to this restricted access to known reserves, many public companies are shifting their operations to higher-risk areas and to unconventional oil and gas deposits. High-risk regions are generally characterized by social volatility or environmental sensitivity, while unconventional deposits are those that either contains heavier or more contaminated oil or gas, or that occur in less accessible reservoirs or rocks. For unconventional deposits, conventional extraction methods do not generate profitable returns.

The scale of global unconventional fossil fuel resources is vast. Deepwater and Arctic oceanic reservoirs can be considered unconventional as they are situated in locations that are difficult to access. More than half of the oil discovered since 2000 is in deepwater oilfields, and the production of oil from these reservoirs is expected to grow in the coming decades.3 In the case of offshore reserves located north of the Arctic Circle, undiscovered resources are estimated to be 90 billion barrels of oil, of which 84 per cent occurs offshore. Moreover, the extensive Arctic continental shelves may constitute the world’s largest unexplored prospective area for petroleum.4

Oceanic Oil and Gas Development Explained

Defining Deepwater, Ultra-Deepwater and ArcticDeepwater and ultra-deepwater projects occur outside of the continental shelf. Deepwater drilling is carried out at water depths between 400 and 1,500 meters and ultra-deepwater activities begin at water depths greater than 1,500 meters.5, 6 Such projects require the use of floating drilling rigs, and all underwater drilling and production components must be able to withstand high pressures and extremely low temperatures.




Offshore Arctic drilling refers to oil and gas development activities that take place on the continental shelf above the Arctic Circle or at locations at such high latitudes that the average daily summer temperature does not rise above 10 degrees Celsius. While drilling in the Arctic could certainly involve deepwater operations in the future, current activities are carried out in shallow waters. Operating conditions include potential exposure to long hours of darkness, pack ice, icebergs and extremely low temperatures. Thus, companies operating in this region must ensure that vessels are able to withstand pressure exerted by the ice and potential iceberg collisions.

Shallow water drilling: 0 - 400m

Deepwater drilling: 400 - 1,500m

Ultra-deepwater drilling: > 1,500m

The Growth of Oceanic Oil and Gas DevelopmentTechnological innovation within the offshore oil and gas industry has increased the economic viability of offshore projects. Drilling for hydrocarbons underwater began in the 1890s off the U.S. west coast. Since then, oil exploration and production have continued in the shallow waters of the continental shelves around the world. Early Arctic seismic surveys in Alaska and deepwater exploration projects in the Gulf of Mexico did not begin until the 1970s.

The deepwater oil and gas development boom started in the late 1990s and accelerated from 2000 onwards as rising oil prices increased the economic feasibility of such projects. Total global production from deepwater fields rose from less than 200,000 barrels a day in 1995 to over five million barrels a day in 2007. The IEA expects that by 2035 eight million barrels a day will be produced from deepwater resources.7, 8 Estimates of recoverable oil located in deepwater and ultra-deepwater lies between 160 and 300 billion barrels, which is between six and 12 per cent of the 2.5 trillion barrels of total oil the IEA estimates remains to be produced worldwide. Although much of the development of deepwater fields has occurred in the Gulf of Mexico, deepwater discoveries have occurred in various basins around the world, notably in Brazil, West Africa and South East Asia.9, 10

According to a study by the U.S. Geological Survey, the mean total of undiscovered conventional oil and gas resources in the Arctic is estimated to be approximately 1,669 trillion cubic feet of natural gas, 90 billion barrels of oil and 44 billion barrels of natural gas liquids of which approximately 84 per cent is expected to occur offshore.11 This number represents 30 per cent of the world’s undiscovered conventional natural gas, 13 per cent of the world’s total undiscovered oil resources and about 20 per cent of the world’s natural gas liquids.12 Reservoirs are spread among the various Arctic littoral countries: U.S., Canada, Greenland, Norway and the Russian Federation, the latter holding the vast majority of the undiscovered natural gas.13 (See figure 1)

Natural Gas

1,669 Trillion*

30%

Oil

90 Billion*

13%

Natural Gas L iquids

44 Billion*

20%

% = Percentage of world’s supply

* = Measured in cubic feet

Figure 1



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Gulf of MexicoThe Gulf of Mexico is the largest deepwater and ultra-deepwater production area in the world. Total proved hydrocarbon reserves in 2008 amounted 4.21 billion barrels, of which 3.59 billion barrels was crude oil. In 2009, around 32 per cent of the total oil produced in the Gulf of Mexico came from ultra-deepwater wells, 50 per cent from deepwater and 18 per cent from shallow water production. Active companies in the region include Anadarko, Apache, BP, BHP Billiton, Chevron, Eni, and Royal Dutch Shell.

BrazilRecent large deepwater discoveries in Brazil have the potential to double the country’s reserves. In 2011, the country’s oil reserves amounted to 12.85 billion barrels, of which 80 per cent is located in deepwater reservoirs in the Campos and Santos basins. Active companies include BG Group, Chevron, Petrobras, Repsol, Royal Dutch Shell, Sinopec, and Total.

West AfricaIn the last 15 years, Angola has become the second largest oil producer in Africa after Nigeria. The country has proven reserves of approximately nine billion barrels and it has managed to produce almost two billion barrels per day. Of the 40 offshore oil concessions in Angola, 27 are deepwater or ultra-deepwater in the Kuito, Girassol, Belize and Tomboco fields. Active companies include BP, Chevron, CNOOC, Exxon, Sinopec, Sonangol, and Total.

