Incentives Matter: BP / Deepwater Horizon

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. [...] BP would have been more safety-conscious if it had been the owner of the Deepwater Horizon rather than its renter.
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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.
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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 deeper 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.1

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In a free market, where BP would bear full responsibility for damages caused by its operations, there might not be such a mess to deal with in the gulf. Additionally, private insurers for BP would not have allowed for such a shoddy inspection record on the safety of a very complicated and difficult operation. Drilling far out in the ocean waters would likely have been pursued in some form, but with the companies bearing all the risk — and certainly not being rewarded for taking economically unsound actions — there would have been far less activity in deep waters.2


  1. William Shughart – Some Pieces of the Deepwater Horizon Puzzle []
  2. Matthew J. Novak – Bashing BP (For Doing Exactly What Government Led Them to Do) []