Deterring and Compensating Oil Spill Catastrophes: The Need for Strict and Two-Tier Liability

Abstract

The BP Deepwater Horizon oil spill highlighted the glaring weakness in the current liability and regulatory regime for oil spills and for environmental catastrophes more broadly. This article proposes a new liability structure for deep sea oil drilling and for catastrophic risks generally. It delineates a two-tier system of liability. The first tier would impose strict liability up to the firm’s financial resources plus insurance coverage. The second tier would be an annual tax equal to the expected costs in the coming year beyond this damages amount. A single firm will be identified as responsible for generating the risk. It would be required to demonstrate substantial ability to pay in the first tier before being permitted to engage in the risky activity. This structure provides for efficient deterrence for environmental catastrophes, since the responsible party is bearing in expectation the risks it is imposing. It also addresses the challenges posed by the fat-tailed distributions of catastrophic environmental risks and provides for more assured and adequate compensation of potential losses than current liability and regulatory arrangements.

Keywords: BP Deepwater Horizon, oil spills, liability, catastrophic risk, environment, fat-tailed distributions

JEL Classification: K32, G22, Q3, Q4