AsiaIn recent years there has been an increase in deepwater activities as Asian oil companies have signed large agreements with European oil majors, such as the 2008 deal to explore the deepwater Gumusut field in Malaysia (signed by: Shell, ConocoPhillips, Murphy Oil and Petronas Carigali); or the 2011 upstream partnership between Reliance Industries and BP to explore and produce offshore oil, including ongoing deepwater projects in the Krishna-Godavari basin. Chinese companies are also developing deepwater rigs, such as the CNOOC981, that will allow deepwater exploration and production from the Peal River Mouth Basin and the Qiong Dong Nan Basin in the South China Sea.

ArcticThe Arctic remains the largest unexplored oil and gas reservoir on Earth. There have been an increased number of continental shelf exploration licenses awarded and new licensing rounds in the Arctic littoral countries (U.S., Canada, Greenland, Iceland, Norway, and Russia) in the last 10 years. Notably, in October 2011, the Obama administration upheld 500 leases issued in the Alaskan Chukchi Sea after several environmental groups challenged the sale of the leases in court. Gazprom expects to start oil production in the Russian Pechora Sea shelf from Prirazlomnoye field in 2012.

1

2

3

4

5

Deepwater and Arctic Development Around the World

1

2

3 4

5

Gulf of Mexico

Brazil

West Africa Asia

Arctic



Air

Potential Impact of O ce anic Oil and Gas Development

Emissions from combustion engines, the flaring of gas for safety reasons, and the escape of fugitive methane emissions during transport cause the release of greenhouse gases (GHG) and volatile organic compounds (VOCs). Emissions are higher on deepwater platforms than on shallow water platforms because of the extra energy required to drill deeper. Moreover, the farther a rig is from shore the higher the cost to ship by-products to land for disposal, therefore, more natural gas is flared on deepwater rigs.14

Habitat DegradationPHYSICAL DISTURBANCEMarine animal life can be negatively affected by various stages of deepwater and Arctic oil development. Air guns, used during seismic surveys of potential oilfields, vent pressurized air into the water producing noise up to 259 decibels. Studies have shown that as a result of these acoustic disturbances some animal species can suffer hearing loss, stress, and a change in behavioural patterns due to their hampered ability to communicate.15, 16 While the effects of air guns on shallow water species can be easier to ascertain, the effects on species inhabiting the deepwater are difficult to determine due to limited knowledge of their baseline behaviour.

Deepwater installations often encounter large fish, marine mammals, and giant cephalopods, whose habitats are disturbed or destroyed by the presence of drilling equipment and underwater hydrocarbon transport infrastructure. Moreover, offshore development in the Arctic has the potential to negatively impact the habitats of mammal species considered vulnerable and near threatened, including polar bears and some whale species, as well as the routes travelled by migratory animals such as the humpback whale.17

Shoreline ecosystems provide the mainland with natural protection against hurricanes and storms. Hydrocarbon transport to refining and consumption centres can cause shoreline erosion and damage to coastal wetlands, coral reefs, and mangroves. In the Gulf of Mexico, Louisiana’s shorelines have lost approximately 3,000 km due to human activities including the construction of more than 12,000 km of pipelines to transport hydrocarbons onshore.18 Increased activity in deepwater development regions like Brazil and West Africa can exacerbate shoreline change in these areas.

PLANNED DISCHARGES During any drilling operation, waste is produced and requires disposal. Proximity to land determines the viability of onshore disposal. Deepwater and Arctic operations typically discharge drilling fluids, cuttings, produced water, and domestic waste to the sea and the subsurface. Produced water often contains polycyclic aromatic hydrocarbons (PAHs) along and other hazardous substances such as heavy metals. Concentrations of PAHs




in produced water are toxic and can negatively impact local ecosystems. In 2008, on average, an offshore installation drilling in the North Sea discharged 1,681,916 cubic meters of produced water into the ocean.19 Since more than 200 deepwater wells reached production status in 2011, hundreds of millions of litres of produced water are discharged into the oceans every year.

Depending on the composition of the drilling fluids, synthetic oil and chemical components containing traces of heavy metals, such as lead, can be discharged into the sea. Deepwater projects require much larger volumes of drilling mud than shallow water projects. Although several technologies exist to handle drilling fluids with contaminated cuttings, companies often release fluids into the sea. Also, while some jurisdictions, like the North Sea and the Gulf of Mexico, prohibit the discharge of synthetic-based mud, West Africa, South America, and the Far East allow controlled discharges if cuttings meet certain toxicity criteria.20

“

“ hundreds of millions of litres of produced water are discharged into the

oceans every year.

UNPLANNED DISCHARGES: OIL SPILLSThere are several ways for hydrocarbons to be released from an offshore installation. Malfunctioning valves, corrosion, and human errors are common. Blowouts, an unexpected and uncontrolled pressure build-up, cause hydrocarbons to flow into the borehole toward the surface. Because of the isolation of deepwater rigs, blowouts and subsequent spills tend to take longer to contain compared to the same scenario in shallow waters or on land. Oil spills undoubtedly have a negative impact on local ecosystems. The almost five million barrels of oil spilled in the Gulf of Mexico during the Deepwater Horizon incident killed 6,814 animals and injured 2,624 birds, sea turtles mammals, and reptiles.21

According to a report by the World Wildlife Foundation, the Arctic offers the highest level of ecological sensitivity and the lowest level of capacity to cleanup after an oil spill. The efficiency of standard industry oil spill response strategies such as mechanical containment and recovery, in situ burning, and dispersant application can be questioned. Again, due to the remoteness of the location and local conditions, such as ice cover, low temperatures, reduced visibility or complete darkness, high winds, and extreme storms, spill response activities can be delayed.22 In cold conditions, oil is less susceptible to bacterial degradation and evaporation, especially when trapped under ice. Conversely, some operators claim that the low oil evaporation rates in the Arctic could result in a more effective cleanup as more of the oil could be disposed of via in situ burning, and that the ice may act as a natural barrier between the oil and the marine environment below.

