20-year-old oil spill liability law creates "incentives for spills"

You can also find a version of this story at The Huffington Post here.

No one knows the economic damage the Gulf oil spill will inflict on fishing fleets and coastal communities -- most observers simply say it will cost "billions" of dollars, and today, President Obama only allowed that the economic consequences will be "substantial" and "ongoing."

But not as much for BP, thanks to a law passed in 1990 that will limit its liability for economic damages to a small fraction of the likely cost of the disaster.

The Oil Pollution Act of 1990, signed in the wake of the Exxon Valdez disaster, limits a firms' economic liability from an oil spill to $75 million -- a fixed number that hasn't been indexed for inflation.

Any costs above that are covered by the Oil Spill Liability Trust Fund -- funded by U.S. taxpayers -- which can spend up to $1 billion per incident for oil removal and damages.

And for a company like BP, $75 million is truly a drop in the bucket: In 2009, BP's daily profits average $93 million a day -- which means they could absorb the loss in 24 hours and still have $18 million to spare.

BP has said that it will waive the limits on its liability and pay whatever claims come their way, although there's nothing in the law that will compel them to do so. And as long as the law allows companies to carry out drilling projects but not face much economic risk in the case of an accident, critics say it gives a green light to risky behavior.

As economist Michael Greenstone of the Brookings Institution wrote last week, this broken system "creates incentives for spills":

[O]il companies make decisions about where to drill, and which safety equipment to use, based on benefit-cost analyses of the impact on their bottom line. For example, in choosing a location, oil companies assess whether the expected value of the oil exceeds the costs. [...]

So the [oil spill liability] cap inevitably distorts the way companies evaluate their risk. Locations where damages from a spill may be costly -- for example, places near coasts or in sensitive environmental areas -- seem more attractive for drilling with the cap than if firms actually were responsible for all damages.

The cap effectively subsidizes drilling in the very locations where the damages from spills would be the greatest.

Greenstone also notes that the cap reduces the incentive to use the safest equipment and drilling methods.

A bill introduced May 4 by Sen. Robert Menendez (D-NJ) to raise the liability cap to $10 billion has been blocked by Republicans and fiercely opposed by oil lobbyists, who argue it will increase the cost of oil (Greenstone says the impact on a global industry like oil would be "imperceptible"). Other Democrats have pushed to lift the liability cap entirely.

It's true, as the New York Times points out today, the law doesn't cap claims in state courts, and the limits don't apply if it's proven that federal safety regulations were violated by the company.

But in the multi-billion dollar deep water oil drilling industry -- which only took off in earnest in the mid-1990s -- the $75 million cap certainly looks quaint and anachronistic.

And for BP and other offshore oil giants, it would have a negligible impact on their bottom line -- quickly absorbed in less than a day's work.