Deepwater Horizon Incident, Economic Damages, and Evaluating Risk

Richard H. Thaler, in his "Economic View" column in Sunday's New York Times Business section, responds to the question: "How to make companies more accountable for their risks?"

Related to economic damages, Thaler comments:

In thinking about governmental reform, one place to start is the 1990 Oil Pollution Act, enacted after the Exxon Valdez accident. The law fines companies $1,000 for every barrel spilled, $3,000 if they were found negligent, and holds them responsible for the costs of cleanup. They are also responsible for economic damages, like those to fisheries, but these costs are capped at $75 million unless there is negligence or a violation of safety rules.

We could raise the cap on damages, as some have suggested, but the uncapped removal costs will typically exceed economic damages, and there is a real concern about whether companies will have the ability to pay. A policy with some appeal might make drilling rights include a mandatory insurance policy with a big deductible, say $100 million, and a cap somewhere in the billions. In an ideal world, this would influence insurance companies to monitor risks closely. (But the recent experience with the American International Group reminds us that we do not live in an ideal world.)

Furthermore, this economic solution assumes that companies make good decisions once they’re given correct incentives. But the financial and oil crises should make us less confident that companies are up to the task. Mr. Hayward has acknowledged that it was “an entirely fair criticism” to say the company had not been fully prepared for a deepwater oil leak. “What is undoubtedly true,” he said, “is that we did not have the tools you would want in your tool kit.”

The spill has reduced BP’s market value by 44 percent, or about $82 billion, so it’s clear that BP had a strong economic incentive to make good contingency plans. How to require sufficient contingency planning should be a high priority in the future, along with ensuring that the Minerals Management Service has the expertise to evaluate those plans. As a Coast Guard inspector said at a Congressional hearing last month, “The pace of technology has definitely outrun the regulations.”

We are left in a difficult place. Neither the private nor the public sector seems up to handling these kinds of problems. And we can’t simply wait for the next disaster, because, as people might say if they had to use G-rated language, stuff happens.

In Tuesday's New York Times, a "News Analysis" by Jad Mouawad and Clifford Krauss reviews the current thinking on the scale of economic damages related to the Deepwater Horizon Incident:

“Our asset base is strong and valuable,” BP said in a statement last week, adding that it had “significant capacity and flexibility in dealing with the cost of responding to the incident, the environmental remediation and the payment of legitimate claims.”

With each passing day, however, the bills keep growing. If the spill were somehow stopped today, the cost to BP could be as little as $9.6 billion, according to Kevin Book, an analyst at Clear View Energy Partners. If the spill were to stop in July, 90 days after the accident, it would cost as much as $29.2 billion, he said.

BP projects that it will not be able to completely stop the spill until August, when it hopes to complete the drilling of a relief well to kill the leaking one.

Fadel Gheit, a senior oil and gas company analyst at Oppenheimer, estimates that BP will eventually face $20 billion in claims and cleanup costs. Punitive damages to the federal and state governments could double that figure. Mr. Gheit said the maximum cost could be as much as $60 billion, paid over many years.

Costs include payments for lost tourism and commercial fishing revenue in the four states most affected by the spill — Alabama, Florida, Louisiana and Mississippi.

Damages related to tourism are potentially enormous if the spill spreads beyond the Florida Panhandle and spoils beaches across that state’s coasts. Nearly 5 percent of Florida’s 19 million residents work in the tourism industry, according to tourism officials, and the nearly 80 million visitors a year bring the state an estimated $60 billion in revenue.

An analysis by the Institute for Economic Competitiveness at the University of Central Florida estimated as a worst case that the spill could cost the state $10.9 billion in lost economic activity and 195,000 jobs. Hotel owners in the beachside city of Pensacola have already projected revenue losses for June of as much as 60 percent.

Finally, in the New York Times "Reuters BreakingViews" section, Christopher Hughes sets forth some reasons why BP might not agree to set setting up and funding an escrow account to cover the increasing claims (including economic damages) related to the Incident.

President Obama may speak to the issues of economic damages during his address from the Oval Office tonight.