Employee and Contractor Health and SafetyWork-related risks offshore can be operational, resulting from human error and impaired performance, and/or anthropological, related to the physical and psychological well-being of individual offshore workers.23, 24 In the Gulf of Mexico, where most deepwater operations are currently located, there were 3,695 safety incidents registered between 2006 and 2010, including 42 fatalities and 1,620 injuries of varying severity.25 Geography also plays a role in dictating other vessel safety risks such as severe weather or iceberg collision.




The majority of the activities carried out on offshore platforms, including most of the high risk activities, are performed by contractors on the payroll of oilfield service companies. From drilling, cementing, circulating mud, and running geophysics, all the way down to the cooks, contractors are essential for rig operation. In fact contractors far outnumber the oil and gas company representatives on a rig. According to a study carried out by the Offshore Division of the Health and Safety Executive analysing the underlying causes of the offshore accidents, contractors accounted for 62 per cent of injured parties.26

Investor Risks

Regulatory RiskThe negative attention deepwater and Arctic drilling has received as result of recent offshore catastrophes has had implications on regulatory frameworks. Various jurisdictions have begun to review, or have already tightened, environmental and safety requirements for the issuance of drilling permits (see text box 1 on page 12). Following the Deepwater Horizon incident, the U.S. imposed a six-month moratorium on deepwater projects, and issued new rules to address major safety gaps identified by investigations into the incident (see text box 2 on page 12).27 Companies whose operations were halted had to resubmit safety plans in order to receive approvals to resume operations. In the aftermath of the Deepwater Horizon incident, Arctic developments have also experienced slowdowns partly due to the regulatory review sparked by the Gulf of Mexico spill. Royal Dutch Shell’s plan to start exploration drilling in the Beaufort Sea in 2010 has experienced a longer permitting timeframe that has delayed operations for at least two years.

Investors in companies holding deepwater and Arctic projects will see that, as a result of tougher regulations and increased oversight, it will take more time to produce first oil. If production takes longer, the development and operational costs of projects increase and revenues are delayed. Companies with strong environmental and social management practices should obtain permits more efficiently, have lower compliance costs and experience fewer delays. Furthermore, these companies also lower the risk of a costly non-compliance incident.

While more stringent regulations may increase costs or cause production delays, they also help ensure higher safety standards and practice. In doing so, regulatory changes play a critical role in managing risk and helping to avoid disastrous and costly events. As a result, raising standards aids in the protection of the industry’s reputation as a whole.



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New U.S. Environmental and Safety Rules Prompted by the Deepwater HorizonAs a direct consequence of the Deepwater Horizon tragedy, the U.S. Minerals Management Service was restructured to separate the

energy development functions from the safety and environmental enforcement function. Two new organizations emerged in October

2011: the Bureau of Ocean Energy Management (BOEM) and the Bureau of Safety and Environmental Enforcement (BSEE). The BSEE

developed and implemented two rules aimed at raising operations standards for companies operating in the U.S. outer continental shelf:

• A Drilling Safety Rule set new standards for well design and well control equipment. Voluntary well design practices, recommended by the American Petroleum Institute (API) became mandatory and third-party inspections and certifications are necessary for every stage of the drilling process. In terms of well control equipment, an engineer must certify that blowout preventers meet new standards for testing and maintenance, and are capable of severing the drill pipe under anticipated well pressure.

• A Workforce Safety Rule requires companies operating offshore to develop and maintain a safety and environmental management system (SEMS) making 13 previously voluntary health and safety elements mandatory. Companies are also required to provide documentation that describes all elements of the SEMS program. Procedures such as emergency evacuation plans and oil spill contingency plans must now be in place and validated by drills or records and documentation.

Source: Bureau of Safety and Environmental Enforcementhttp://www.bsee.gov/BSEE-Newsroom/Speeches/BOEMRE-Director-Discusses-Strengthened-Oversight-of-Offshore-Oil-and-Gas-Drilling-and-Development-at-the-Baker-Institute-s-Energy-Forum.aspx

Box 2

Offshore Safety Regulation Revisions in Various Global Jurisdictions

• European Commission: In October 2011, the European Commission proposed a new law to ensure that European offshore hydrocarbon production in EU waters follows the highest safety, health and environmental standards during the entire life cycle of an operation. The proposal has mandatory requirements in the areas of emergency response, transparency and inspections. Public participation is foreseen in licensing, and companies need to demonstrate technical and financial capabilities to ensure environmental protection. The proposal will be discussed by the EU throughout 2012.

Source: European Commission

• Canada: In December 2011, the Canadian National Energy Board (NEB) concluded a review of the safety and environmental requirements for offshore drilling in Canadian Arctic waters. The process included consultation with interested parties such as non-governmental organizations, local communities, other regulators and the oil industry. The NEB states that companies must demonstrate that they would be able to complete a relief well and cap a blowout in the same season. Companies can get an exemption to this requirement if they show they have alternative methods for quickly killing a blowout.

