Oil Liability

June 9, 2010

In the wake of the Deepwater Horizon spill, Senior Fellow Michael Greenstone looks at existing legislation that regulates drilling and urges the removal, or substantial increase, of the liability cap on economic damages. Testifying before the House Transportation and Infrastructure Committee, he says that current law provides economic incentives for spills rather than preventing them.


Equitable Market-Friendly Regulation

Lifting the liability cap would make the marketplace more equitable in two ways. The first is the most direct one – it would reduce the chances of future spills, and that would save us from the damages like what we are seeing in the aftermath of the Deepwater Horizon spill. The second is that lifting the liability cap is a market-friendly version of regulation. What do I mean by that? It does not involve the government dictating particular safety techniques [for companies to undertake], but rather it makes the oil companies a partner in figuring out the cheapest, least-cost way to reduce the probability, or reduce the chances, of oil spills.

Conflicting Objectives: Energy Security Goals and Environmental Goals

I think the uncomfortable truth when it comes to oil production is that our energy security goals and our environmental goals are in conflict with each other. Currently, while we are trying to achieve them with the liability cap, it is a ham-handed way to try to achieve these two goals that push in opposite directions. My own view is that the best way to satisfy both of our goals is to have an unlimited liability cap that would cause companies to focus on the environmental consequences of their drilling activities, and to accompany that with a set of complementary policies that focus on restraining domestic consumption and/or increasing domestic production.

Liability Cap Misconceptions

A common misconception is that a change in the liability cap would change the price that consumers pay for gasoline at the pump. The reason that that is a misconception is that there is a world market for petroleum, and the U.S. reserves are just a very small fraction of that. So, through the liability cap, if we slightly change the amount of oil that is produced in the U.S., it is almost impossible to imagine that it would have a perceptible impact on the world price of petroleum.

It is possible that [lifting the liability cap] would mean a loss of jobs in the oil exploration business. We don’t know the full extent of that. In order to gauge the full extent of that we would have to have data that the oil companies and insurance companies have not made public yet. It is also worth noting that the jobs that would be lost if we were to lift the liability cap would be the very jobs that are occurring at the sites where the risk from spills are quite large. Those are the jobs that are, effectively, being subsidized by the liability cap. So, from a social perspective, it is not clear that those are the types of jobs that we want to have. In addition, I think the Deepwater Horizon spill makes clear that drilling in risky places introduces job losses through a different channel, which is the spill is now lapping up on the shores of Louisiana, it is lapping up on the shores of Florida, you are seeing the tourism industry decline in those places, you are seeing fishing decline in those places, and a series of other related industries.