Outdated Law Gives Oil Companies Incentives to Spill

Any costs above the $75 million are covered by the Oil Spill Liability Trust Fund.
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No one knows how much economic damage the Gulf oil spill will inflict on fishing fleets and coastal states: Most observers simply say it will cost "billions" of dollars, and this week President Obama only allowed that the economic consequences will be "substantial" and "ongoing."

But how much of that cost is BP on the hook for? Not much, thanks to a law passed in 1990 that will limit the oil giant's liability for economic damages to a small fraction of the actual economic cost of the disaster.

The Oil Pollution Act of 1990, signed in the wake of the Exxon Valdez oil spill, limits the economic liability a company is responsible for from an oil spill to $75 million -- a fixed number that hasn't risen with inflation over the last 20 years.

Any costs above the $75 million are covered by the Oil Spill Liability Trust Fund, funded by a few sources, but importantly, U.S. taxpayers, which can spend up to $1 billion per incident for oil removal and damages.

For a company like BP, $75 million is truly a drop in the bucket: In 2009, BP's daily profits averaged $93 million a day -- which means they could absorb their entire liability losses 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 compels them to do so. And critics say that as long as the law only threatens companies with a financial slap on the wrist, they have no reason to stop risky drilling activities.

In fact, 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.

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

There are some loopholes for those seeking to hold a company like BP liable: The $75 million cap doesn't apply to claims made in state courts, and the limits don't apply if it's proven that the company violated federal safety regulations.

But for today's 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 out of date.

And for BP and other offshore oil giants, it certainly won't do enough to their bottom line to convince them that protecting communities and the environment is a good investment.

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