Oil Spill Theory

My previous post on the spill lead to a little bit of thinking about oil spills. The current law is a bit strange, and I'm not sure I really understand it. It sounds like this law limits the damages that can be attained in Federal court to $75 million and that includes removal costs, damages to both public and private property and resources, lost tax revenue, and lost profits. According to this, there is still unlimited liability in state courts. Can the U.S. government sue a company in a state court? Can the state government? My guess would be that the local businesses can still sue in state court, but the taxpayers would get screwed under current law. If anybody knows more, please comment.

What I want to focus on is the Oil Spill Liability Trust Fund. Basically, a 5 cent per barrel tax on oil was created and put in a fund to clean up future oil spills. The fund can provide $1 billion dollars for oil spill cleanup. So, what the government basically created was an insurance fund paid for by oil consumers to clean up oil spills. It's still funded by taxpayers, but not by the income, rather, by their consumption of oil. So in a sense, it's a good thing. The people that benefit the post from off-shore drilling (whoever they are) are buying insurance for taxpayers as a whole. The problem is that with insurance the incentive to be diligent goes down. The driller is no longer paying the cost of the clean up. Of course, the response should be oversight. Unfortunately, the regulator of this was completely corrupted. I encourage everyone to check out Rachel Maddow document the extent of this corruption that I happened to catch at breakfast.

One response is that we need better regulators, and to the extent that is feasible, there is no doubt that would help. Unfortunately, a critique of that is that the nature of government is to get compromised by industry. Economists often call this "rent seeking." So what is another possible answer? Well, we could mandate firms buy a billion dollars of insurance. Then we don't need to worry about the government to be the oversight, we can work through the market. Let Warren Buffett (or whoever) collect premiums and audit safety as the insurer has an incentive not to make large payouts. This really just pushes the problem one stage back though, because now we have to regulate the insurer to make sure they can actually provide insurance. Otherwise, I'd be happy to sell the insurance to oil companies collecting revenues for doing nothing and declaring bankruptcy if the big spill came.

What I find interesting is that this is the exact same predicament that we are going through with the financial reform bill the Democrats proposed. Basically, we are insuring the banks against future bailouts by collecting a tax on banking. In this case, the fallout of financial failure is equivalent to an oil spill. It takes out a lot of industries just chillin in the surrounding waters. It's not clear which model is better. The first one has worked for a long time with the FDIC and member banks and deposit insurance. But it also looks really bad when the regulators look really bad. The second model works well on a small scale. I have to buy insurance for the benefit of other drivers I might hit with my car, but it's unclear if it scales all the way up. If payoffs are large and rare, collecting premiums with no intent to be able to payoff if the big one comes looks more and more appealing.