Santa Barbara County is the latest seaside community to watch its coastline dirtied by an all-too-recognizable black sludge. Early estimates project that more than 100,000 gallons of oil have spilled onto Refugio State Beach via a pipe that burst the morning of May 19. To address the spill, Gov. Jerry Brown has declared a state of emergency so that special state funds can be dedicated to the cleanup effort.
As regulators endeavor to discover the cause of the spill and plaintiffs line up to be made whole, it may surprise some that, no matter how much actual damage was caused by the spill, there’s a hard cap on the liability the responsible parties will face.
The oil spill liability cap traces its genesis to 1990’s U.S. Oil Pollution Act. That year, a $75 million cap was placed on the amount of economic damages that a company could be required to pay in the event of a spill. Cleanup costs and fines for breaking environmental laws may be levied on top of that amount. But compared to the true cost of oil spills, the cap represents a windfall for those responsible for oil pollution.
Liability caps may sometimes be necessary to preserve the viability of businesses that are risky but essential. But the $75 million cap on oil spills desperately needs to be raised. In February 2014, the Obama administration proposed to do just that. The Bureau of Ocean Energy Management sought to increase the cap to $134 million, to account for inflation since the cap was imposed a quarter-century ago. In December, the $134 million increase to the cap was approved through administrative procedures.
While an encouraging development, the cap on oil spill liability should be higher still, particularly in light of the amount of damage that spills repeatedly have been shown to cause. The most memorable spill of late, the Gulf of Mexico’s Deepwater Horizon spill in 2010, is estimated to have caused $8 billion worth of economic damage. Even the newly raised cap pales in comparison to that amount.
The commonly articulated rationale for increasing the cap, the need for remuneration after a spill, belies a more important reason – deterrence. Civil liability can act to discourage risky behavior. Would wells and pipelines be placed in anything but the safest locations were the cost of an accident borne by those responsible? The cap is, in a sense, a form of too-cheap societal insurance.
Liability caps are a form of subsidy. Like any other subsidy, they distort markets, in this case by signaling that the value of drilling is so great that society as a whole should be willing to take on the risk. The result of shifting the risk is moral hazard, since the firms responsible for oil spills can avoid carrying an otherwise appropriate amount of private insurance. When those firms do not properly account for the real risks they incur, they miss crucial price signals that would otherwise discourage such behavior.
Though it belies convention, there is a free-market solution to oil spills. Raise the oil spill liability cap, substantially, and allow private risk-transfer mechanisms to send the sort of price signals that will deter risky behavior. Failing that, the devastation in Santa Barbara will stand as yet another missed cautionary tale.