Source: National Energy Board of Canada

• United Kingdom: One of the priorities for 2012 of the offshore division (OSD) of the U.K. Health and Safety Executive is to conduct a revision of the U.K.’s offshore oil and gas regulatory approach, touching upon health and safety and oil spill response aspects.

Source: Health and Safety Executive

• Greenland: With no producing wells in the country, the first offshore drilling legislation was introduced in 2010. In 2011, the Ministry for Industrial and Natural Resources announced that it was setting higher requirements in Arctic waters. The new requirements include ice handling programs and an exceptional two rig policy that demands companies install two drilling rigs for every well. The purpose of the second rig is to reduce the time needed to mobilize a rig to drill an emergency relief well.

Source: NANOQ

• China: In September 2010, the government began three weeks of additional safety checks to all offshore installations in the wake of an oil spill at a Bohai Bay platform run by ConocoPhillips. In November 2011, it was reported that a revision of joint offshore hydrocarbon development may be undertaken by the Ministry of Land and Resources. Current regulation lacks clarity with regards to the obligations and responsibilities of companies and regulators during unplanned events.

Source: Reuters News

The International Maritime Organization, a UN body tasked with protecting the marine environment from pollution from ships, has set up a working group to address pollution from platforms. If the working group succeeds, oil companies will witness the start of the first international agreement ever dealing with offshore hydrocarbon development. Box 1


http://www.bsee.gov/BSEE-Newsroom/Speeches/BOEMRE-Director-Discusses-Strengthened-Oversight-of-Offshore-Oil-and-Gas-Drilling-and-Development-at-the-Baker-Institute-s-Energy-Forum.aspx

http://ec.europa.eu/energy/oil/offshore/standards_en.htm

http://www.neb-one.gc.ca/clf-nsi/rthnb/pplctnsbfrthnb/rctcffshrdrllngrvw/rctcffshrdrllngrvw-eng.html

http://www.hse.gov.uk/offshore/priorities.htm

http://uk.nanoq.gl/sitecore/content/Websites/uk,-d-,nanoq/Emner/News/News_from_Government/2011/08/hoeje_sikkerhedskrav.aspx

http://www.reuters.com/article/2011/11/07/us-china-oil-regulation-idUSTRE7A60IX20111107



Litigation RiskGenerally, litigation risk relates to the effects of pollution and the subsequent compensation claims filed by affected parties, who might also seek to receive punitive damages after an unplanned event. In December 2010, BP took a pre-tax charge of USD 40.9 billion in order to fund claims, cleanups, and damages from the Deepwater Horizon incident. As oil spills can have a large material impact on companies, there is also a risk of litigation from a company’s own shareholders. After the Deepwater Horizon incident several groups of shareholders filed lawsuits against BP claiming that the company misled them about its commitment to safety and operational integrity.

Liability is a deterrent to spills. Currently, the operators hold the liability, however, the contractors physically perform the work and thus control a portion of the risk. In the case of the Deepwater Horizon, the U.S. Coast Guard named some contractors as potentially responsible parties, thus complicating traditional liability lines. Furthermore, BP began an aggressive legal campaign to recover some costs from its contractors. Post-Deepwater Horizon, the traditional distribution of risks and benefits between operators and contractors is being challenged.

Stakeholders who oppose projects may also use legal tactics such as lobbying regulators, challenging permits, or obtaining court injunctions, to delay or derail projects. Since 2010, environmental groups and local Inupiat communities have been legally challenging air permits issued by the U.S Environmental Protection Agency to Royal Dutch Shell’s drilling vessel. Shell’s plans to start drilling during the Arctic summer of 2012 may experience another delay if these appeals succeed. Operators that have strong relationships with their stakeholders may benefit from reduced resistance to permitting and fewer lawsuits.

Reputational RiskThe powerful images of oil spills, worker fatalities, and the effects of climate change in the Arctic can induce strong emotion among the general public and can expose companies involved in deepwater and Arctic operations to significant negative media attention. Negative reputational impacts related to operations in sensitive environments are an issue that both companies and the industry as a whole have been facing for decades. Exposure to reputational damage increases as non-governmental organizations (NGOs) and local communities organize themselves in more sophisticated ways. Visual NGO campaigns outlining the potential environmental effects of an Arctic oil spill provide a significant amount of negative media attention that can lead to further distrust of the offshore industry and an increase in opposition to drilling projects. In the 1990s Royal Dutch Shell was subject to a boycott in Europe after it announced plans to sink the Brent Spar storage installation in the North Sea. Some BP gas filling stations in the southern U.S. were boycotted by consumers after the Deepwater Horizon sank resulting in a temporary loss of business opportunities and reduced revenues.




Operational Risk

Operating in deepwater and Arctic environments is generally more complicated than operating in shallow water. The depth of deepwater drilling translates into extremely low temperatures and high pressures. Drilling risers and other equipment are built with thicker walls and higher grade materials to handle the additional stress. However, there is no one-size-fits-all technology that guarantees safe operations. For example, Brazilian deepwater basins require well integrity techniques designed to adjust for shifting sand that falls back into the well, while Gulf of Mexico operations need to be designed to withstand severe storms and hurricanes.

In the Arctic, the most obvious operational challenge is ice. Ice movement is subject to wind and water currents. Ice conditions can also vary significantly season-to-season, or year-to-year, within an area. Thus, fixed platforms must be designed to withstand the pressure exerted by ice. Drilling activities and support vessels can be delayed by approaching icebergs or the more difficult to detect ice growlers.

