President Obama’s seven-person Oil Spill Commission released its long-awaited final report this morning and includes details on the “before, during and after” of the Macondo well explosion that occurred on April 20 last year. The commission’s site also has a “Recommendation for Decision Makers” section that has drawn much of the media attention. This post will largely draw from that section as well.
The bipartisan report predictably calls for tougher regulations and more government control with regard to offshore drilling and continually refers to systemic flaws of the oil and gas industry as a whole. But the reality is that oil and gas exploration and development operate safely for the most part; the offshore explosion was a rare and isolated incident. That’s not to say flaws do not exist in the current system or that improvements cannot be made. But tougher regulations for the sake of tougher regulations can make it unnecessarily difficult to access oil and gas off the 15 percent of America’s coasts where we’re allowed to drill.
The real value added of the commission’s report is the recognition of risk-based assessment for all individual offshore activities and operations. Using private risk assessment to address the low liability cap concern would go a long way in promoting safety, assigning full liability, protecting the taxpayer, and allowing offshore gas and oil exploration to continue.
The major recommendations of the report include:
- Significantly increasing the $75 million liability cap, although the report does not give a recommendation as to what that figure should be. The liability is the costs incurred by individuals, businesses, and communities that suffer as a result of the oil spill beyond direct cleanup costs. Liability costs above $75 million up to $1 billion are funded by the Oil Spill Liability Trust Fund (OSLTF). The OSLTF is financed by an 8-cent-per-barrel tax on imported and domestic oil. The commission recommends raising the $1 billion per incident limitation from the OSLTF.
- Calling for a new approach to risk assessment. The report says that regulators “should shift their focus from prescriptive regulation covering only the operator to a foundation of augmented prescriptive regulations, including those relating to well design and integrity, supplemented by a proactive, risk-based performance approach that is specific to individual facilities, operations, and environments. This would be similar to the ‘safety case’ approach that is used in the North Sea, which requires the operator and drilling rig owners to assess the risks associated with a specific operation, develop a coordinated plan to manage those risks, integrate all involved contractors in a safety management system, and take responsibility for developing and managing the risk management process.”
- Ensuring that the oil industry and the government have adequate response capability before any new drilling occurs in the Arctic. The report also recommends better industry and government preparedness to have up-to-date information to assess the damage of a potential spill as well as contain and clean up any future spill.
- Providing more resources for the Bureau of Ocean Energy Management, Regulation and Enforcement—the agency that oversees offshore drilling. The report also recommends including experts from National Oceanic and Atmospheric Administration and the Coast Guard in leasing decisions.
- Using most of the Clean Water Act penalties for the long-term restoration of the Gulf of Mexico.
- Creating an industry-funded independent safety organization similar to the creation of the Institute for Nuclear Power Operations after Three Mile Island.
Putting It Together
Congress should use the report’s assessment of risk-based management and apply it to fixing the broken liability regime. The current liability system distorts the ex ante risk of oil and gas operations in two fundamental ways:
- The artificially low cap of $75 million established 20 years ago does not fully or directly capture the risk of offshore operations; and
- Rather than placing responsibility with the responsible company, the OSLTF shifts responsibility to the entire industry and, ultimately, the federal government, thereby reducing the incentive for individual companies to operate safely. The report recognizes this and also notes that removing the liability cap completely could unnecessarily drive smaller, independent companies out of the marketplace.
As a solution, Congress should reform the OSLTF and remove the $75 million liability cap, replacing it with a new system that accurately assesses the risks of offshore oil and gas operations and appropriately assigns those risks to industry operators. Private risk assessors would determine liability-coverage requirements for specific activities, and federal regulators would certify that liability requirements are met. The means for meeting liability-coverage requirements would not be limited but could include self-insurance, insurance pools, dedicated assets, or private insurance policies. The federal government would create a private, tiered insurance framework and administrative process to manage claims. The central element of the insurance framework would be a private and voluntary pooled insurance fund for claims above $1 billion. The claims process would ensure that legitimate claims are paid fully and efficiently while protecting responsible parties from frivolous lawsuits. The report recognizes the desirability of such a system:
One option for keeping competent independents in the market is a mutual insurance pool. Under such an arrangement, individual companies engaged in offshore drilling would pay premiums into a pool, which would pay out damages caused by a company as a result of a spill. A possible downside is that the mutual pool could have the effect of undercutting incentives individual firms might otherwise have to improve safety practices—but this problem could be addressed, for example, by tying premium levels to the financial and safety risk posed by an individual company’s activities. This option would allow companies to demonstrate financial responsibility for the cost of spills, at least to the limit paid out by the pool.
This is where the independent, industry-established safety organization would come in. The organization would share safety standards and practices, including quality assurance and operating and management procedures, and it would conduct evaluations of such standards. For it to be successful, protecting proprietary information would be essential. Oil companies maintain their competitive advantage by investing significant resources into research and development. Without adequate protections of these investments, no company would participate in such a regime. One way that this information would be used is to create a safety rating system. Insurance companies could then choose to base their premiums in part on the rating. At a minimum, the rating system, which should be made public, should be used to determine the amount each company pays into the pooled insurance fund. Companies would then have a financial and public relations incentive to achieve the best rating and have better demonstrated preparedness and response capabilities.
The key to reform is fixing the liability cap. Congress should create a liability system that clearly identifies risks and allocates associated liabilities, ensures that those engaged in the industry can meet their potential liabilities, protects industry from frivolous lawsuits, and assures the public that both environmental and economic damages from an oil spill can be addressed in full. Congress and the Obama Administration should not use the spill as an excuse to over-regulate the industry to a point that it becomes nearly impossible to drill where we can and should be drilling. Fixing the liability system would allow the Administration to re-open all the areas off America’s coasts that are currently off limits.