Drilling for Arctic oil: When markets conquer ethics

This week's news that Cairn Energy has begun drilling in Arctic waters between Canada and Greenland, also known as Iceberg Alley, has inspired me to write about a somewhat gloomy economic principle.

The principle in question is this: that market forces can crush the best of intentions. And when you look for someone to blame, it's nobody's fault.

In this case the principle has created the bizarre situation where a company partly owned by Canadian taxpayers is taking risks with the Canadian environment that Canadian law would prevent.

Here's the background. The horrendous mess created by BP's blowout in the Gulf of Mexico has quite reasonably made thinking people think about how to prevent it from happening again. After the BP spill, the Canadian and US governments both put a stop to Arctic drilling for now. They want to be certain a similar disaster won't happen in the Arctic's fragile environment. Among other things, they want to make sure they have a sound plan if a blowout happens late in the season, when August frosts start to re-freeze the Arctic ice before oil companies have a chance to complete relief wells.

But here is where market forces step in. When there is oil in the ground (even when that ground is deep under the ocean), there is money to be made.

So this week, with the approval of the Greenland government, a smallish Scottish oil company calledCairn Energy began drilling just outside Canadian coastal waters.

Greenland, with traditional industries that extend to fishing and fish-packing, is a bit like Newfoundland except with no trees and without the cozy climate. It is hard to fault Greenland for wanting to emulate Newfoundland's rise from have-not to energy hub.

On the company's part, there is no sign that Cairn is by any means evil or unscrupulous. Based on some superficial research, it seems to be a well-run, law-abiding, family concern that grew. Cairn Energy made its mark doing the very things that make capitalism great. It expanded in under-served niches. It experimented in areas ignored by more established companies.

And by doing that it earns good money for shareholders, including Canadian pensioners. As of March, the Canadian Pension Plan Investment Board owned 158,000 shares in Cairn, and nearly half a million more shares in its sister company Cairn India.

While Canada prevents companies operating within its jurisdiction from drilling in order to preserve the Arctic environment, another company, partly owned by Canadians, is effectively doing what the Canadian-regulated companies can't.

And here is the conundrum. While Canada prevents companies operating within its jurisdiction from drilling in order to preserve the Arctic environment, another company, partly owned by Canadians, is effectively doing what the Canadian-regulated companies can't. Not only that, but the Canadian prohibition gives Cairn an advantage, giving it more experience and fewer competitors in the Arctic drilling specialty.

This is not a unique case. It happens in many free markets where there is no single authority in charge.

The same principle prevents boycotts from working. And it weakens the market clout of anyone who wants to try to use their purchasing power to make the world a better place. It's because market forces sweep in to counteract any action that you take.

It is why "sin stocks" are some of the most profitable. It is why your taking the bus does not decrease the traffic on city streets, and why burning less gasoline doesn't reduce the worldwide demand for oil.

Let's look at the examples one by one.

Traditionally, investors have avoided investing in stocks that seem unethical. Cigarette companies are the most unequivocal example. But arms manufacturers and companies doing business in unsavoury regimes have often noticed the same effect.

The fact that people don't want to buy a company's shares pushes the share price down. But lower share prices have only a weak effect on company profits. So those people who have fewer scruples make more money by investing in sin stocks. The higher profitability attracts investors, restoring the company's access to capital.

Repeated studies have shown that the main thing that limits road use is road congestion itself. If you build more highways, the relief is short-lived. New highways fill up until horrible traffic makes the cost of driving higher in cash, in time, or in frustration than the alternative. That means convincing people to take public transit does not decrease traffic congestion in crowded cities. No matter how many ethical people you convince to stuff themselves onto the bus, there is always someone ready to take their place once the roads become less congested.

Something similar applies when you decide to use less gas to prevent global warming. In free global markets, price is the main thing that limits energy use. So if you use less, your reduced demand for oil will send prices lower. But elsewhere in the world cheaper gas will encourage someone else to buy more.

In markets, if you create a gap, something will rush in to fill that gap if given the chance.

This does not mean markets are somehow evil. Markets are just one more force of nature, and nature is never simple.Nor does this does mean we should be discouraged.

It just means we should not fool ourselves into thinking we are successful when we are not. The traffic congestion case tells us that we must make public transit more convenient, or a lot cheaper, than driving, so that market forces make people want to switch. In the case of reducing global fossil fuel demand, the only long-term solution is to capture the damage of climate change in world prices until we can create technology that makes burning oil and coal the more expensive alternative.

Odds are, Cairn will not have a blowout. It is after 2014 when Canadian drilling is allowed to start that things are likely to go wrong. Once there are many wells, as in the Gulf of Mexico, eventually, almost inevitably, something unexpected will happen. An iceberg, a storm, an explosion, a piece of technology that fails.

International standards agreed to by everyone, including Greenland, will help in the short term. A moratorium would help more. That would require governments and voters everywhere to sign on. While the market favours more and more drilling to feed relentless consumer demand for oil, that will be hard.

The long-term answer is to create a market environment where the high cost of drilling in fragile ecosystems doesn't pay. We must find cheaper ways to satisfy our energy needs.For now, the creatures of Davis Strait and Lancaster Sound have their flippers crossed for luck.