Congress was unable to pass an oil spill bill in response to the Macondo well blowout last year, and now policymakers are eager to return to the issue.
The largest outstanding issue is undoubtedly the oil spill liability or the secondary costs that stem from offshore oil and gas accidents. The law currently caps liability at $75 million, with up to an additional $1 billion available from the Oil Spill Liability Trust Fund paid for by a per-barrel tax on imported and domestic oil. Both Republicans and Democrats offered knee-jerk responses last year, either removing the cap or lifting it to another arbitrary number ($10 billion the most commonly floated), but neither idea fixes the problems with the current system. The liability structure in place does not sufficiently align risk and liability with individual behavior. It socializes risk by spreading the costs across the entire industry and does not inherently promote safe operations.
Since that time, a number of sensible ideas have been proposed both by Congress as well as members of the President’s oil spill commission report; however, no one tied these good ideas together to create a workable solution. If Congress properly fixes the broken liability system, we won’t need overregulation, drilling moratoriums, permitoriums, and other needless delays that prevent us from accessing our domestic energy supply. Independently, the ideas are good but incomplete.
In August, Heritage developed a plan that addressed these issues and ties them all together to create an integrated market-based system that will satisfy the concerns of all parties. It removes the artificially low cap and creates a framework that protects the taxpayer, promotes safety, and allows drilling to continue if it makes sense to do so. Below are the ideas proposed by Congress and the commission report and how we integrate them.
The Idea: Aligning Risk with Behavior. President Obama’s oil spill commission report was not without faults, especially its calls for more regulation and permitting delays (see here and here), but it did acknowledge gaps in the way we assess oil and gas activities off our coasts. Calling for a new assessment of risk, the report concludes that “the current system does not sufficiently align risk and liability with individual behavior. It socializes risk by spreading the costs across the entire industry and does not inherently promote safe operations.”
Implementation: Allow Private Risk Assessors to Determine Liability. Private risk assessors, not bureaucrats and politicians, should determine the liability associated with covered activities. These professionals maintain the specialized knowledge and expertise to accurately assess the risk of offshore oil and gas operations. They use many variables, such as safety records and depth and pressure of wells, to calculate their assessments. Private insurers can then use that information to determine the premiums required to insure against potential liabilities. Removing the process from government control would help to ensure more objectivity. Relying on professional risk assessors to determine liability removes the need for arbitrary, legislated liability caps.
The Idea: Create Categories of Liability with an Insurance Pool. Senator Mary Landrieu (D–LA) has taken an obvious interest in the issue of oil spill liability and plans to introduce legislation next week that would create categories of liability. Bloomberg reports that the “company responsible for the spill would pay as much as $250 million, and additional costs as high as $10 billion would be covered by a mutual insurance fund supported by companies in the Gulf. Damages exceeding $10 billion would be paid by the responsible party.”
Implementation: Tie Risk Assessment to the Insurance Pool. Congress should establish an insurance and claims process that fully assigns risk of offshore oil and gas operations to the responsible party and allows victims to be fully compensated while protecting companies from frivolous lawsuits. Without knowing the full details of Landrieu’s plans, her idea of a tiered liability system is a good one. We prefer that liability of up to $1 billion per accident (rather than $250 million), indexed for inflation, be the responsibility of the operator since the value of the equipment can quickly exceed Landrieu’s threshold. The insurance pool should be industry-funded and privately managed and have government oversight. In the event of a spill, it should immediately create an administrative process to manage claims and distribute funds. It should further establish an appeals process to ensure that all legitimate claims are met. Participation in a pool should be voluntary and entry into the pool should have the condition that a company must first undergo a safety evaluation by an independent organization (more below) to determine that it operates at acceptable safety levels, thus protecting existing fund participants against undue risk.
The Idea: Create an Independent Safety Organization. The oil spill commission report also recommends creating an industry-funded independent safety organization similar to the creation of the Institute for Nuclear Power Operators after Three Mile Island. This is a recommendation that would not only promote safety but help open the 85 percent of territorial waters that are off-limits to oil and gas exploration. 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.
Implementation: Tie the Independent Safety Organization to Insurance Premiums. Another critical role for the independent safety organization would be 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 commission report recognizes this as a possible solution saying, “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.” The independent safety organization could facilitate such a system through the creation of a safety rating system.
The ideas are all there, but separate from one another, they do no good. On the other hand, our comprehensive reform proposal integrates the ideas of risk assessment, insurance pools, and an independent safety organization and would seamlessly transition us to a system that removes the liability cap and ensures that companies will have the ability to go out and drill if they can prove they can handle the liability. It’s time for Congress to put the pieces together.