Blowouts are often caused by well integrity issues related to poor cementing jobs or loss of drilling mud pressure. The deeper the well, the more cement and drilling mud is used, increasing the likelihood of well integrity failure. Furthermore, because of the isolated nature of deepwater rigs, blowouts and subsequent spills tend to take longer to contain compared to the same scenario in shallow waters or on land. In terms of emergency planning, the last line of defence for an uncontrolled offshore spill is to drill a relief well. The relief rig is relatively easy to acquire in the Gulf of Mexico with hundreds of rigs operating in the area. However, in the remote Arctic, that relief well rig may take several months just to reach the site, prior to beginning the drilling process.

Equipment selection for deepwater and Arctic operations requires an immense amount of technical consideration. Due to the specialized equipment and risk profile of the activities, average day rates for deepwater and Arctic projects vary from around USD 250,000 to USD 415,000 per utilization day.28 Therefore, temporary stoppages or delays due to operational failures, even if not critical, can represent high and unwelcomed expenses for the company.

Best Pr actices

There are general operational best practices that oil and gas companies and their servicing companies can employ to address the risks inherent to deepwater and Arctic operations. While some best practices have been identified by evaluating what went wrong in past incidents, other practices are based more on a precautionary approach and the need to establish baseline data. Although not an exhaustive list, below are some examples of leading practices for deepwater and Arctic operations.




Transparency and Disclosure

As unconventional resources carry more risk than conventional resources, the portion of reserves in higher risk regions is a key indicator of risk exposure. Investors would benefit from companies disclosing the percentage of offshore resources compared to overall reserves, with a clear distinction between shallow water, deepwater and Arctic reserves. Stock exchanges require oil companies to disclose oil and gas reserve information. In January 2010, a rule requiring oil and gas companies to categorize reserves based on final product (either conventional or unconventional) was implemented by the U.S. Securities and Exchange Commission.29 These revisions provide investors with a better understanding of risk exposure and will facilitate a more meaningful comparison between companies. Although this rule is an improvement, it does not allow investors to distinguish between oil and gas from deepwater or Arctic reserves. As both costs and risks are higher with deepwater and Arctic reserves compared to shallow water or onshore reserves, investors would benefit from, and should encourage, a more detailed categorization of reserve information.

Leading Practice Example: NEXEN INC. RESERVES DISCLOSURE

In its FY 2010 annual report, Nexen Inc. provides a graphic breakdown of its 2010 Proved +

Probable Reserves, under its major operating categories such as Synthetic, Syncrude, North Sea,

Other International, Canada, Gulf of Mexico, and Yemen. Analysts with some knowledge about

the company’s operations in these regions would be able to distinguish the Gulf of Mexico as

containing some deepwater reserves. This level of disclosure is stronger than the industry average,

however a further company-wide breakdown of deepwater reserves would be a leading practice.

Process Changes: Activities to Decrease Impact on Biodiversity

A greater understanding of deep marine life is needed in order to inform oil and gas production best practices. Early partnerships between science-based research organizations and oil and gas exploration companies can produce scientific data useful for both groups. Companies operating in deepwater and the Arctic can aid in the development of best practices by building a baseline data set that can be used to inform mitigation strategies and avoid negative impact. For example, by monitoring local whale behaviour drilling operations can be scheduled to avoid migration and calving periods. Gathering baseline biodiversity data is important in deepwater and Arctic regions as such data is lacking in comparison to warm water continental shelf regions.

Companies can implement strategies for reducing physical impacts such as reducing underwater sound disturbances. For example, soft starting is recognized as a best practice for seismic testing. The procedure begins by producing a low level of noise that is gradually increased. The gradual increase allows marine mammals and fish to move away from the testing areas and avoid exposure to high-volume sound. Companies can




also replace air guns with marine vibrators, which produce much lower pressure and sound. Although it has a lower impact, marine vibrator technology is not yet as reliable as traditional seismic technology.

Leading Practice Example: JOINT INDUSTRY RESEARCH - EXPLORATION AND PRODUCTION SOUND AND MARINE LIFE JOINT INDUSTRY PROJECT

In 2005, the International Association of Oil & Gas Producers (OGP) began the exploration and

productions sound and marine life joint industry project. The program systematically surveyed

the literature for knowledge gaps about underwater sound and its effects on animals, and funds

research programs focused on sound source characterization and propagation; physical and

physiological effects and hearing; behavioural reactions and biologically significant effects; and

mitigation and monitoring. Participating companies include: BG Group, BHP Billiton, Chevron,

ConocoPhillips, Eni, ExxonMobil, Santos, Statoil, and Woodside. Shell and BP halted their

participation in the project in 2010.

Process Changes: Practices to Maintain Well ControlControlled wells have a lower impact on biodiversity as the likelihood of unplanned discharges is lower. Furthermore, blowouts are costly and preventable. If well integrity is lost and emergency control equipment malfunctions, hydrocarbons can ignite and cause spills, fires, and explosions. While there are regulations requiring that well control systems function properly, these regulations vary between jurisdictions. Companies can show best practice by setting voluntary internal standards that go beyond local regulations. For example, companies can require laboratory testing for cement slurries that will be used in cementing deepwater wells, increase blowout preventer (BOP) testing frequencies, and increase the effectiveness of BOPs by using multiple sets of rams (steel blades) designed to cut the drill pipe in case of an emergency. In order to systematically reduce risk, companies need to rollout company-wide standards and not simply implement new standards in specific regions.

