Archive for the ‘BP’ Tag

Holding BP Accountable (Hopefully): The Case to Remove Liability Limits

By William Schoell and Jeremy Koulish

One cannot turn on the news today and not get pelted with an overload of Deep Horizon oil leakage updates and BP slamming.  The president is consulting with experts so he knows whose ass to kick on this whole ordeal.  So when it’s time to settle up with BP, what laws are in place to allow our government to hold BP accountable and ensure taxpayers aren’t stuck with the bill? You likely have heard about the current $75 million cap on liability for damages.  So how did that cap get into place, is it justified, and what can be done to rectify the situation?  The House Transportation and Infrastructure Committee held a hearing to examine these issues on June 9th.

For starters, here’s a brief overview of the current law.  The Oil Pollution Act of 1990, or OPA90, was written in response to the Exxon Valdez Oil spill in 1989.  This bill requires the responsible company to pay all of the damages associated with cleanup and pay economic damages related to lost incomes of newly unemployed fishermen, decreased tourism and more.  The catch is that OPA90 has a liability limit for those economic damages of $75 million.  That amount is utterly dwarfed by estimates for the damages related to Deep Horizon ranging from a “modest” $1-$3 billion as quoted by Chairman James Oberstar (D-MN08) to more current projections of closer to $40 billion.  Clearly that $75 million cap will not do the trick when holding BP accountable on its promises to cover all costs related to the spill.  Aside from the cleanup responsibilities and responsibilities for economic damages (with the cap), the bill also has created an industry-financed $150 million trust fund for emergency spending.  Its purpose is to fund the Coast Guard to start containment and cleanup work before any company pays the government or starts working themselves.  Problem is, the Coast Guard is almost out of that money.

Some valuable ideas emerged from this hearing, although their fate remains unclear given the institutional obstacles in Congress.  A few possible actions the Congress could take are increasing the liability cap, removing the cap altogether, expanding the emergency trust fund and implementing tighter regulations on offshore drilling.  At the hearing, those supportive of action seemed content with expanding the emergency trust fund and raising the cap on liabilities, although there were differences over how much to raise the cap, how much to expand the trust fund and when to pay for it.  But seeing how most Americans want to see swift actions taken on this issue, these kinds of deals will most likely be worked out in the near future.  Indeed, Chairman Oberstar said he hopes to see a bill on the floor and passed before the 4th of July recess.

One of the hearing’s witnesses, MIT economics professor Dr. Michael Greenstone, set forth a concise argument for why there should be no cap at all on damages.  The main problem with capping damages is its moral hazard effect, in other words that it creates an incentive to ignore safety protocol and cut corners in order to save money.  This is because a company knowing of a cap will not care if damages exceed the cap’s value.  In this case, BP will not care if damages are $75.1 million or $75 billion; with the cap they are only responsible for $75 million.  Not only does BP not care, insurance companies will only insure them up to that $75 million because the insurance company knows quite well that $75 million is all BP would be responsible for.  So in effect a cap gives a company incentive to act with excessive risk because they know that they will only be responsible for the cap’s value.

One of the arguments against removing the caps (or even raising them) that served as the g0-to point for Republicans including Ranking Member John Mica (R-FL07), was the unintended consequence of small and medium sized businesses would not be able to afford insurance with raised caps or no caps at all.  If the cap were raised significantly, the argument goes, companies would have to be able to pay higher premiums on more coverage, driving out smaller companies with less money.

However, regardless of the issue that barriers to entry in the oil-drilling business are already extremely high for all but the largest conglomerates, another major  problem with this argument exists. As Robert P. Hartwig of the Insurance Information Institute and others pointed out, insurance companies generally price premiums based not on company size but rather on risk.  It does not matter to an insurer if your company is worth $500,000 or $20 billion, the riskier the behavior the more their premiums will be.  So as long any company, small or large, takes the right levels of safety precaution then no company should have a problem getting insurance.  Looking at the issue a slightly different way, an efficient market for oil-drilling operations would price the full costs of unforeseen events to society into the cost of doing business. Therefore, if a company cannot afford insurance in the absence of a liability cap, drilling on oil well is not an economically viable endeavor and therefore should not be undertaken. Thus, the argument favored by most Republicans seemed oddly out of step with their traditional embrace of free market principles.

In summary, removing liability caps actually creates proper incentives for companies and insurers to act safely.  As Dr. Greenstone mentioned, the goals of off shore drillers and the public are not in line, and a cap on liability only increases this effect.  Without a cap, companies will be forced to place their drills in the safest areas with proper safety regulations in order to get insurance and/or avoid paying damages.

Congressman Rush Holt (D-NJ12) has introduced a Big Oil Bailout Prevention Act that would retroactively increase the cap limit from $75 million to $10 billion. In the hearing, Rep. Holt said he did not close the door on removing all cap limits, but he did not include it in the bill. That bill is matched by a similar proposal in the Senate by Sen. Robert Menendez (D-NJ), which has been brought to the Senate floor only to be blocked multiple times, first by Sen. Lisa Murkowski (R-AK) and then by Sen. James Inhofe (R-OK).