Some Pieces of the Deepwater Horizon Puzzle

Disasters have many fathers. The tragic explosion at BP’s well in the Gulf of Mexico, which killed 11 members of the Deepwater Horizon’s crew and continues to cause unprecedented economic and environmental damage from the oil “spill” that began more than two months ago, is no exception.

President Obama and many others have been quick to point the finger of blame at BP as well as to ineffective oversight by the Interior Department’s Minerals Management Service, some of whose staffers reportedly have been in bed (literally) with executives in charge of BP’s offshore drilling operations.

BP surely is culpable. The company’s penchant for cutting corners when it comes to managing risk has been an open secret among oil industry insiders for many years. BP has “the worst safety record of any oil company”, as written by Tim Dickinson recently in Rolling Stone.

However, several factors contributing to the accident on April 20 either have been downplayed or ignored in the rush to judgment.

First and foremost, BP did not own the Deepwater Horizon, now at the bottom of the sea, but instead leased it from a company called Transocean for purposes of exploratory drilling in the Mississippi Trench. The contractual relationship between Transocean and BP created a classic principal-agent problem in which the duties and responsibilities of lessor and lessee undoubtedly were not spelled out fully, especially with respect to maintenance and testing of the rig’s blowout preventer as well as to the advisability of installing a second “blind sheer ram”, which may have been able to plug the well after the first (and only one then in service) failed to do so. Incentives matter. BP would have been more safety-conscious if it had been the owner of the Deepwater Horizon rather than its renter.

Transocean and BP now are at loggerheads. Lots of lawyers will get rich in the process of determining the extent to which BP and Transocean were negligent.

Second, federal law limits liability for damages caused by offshore oil spills to $75 million. Although that limit can be waived in cases of proven gross negligence (and it in all likelihood will be waived in the event at hand), such a limit on liability would have led BP to be less cautious before the fact than if it would have been if it expected to pay accident-related damages in full.

As an aside, the criminal law allows judges to impose monetary fines, prison sentences or both on guilty parties. That is because poor criminals may not be able to pay the fine the law stipulates, and because rich criminals may easily do so. Incarceration therefore sometimes is necessary optimally to deter criminal activity. Tony Hayward, BP’s CEO, will walk away from his job with no criminal liability and a very generous pension. If before the fact he had been exposed to fines against himself personally, the prospect of spending time behind bars or both, he certainly would have been more engaged with the activities at his company’s wells than he admitted to before a congressional panel.

Third, according to the Wall Street Journal, BP may have been misled in calculating its exposure to risk by models produced by the MMS that predict the trajectories of crude oil released by oil spills in the Gulf of Mexico. Those models apparently have not been updated since 2004 and have never considered scenarios in which blowouts happened in ultra-deep waters, which heretofore the MMS and the industry considered to be low-probability events. After all, the last accident of any consequence at an offshore oil well in U.S. waters was off the coast of Santa Barbara, California, in 1969.

Fourth, BP and other oil companies have been forced to drill in ultra-deep waters as a result of rules that limit access to proven oil reserves in shallower waters and on federally owned properties within the continental United States. No major oils spills have occurred on dry land or in waters shallower than 500 feet.

Last, the federal government’s response to the catastrophe in the Gulf has been as muddled, inept and counterproductive as was its response to Hurricane Katrina. Indeed, President Obama has been more derelict than his predecessor insofar as he has failed to waive the provisions of the Merchant Marine Act of 1920 (the so-called Jones Act), which prevents the United States from accepting expert help from foreign nations because their vessels do not fly the American flag and are not crewed by American citizens.

Transocean, BP and federal regulators jointly are responsible for the disaster at the Deepwater Horizon. But, Americans should not jump to the conclusion that the best way of preventing future catastrophes at offshore wells is to adopt more stringent regulations.

More regulation will not work any better than it has in the past. Getting the incentives right and exploiting proven oil reserves onshore and in shallow waters offshore will.

William F. Shughart II is Research Fellow and Senior Fellow at the Independent Institute, the J. Fish Smith Professor in Public Choice at Utah State University, past President of the Southern Economic Association, and editor of the Independent book, Taxing Choice: The Predatory Politics of Fiscal Discrimination.
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