Leading Practice Example: BP’s ENHANCED DRILLING STANDARDS IN THE GULF OF MEXICO

In the aftermath of the Deepwater Horizon incident, BP announced a set of voluntary performance

standards that go beyond U.S. regulatory requirements and will be implemented by the company

for its operations in the Gulf of Mexico. Under the new drilling standards BP commits to:

• Require contractors to use BOPs equipped with no fewer than two blind shear rams and a casing shear ram on all drilling rigs under contract to BP for deepwater service;

• Third-party verification in testing and maintenance of BOPs, in accordance with manufacturer recommendations and industry recommended practice; and

• Laboratory testing of cement slurries used in wells and disclosure of tests to the regulators

Although the enhanced standards go beyond regulatory requirements in the U.S., BP is not

requiring all of its worldwide drilling rigs to conform to this leading practice.




Process Changes: Emergency Management

Lessening the environmental impact of an event will also lessen potential legal claims, compensation payouts, and regulatory fines. The management of emergencies begins with preparedness. Realistic oil spill contingency plans that assess a company’s oil spill scenarios should be disclosed by every company intending to perform operations offshore in compliance with or beyond regulatory requirements. Industry initiatives can provide assistance to companies in the preparation of such plans. The International Petroleum Industry Environmental Conservation Association (IPIECA) has a complete guide to contingency planning for oil spills on water that companies can deploy for deepwater projects.30 This guide includes a toolkit for identifying potential response capacity in relation to the size and location of the spill. Deepwater and Arctic spills are often considered remote and their distance from infrastructure generally means a longer response time. Smaller spills may be dealt with at the company level; however, larger spills will need the resources of multiple companies. Such capacity currently exists in the Gulf of Mexico, and other major deepwater basins should explore similar arrangements.

Leading Practice Example: MARINE WELL CONTAINMENT COMPANY (MWCC) AND HELIX ENERGY SPILL CONTAINMENT SYSTEM

In the aftermath of the Deepwater Horizon spill, Anadarko, Apache, BHP Billiton, BP, Chevron,

Conoco Phillips, ExxonMobil, Hess, Royal Dutch Shell, and Statoil formed the Marine Well

Containment Company (MWCC), a non-profit company that will be ready to deploy an interim

containment system in case of an incident in the Gulf of Mexico. The equipment is owned and

maintained by the MWCC and vessels and mutual aid equipment will be made available by and

to the aforementioned companies. Companies must be a member in order to use the equipment

and services of the MWCC.

Oil spill containment also presents business opportunities for companies. Helix Energy Solutions

Corp. has designed a fast response system (HFRS) for future spills that has been cited as the spill

response system of record for six new drilling permits issued in the Gulf of Mexico.

MWCC and the HFRS are examples of leading practices, however, both are only available in the

Gulf of Mexico and other high risk deepwater and Arctic regions remain underserviced.

Process Changes: Precautionary ApproachEmergency management in the Arctic poses a different set of challenges. While some companies claim an ice environment will provide recovery opportunities not present in open water and enhance the use of mechanical recovery, in situ burning and dispersant use, there is no real-world data available to support those claims.31 IPIECA, together with the API and other partners are developing new guidance for responding to spills in icy waters.32 In line with the precautionary approach to development of Arctic oil and gas deposits, more information is needed before the industry understands the best ways to




manage environmental emergencies in the Arctic. Effective cleanup mechanisms may include traditional containment methods, however, it is more likely that contingency plans will be more complex for Arctic projects. Committing to drill exclusively during open water season, when the presence of ice is lower and accessibility to spill sites is greater, would reflect a precautionary approach. Companies can also allocate financial resources for research on Arctic oil spills, for example through the Oil Spill Response and Research Program of the BSEE.

Process Changes: Decrease Fluid ToxicityCompanies can reduce the impact of planned discharges by adopting strict discharge policies such as sourcing products and services that are designed to comply with stringent regulations and minimize environmental impact. Some oilfield service companies have viewed this shift towards less toxic materials as an opportunity and are offering water-based drilling fluids with lower marine toxicity and faster biodegradation, as well as cuttings collection and containment systems that considerably reduce the environmental impact of planned or unplanned discharges.

Leading Practice Example: OSPAR DISCHARGE GUIDELINES

The OSPAR commission is a regulatory body tasked with protecting the marine environment of the

North-East Atlantic. It has in place a number of measures to reduce discharges from the oil and

gas industry, considered to be the most stringent worldwide. OSPAR has an oil discharge standard

of less than 30mg/l (on average) for the total quantity of oil in produced water discharged. Since

1992, OSPAR has prohibited the use of diesel oil-based drilling fluids. Companies can improve their

environmental performance in the area of planned discharges by adopting a policy that follows

the OSPAR discharge standards.

Contractor Supervision and ManagementIn a business where contractors play such a prominent role, it is expected that operators have a system in place to supervise contractors and to ensure that contractors conduct operations in a manner consistent with the operators standards. Employee safety is at stake and traditionally the operators hold the liability for unplanned events. Operators should adopt a comprehensive, audited safety and environmental management system (SEMS), including contractor pre-qualification and auditing, and ensure that the SEMS is followed on board contracted rigs. The alternative is that contractors follow their own management system, however, with several contracted service companies working on one rig, independent management systems would not be efficient. The safer option is to have all rig personnel working under the same high standards and expectations. If a SEMS is properly implemented, auditing and monitoring functions should be conducted to determine a contractor ’s compliance. The presence of an on-site company representative can also help ensure that the operations are conducted in




accordance with the operator’s standards. As a best practice, prior to drilling, operators and contractors should prepare a bridging document that outlines how the contractor’s safety and environmental standards can link with the oil and gas company’s standards. Such documents are prepared on a well-by-well basis, are tailored to specific local conditions, and outline chains of command during an emergency.

