Deepwater Drilling: Law, Policy, and Economics of Firm Organization and Safety

Abstract

Although the causes of the Deepwater Horizon spill are not yet conclusively identified, significant attention has focused on the safety-related policies and practices - often referred to as the safety culture - of BP and other firms involved in drilling the well. This paper defines and characterizes the economic and policy forces that affect safety culture and identifies reasons why those forces may or may not be adequate or effective from the public’s perspective. Two potential justifications for policy intervention are that: a) not all of the social costs of a spill may be internalized by a firm; and b) there may be principal-agency problems within the firm, which could be reduced by external monitoring. The paper discusses five policies that could increase safety culture and monitoring: liability, financial responsibility (a requirement that a firm’s assets exceed a threshold), government oversight, mandatory private insurance, and risk-based drilling fees. We find that although each policy has a positive effect on safety culture, there are important differences and interactions that must be considered. In particular, the latter three provide external monitoring. Furthermore, raising liability caps without mandating insurance or raising financial responsibility requirements could have a small effect on the safety culture of small firms that would declare bankruptcy in the event of a large spill. The paper concludes with policy recommendations for promoting stronger safety culture in offshore drilling; our preferred approach would be to set a liability cap for each well equal to the worst-case social costs of a spill, and to require insurance up to the cap.

Keywords: Deepwater Horizon, BP Oil Spill, Safety Culture, Government Policy, Liability Caps, Financial Responsibility, Insurance