Tuesday, May 4, 2010

Are oil companies rational actors?

There are some good pieces out on the economics of oil spills from Jonathan Chait and Ezra Klein, but the best of the bunch is by William Galston:
Second, the oil well now spewing large quantities of crude oil into the Gulf of Mexico lacked a remote-control acoustic shutoff switch used by rigs in Norway and Brazil as the last line of defense against underwater spills. There’s a story behind that. As the Journal reports, after a spill in 2000, the MMS issued a safety notice saying that such a back-up device is “an essential component of a deepwater drilling system.” The industry pushed back in 2001, citing alleged doubts about the capacity of this type of system to provide a reliable emergency backup. By 2003, government regulators decided that the matter needed more study after commissioning a report that offered another, more honest reason: “acoustic systems are not recommended because they tend to be very costly.” I guess that depends on what they’re compared to. The system costs about $500,000 per rig. BP is spending at least $5 million per day battling the spill, the well destroyed by the explosion is valued at $560 million, and estimated damages to fishing, tourism, and the environment already run into the billions.

There’s something else we know, something that suggests an explanation for this sequence of events. After the Bush administration took office, the MMS became a cesspool of corruption and conflicts of interest. In September 2008, Earl Devaney, Interior’s Inspector General, delivered a report to Secretary Dirk Kempthorne that has to be read to be believed. One section, headlined “A Culture of Ethical Failure,” documented the belief among numerous MMS staff that they were “exempt from the rules that govern all other employees of the Federal Government.” They adopted a “private sector approach to essentially everything they did.” This included “opting themselves out of the Ethics in Government Act.” On at least 135 occasions, they accepted gifts and gratuities from oil and gas companies with whom they worked. One of the employees even had a lucrative consulting arrangement with a firm doing business with the government. And in a laconic sentence that speaks volumes, the IG reported: “When confronted by our investigators, none of the employees involved displayed remorse.”

Was leaving out these shut off switches a rational decision? Between direct costs, lawsuits and PR, BP may take a ten figure hit here, but they spent a great deal of money and effort lobbying not to take a measure that, to the casual observer, would seem to have a positive expected value.

Is it possible that, even for huge corporations, the natural distaste for being told what to do is stronger than the desire to maximize utility?

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