Leading Practice Example: COMPREHENSIVE BRIDGING DOCUMENTS

Following the Deepwater Horizon incident, the API and the International Association of Drilling

Contractors (IADC) created a template for a comprehensive bridging document. The API/

IADC Bulletin 97 Well Construction Interface Document allows the two sides to formally align

a contractor safety case with the operator’s safety management system. Although the concept

of a well-by-well bridging document is not new, this standard adds the elements of well design,

well execution plan, and critical well activity risk assessments to the traditional SEMS bridging

arrangement. By including these additional factors emphasis is placed on the higher risk activities

associated with deepwater and Arctic wells.

Acting on Investor Risks and Opportunities

As global demand for hydrocarbons increases, oil and gas producers will continue to push offshore projects into extreme and sensitive environments in their quest to secure future reserves. These higher-risk deepwater and Arctic unconventional supplies are associated with environmental and social impacts, the most significant of which are on biodiversity and employee health and safety. Such impacts create reputational, regulatory and litigation risks for companies and their investors. Furthermore, the deepwater and Arctic industry faces a greater degree of operational uncertainty that investors have not been able to fully evaluate. As a result of the Deepwater Horizon incident, for example, investors learned that the information they needed to analyze risk exposure and risk mitigation in offshore activities was not readily available. The uncertainties and risks associated with deepwater and Arctic extraction call for a response from investors.

Months after the Deepwater Horizon incident, a Ceres-led coalition of 62 global investors with USD 2.5 trillion in assets under management sent letters to the CEOs of 28 major energy companies engaged in deepwater drilling and 26 insurers. The letters requested further disclosure of the companies’ risk oversight measures for deepwater drilling.33

Current engagement should follow the same track of improved disclosure with a particular focus on reserve disclosure and best practices. In order to better understand their level of exposure to unconventional oil and gas, investors should request that companies disclose a breakdown of higher risk reserves including deepwater and Arctic. Environmental and social impacts and their associated risks can, to a significant degree,




be mitigated through the implementation and further development of best practices. In many cases the industry is opting for selective implementation of best practices depending on their exposure to reputational and regulatory risks. In some areas, best practices can be implemented immediately; in other areas they will require time, research and innovation. Of primary importance are:

• Transparency – provide information that allows investors to evaluate the risk exposure of the company’s reserve portfolio.

• Process Changes – include mitigation for impacts to biodiversity, high global standards for maintaining well control, and, as a last defence, strong emergency management programs.

• Product Changes – increase the use of green products and strive to reduce the toxicity of all materials used on board, especially fluids that may be disposed of offshore.

• Contractor Management – operators should ensure that contractors adhere to an audited SEMS and that both parties complete comprehensive well-by-well bridging documents.

While the practices outlined above are important and should be encouraged, it should be noted that they do nothing to address or mitigate the contribution of fossil fuel consumption – specifically oil and natural gas – to climate change. In fact, a positive feedback cycle exists in that, as more oil and gas is extracted from Arctic environments, the associated increase in carbon dioxide decreases the amount of Arctic ice. More ice-free days translate into easier drilling conditions and the production of even more Arctic oil and gas. Therefore, while pushing for impact mitigation in the deepwater and Arctic oil and gas industry, responsible investors should also push for investment in renewable energy and for regulatory environments that incentivize such investments.




1 World Energy Outlook 2010 (Paris: International Energy Agency, 2010).

2 National oil companies (NOC) are companies that are fully or majority owned by a national government. NOCs do not completely impede the access of publicly traded companies to these resources; however, foreign companies are subject to operating restrictions which often include partnerships with NOCs and technology transfer requirements.

3 World Energy Outlook 2010.

4 Peter H. Stauffer, ed., “Circum-Arctic Resource Appraisal: Estimates of Undiscovered Oil and Gas North of the Arctic Circle,” U.S. Geological Survey, 2008, http://pubs.usgs.gov/fs/2008/3049/fs2008-3049.pdf.

5 On October 1, 2011, the U.S. Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE), formerly the Minerals Management Service (MMS), was replaced by the Bureau of Ocean Energy Management (BOEM) and the Bureau of Safety and Environmental Enforcement (BSEE) as part of a major reorganization. BOEM is responsible for managing environmentally and economically responsible development of the U.S.’s offshore resources. Its functions include offshore leasing, resource evaluation, review and administration of oil and gas exploration and development plans, renewable energy development, National Environmental Policy Act (NEPA) analysis, and environmental studies. BSEE is responsible for safety and environmental oversight of offshore oil and gas operations, including permitting and inspections of offshore oil and gas operations. Its functions include the development and enforcement of safety and environmental regulations, permitting offshore exploration, development and production, inspections, offshore regulatory programs, oil spil l response and training, and environmental compliance programs.

6 World Energy Outlook 2010.

7 Ibid.

8 Ibid.

9 Ibid.

10 Ibid.

11 Stauffer, “Circum-Arctic Resource Appraisal: Estimates of Undiscovered Oil and Gas North of the Arctic Circle.”

12 “Arctic Oil and Natural Gas Potential,” U.S. Energy Information Administration, accessed December 6 2011, http://www.eia.gov/oiaf/analysispaper/arctic/index.html#aongr.

