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The BP Disaster: Still, a Very Public Problem

June 1st, 2010 . by economistmom

bp-stock-drop-cnn-money-060110

Hard to believe it’s been almost a month since I first wrote about the BP oil spill–which I noted at the time was more appropriately considered an “explosion” and not just a “spill.”  (Actually, an “unstoppable gusher” is a still better description, as we’ve since learned.)

I wrote at the time that the temptation would be to say it’s all BP’s fault and just punish and fine the hell out of BP until we’ve squeezed every last dollar out of them.  We would get very angry and shout that BP got us into this mess, so BP would have to fix it.  I said then that taking such a position might be emotionally accommodating (it’s always someone else’s fault, not our own), but it wouldn’t be very smart from a public policy perspective.  I made the argument that if government has a goal of “maximizing social welfare,” the best policy response would be to recognize this as a classic “negative externality” situation and use the best policy tool we have to address it–some sort of tax or charge on fossil fuels–explaining it this way (emphasis added):

The right policy needs to indeed spread the burden of the costs of cleaning up the oil spill to all participants in the oil marketplace, including those of us who innocently just fill up our tanks with gasoline.  Only when the extra social costs of the environmental risks associated with both fossil fuel production (e.g., risk of offshore drilling mishaps) and fossil fuel consumption (e.g., global warming, pollution) are incorporated into the prices all of us face in the fossil fuel markets we participate in, will we be led to make the correct, or at least better, decisions from a social welfare standpoint, not just from our own selfish standpoints.  These better decisions include the oil companies using safer production methods (which likely means producing less offshore), and consumers buying less gasoline.

But what I neglected to consider is that a tax or charge on fossil fuels in general would not really get at putting a price on the extra social costs associated with the risky offshore drilling methods.  A carbon tax would be able to price the external costs associated with global warming (a cost that quite appropriately should be designed to hit both consumers and producers), but would not put an extra marginal cost on riskier versus safer ways of producing (or more specifically, extracting) oil.   That additional social cost needs to be imposed on the producers making the decisions about how to produce the oil, or else the incentives to produce using safer methods (especially if they are more expensive than dangerous methods) won’t be there.

So, I want to make an addendum to the post from almost a month ago.  I stick by my position that this is a very public problem in need of a very public (policy not just relations) solution.  But imposing higher prices on fossil fuels in general, to correct for the global-warming-type environmental costs, is not enough.  To get this right, we need to somehow price the expected marginal external costs of offshore oil production as well, if we determine that that production method in particular indeed imposes social costs that exceed private costs.  The lump-sum punitive fine on BP imposed after the incident (as well as what has just happened to BP stock prices, pictured above) may have a deterrent effect on other oil companies who engage in offshore drilling, but it’s not an offshore drilling policy.  If the government’s response is just an ex-post fine on BP alone, going forward, oil companies in general will still have the incentive to produce at least expected private cost regardless of potential external social costs associated with potential (but still low-probability) accidents.

It seems to me that in our negligence regarding public policy toward the oil and gas industry, we have greatly underpriced the cost of fossil fuels produced from offshore drilling methods for two reasons:  (i) for the potential social costs associated with the global warming caused by the consumption and use of fossil fuels in general, and (ii) for the expected environmental costs associated with offshore oil and gas production in particular.   The first problem would be solved by turning to a carbon tax or charge, but the second requires another tax or fee that would be charged to any oil company who engages in offshore drilling based perhaps on the quantity of oil they produce offshore or wells drilled or whatever is best correlated with the imposed social risks.  The revenue from these latter fees/taxes could go into some sort of trust fund designed to cover the (large) costs of cleaning up (low-probability) accidents.  This sounds a lot like an insurance policy, doesn’t it?  But it’s like a social insurance program, because these are social costs and a very public problem.

What I describe above is a public policy approach that relies on creating the right market incentives, correcting how the price system allocates resources in the case of a “market failure.”  The alternative or additional public policy tool is regulation.  It may be the case that we need both better prices and more “command and control” requiring safer production methods.

I don’t know much at all about the Superfund program, but it strikes me that there may be some similarities there in terms of the “insurance” quality of the system I describe.  As explained by the Tax Policy Center, Superfund taxes that went into the Superfund fund expired in 1995, but the Obama Administration’s budget proposes to reinstate them.  I’d love to hear from any of you who know more about Superfund regarding any public policy lessons there for the current mess we’re in with this BP disaster.

3 Responses to “The BP Disaster: Still, a Very Public Problem”

  1. comment number 1 by: VAT Brat

    Diane,

    Ronald Coase won a Nobel Prize regarding the problem of social costs. The fallacy of your proposal is that we don’t know if national income would be optimized by imposing costs on the oil companies instead of imposing costs on the fishermen and vacationers who suffer from the oil slick.

    The classic example of the homeowners surrounding an airport is easier to demonstrate. Should airlines pay compensation to surrounding homeowners or is it better for homeowners to install noise dampening improvements to their homes? Or should there be a combination of noise abatement in the jet engines with noise abatement by the homeowners?

    The most economically “efficient” solution may not be “just,” yet Pigouvian taxes of the type you recommend usually start with the presupposition that a victim suffering costs needs compensation. You forget about the “victims” who suffer higher oil prices as a result of your proposal.

    From a perspective of maximizing national income, it’s probably better to stick the homeowners with the problem, even if it may seem unjust. Likewise, it may make sense to let the fishermen and the vacationers bear the brunt of this cost. The “efficient” solution probably lies in the middle somewhere.

    Is it safer and less expensive to import oil from the Middle East? Add in all the costs of our overseas bases and naval deployments, and I’d argue that this oil gusher is a drop in the proverbial bucket.

    Another problem is that these disasters are Black Swans. It’s not like we can create actuarial tables and make scientifically sound predictions for accurate social cost pricing. These disasters are custom made for deep-pocket, federal remediation on an immediate basis and later using the tort system for retrieiving actual damages after an accounting can be performed.

    Besides, if a tax were imposed and collected by the federal government, it would be used for ongoing operations, not saved in some superfund. In theory, it might sound great, but in practice the money would not be there to compensate the damaged parties.

    The real solution is the expansion of nuclear power. It would lessen our need for foreign entanglements and lessen our carbon footprint by significant orders of magnitude. But that’s for another post.

  2. comment number 2 by: rjs

    the real problem is that there just aint much “safe & easy” oil left…

    …to simplify, the “easy oil” such as we were extracting in the 30s, cost about 1 energy input for each 90 energy outputs…most new oil today, such as deep ocean well drilling, cost us 1/3 of the expected output in energy inputs, not even including the risks of such a disater…that is complicated by the fact that some of the largest other sources of oil, such as the alberta tar sands or the bakken shale, for example, take large quantities of fresh water to extract, which is left polluted after the fact; the tar sands are an environmental disaster and if bakken is to be viable, water will need to to trucked from the missouri river system…

  3. comment number 3 by: rjs

    95 Californias or 74 Texases to replace offshore oil

    http://www.energybulletin.net/node/52965