13 Donald L. Gautier, et al. , “Assessment of Undiscovered Oil and Gas in the Arctic,” Science, 324, no. 5931, (2009): 1175-1179.

14 “MMS GOADS and Offshore Methane Emissions: Lessons Learned from the Natural Gas STAR Program,” U.S. Environmental Protection Agency, published May 6, 2008, http://www.epa.gov/gasstar/documents/workshops/2008-tech-transfer/neworleans3.pdf.

15 “Ocean Noise: Turn it down: A Report on Ocean Noise Pollution,” International Fund for Animal Welfare, published June 2008, http://www.ifaw.org /sites/default/fi les/Ocean%20Noise%20Pollution%20Report.pdf. 16 “Marine Mammals and Noise: A Sound Approach to Research And Management,” Marine Mammal Commission, published March 2007, http://mmc.gov/reports/workshop/pdf/fullsoundreport.pdf.

17 Red List, The IUCN Red List of Threatened Species, accessed December 2, 2011, http://www.iucnredlist.org /.

18 “About Coastal Erosion: What are the causes?” Parishes Against Coastal Erosion, http://www.paceonline.org /erosion_det.php?poErosion_ID=3.

19 “About Coastal Erosion: What are the causes?” Parishes Against Coastal Erosion, http://www.paceonline.org /erosion_det.php?poErosion_ID=3.

20 A. Mclean, A. Wilde, M. Zamora and M. Rafferty, “ The Top 10 Mud-Related Concerns in Deepwater Dril l ing Operations,” American Association of Dril l ing Engineers, 2010.

21 “Deepwater Horizon Response Consolidated Fish and Wildlife Collection Report,” RestoreTheGulf.gov, published November 2, 2010, http://www.restorethegulf.gov/sites/default/fi les/documents/pdf/Consolidated%20Wildlife%20Table%20110210.pdf.

22 “Oil Spil l : Response Challenges in Arctic Waters,” WWF, published October 2007, http://www.worldwildlife.org /what/wherewework/arctic/WWFBinaryitem24363.pdf.

23 The Health and Safety Executive’s Offshore Division is responsible for regulating the risks to health and safety arising from work activity in the offshore oil and gas industry on the U.K. continental shelf.

24 “Offshore working time in relation to performance, health and safety: A review of current practice and evidence,” University of Oxford for the Health and Safety Executive, 2010, http://www.hse.gov.uk/research/rrpdf/rr772.pdf.

Endnotes




25 ”Incident Statistics and Summaries 1996-2011,” Bureau of Ocean Energy Management, Regulation and Enforcement, published February 2011, http://www.boemre.gov/incidents/IncidentStatisticsSummaries.htm. 26 John Hare, and Michael Johnson, “Underlying Causes of Offshore Incidents,” Health and Safety Executive, published May 15, 2009, http://www.hse.gov.uk/offshore/offshore-incidents.pdf.

27 “BOEMRE Director Discusses Future of Offshore Oil and Gas Development in the U.S. at Gulf Spil l Series,” Bureau of Ocean Energy Management Regulation and Enforcement, press release published April 19, 2011, http://www.boemre.gov/ooc/press/2011/press0419.htm.

28 “Offshore Rig Day Rates,” Rigzone, http://www.rigzone.com/data/dayrates/.

29 Security and Exchange Commission, Modernization of Oil and Gas Reporting, accessed January 2012, http://www.sec.gov/rules/final/2008/33-8995.pdf.

30 “Oil Spil l Preparedness and Response Report Series Summary,” IPIECA, 2008, http://www.ipieca.org /publication/oil-spil l-preparedness-and-response-report-series-summary.

31 “Oil Spil l : Response Challenges in Arctic Waters,” WWF.

32 ”Response in the Arctic,” IPIECA, accessed December 2011, http://www.ipieca.org /topic/oil-spil l-preparedness/response-arctic.

33 Peyton Fleming, “Investors Managing $2.5 Tri l l ion Press Energy Companies to Better Disclose Spil l Prevention and Response Plans for Deepwater Wells Worldwide,” press release published August 5, 2010, http://www.ceres.org /incr/news/oil- letters-080510.




About the Author

About Sust ainalytics

Alberto Serna Martin, Associate Analyst Alberto is responsible for research and analysis within the oil and mining sectors. He is also a member of the team responsible for the Global Compact Compliance Service. Prior to joining Sustainalytics, Alberto worked for the Dutch environmental and development non-governmental organization Both Ends. He completed a Master’s degree in English Language and Literature at the University of Alcalá de Henares in Madrid and a Research Master’s in Human Geography, Planning and International Development Studies at the University of Amsterdam (Cum laude).

Alberto Serna MartinAssociate [email protected](+31) 20 205 00 01

Sustainalytics is a leading global provider of environmental, social and governance (ESG) research and analysis for investors and financial institutions. We provide a global perspective, underpinned by nearly 20 years of local experience and expertise in the responsible investment market. Sustainalytics strives to continuously provide high-quality solutions and commits to remain responsive to the current and future needs of our clients. Recently, Sustainalytics was voted Best ESG Research House by IPE/TBLI. Sustainalytics is headquartered in Amsterdam and has offices in Boston, Frankfurt, Madrid, Paris, Timisoara and Toronto; and representatives in Brussels and Copenhagen.

The information herein has been obtained from sources that Sustainalytics believes to be reliable.

However, Sustainalytics does not guarantee its accuracy or completeness. Copyright © 2011

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