Close window  |  View original article

Our Government-Regulated Oil Spill

Federal regulation and oversight has made the Gulf oil spill far worse.

By Will Offensicht  |  July 6, 2010

The oil business has become the latest industry that our government loves to hate.  It's no surprise that the New York Times would publish "As Oil Industry Fights a Tax, It Reaps Billions From Subsidies."  As we know from their past articles, the Times describes any income which any business or taxpayer is permitted to keep as a "subsidy."

When the Deepwater Horizon drilling platform set off the worst oil spill at sea in American history, it was flying the flag of the Marshall Islands. Registering there allowed the rig's owner to significantly reduce its American taxes...

At the same time, BP was reaping sizable tax benefits from leasing the rig. According to a letter sent in June to the Senate Finance Committee, the company used a tax break for the oil industry to write off 70 percent of the rent for Deepwater Horizon - a deduction of more than $225,000 a day since the lease began.

BP's plan, in all its conceptual simplicity, was to drill a hole in the ocean bottom in a place where they thought they'd find oil, pump up the oil, refine it into gasoline, and sell it to us at a profit.  They expected to pay taxes on whatever profit they made after deducting the costs of getting the gasoline to us.

The money BP paid to rent the Deepwater Horizon drilling platform was part of the cost of finding more oil.  Since that cost would be subtracted from eventual profits, if any, why on earth shouldn't it be written off?  What's newsworthy about a business writing off the costs of producing whatever it sells?

Why was BP permitted to write off only 70% of the costs?  Why not 100%?  If you are an oil company, renting and operating an oil-drilling rig is the very definition of a business expense.

The Times also waxes indignant that oil companies have managed to lobby their elected representatives so that oil extraction is taxed at a lower rate than most industries:

According to the most recent study by the Congressional Budget Office, released in 2005, capital investments like oil field leases and drilling equipment are taxed at an effective rate of 9 percent, significantly lower than the overall rate of 25 percent for businesses in general and lower than virtually any other industry.

The Times forgets, or won't admit, who pays whatever the government receives as "corporate" income taxes - the customers.  Drilling for oil is a risky business as the recent oil leak demonstrates.  The only way that investors are willing to take the risks involved in looking for oil is if they're permitted to make a profit selling the stuff.  Any taxes they have to pay get passed right on through to customers by boosting the price.

Anybody who drives in Canada finds out rapidly that gasoline costs a lot more in Canada than in the US.  Is it because Canadian oil companies are so incompetent or so inefficient that their prices have to be higher?

No, it's because the Canadian government puts a high tax on gasoline, which boosts the price customers have to pay.  The oil companies don't pay this tax, their customers pay the tax.

The Times is probably afraid that American gasoline is so cheap that we Americans are going to foul the planet by driving too much.  This position is OK for a New Yorker who probably doesn't need a car to get to work, but it won't work for the rest of us out in the hinterlands.

The Costs of Regulation

The Times doesn't want to point out that the oil business is one of the most heavily regulated industries around.  Government influence is so pervasive that the Times reports that "the oil and natural gas industry has spent $340 million on lobbyists since 2008."  Being sensible businessmen, the oil firms wouldn't be spending that kind of money on lobbying unless they needed to protect themselves from government attack - though we can't help but wonder if they've been getting their money's worth of late.  Perhaps it might have better been invested in, say, the McCain campaign?

The Wall Street Journal was a bit more forthcoming in describing the costs imposed on the industry by the government.  In "BP Relied on Faulty US Data," the WSJ reported:

BP PLC and other big oil companies based their plans for responding to a big oil spill in the Gulf of Mexico on U.S. government projections that gave very low odds of oil hitting shore, even in the case of a spill much larger than the current one.

Some years ago, the House and Senate passed a law requiring oil companies to use a government-supplied software model to determine how to prepare plans for reacting to a major oil spill.  The model, which hasn't been updated since 2004, predicted that it was extremely unlikely that oil would hit the shore even if the spill discharged a lot more oil than BP's leak has produced.

The government's optimistic forecasts reinforced the oil industry's confidence in its spill-prevention technology, leading to decisions that left both oil companies and the government ill-prepared for the disaster that has unfolded in the Gulf since April 20.  [emphasis added]

Although upper management may have lost touch with reality and believed the government data, people at the operating levels in the oil business have known that the models were defective for more than ten years:

The government's spill models have been at the center of years of debate among scientists that study oil spills. One study in the late 1990s used satellites to track almost 100 "drifters" set loose in the Gulf of Mexico to mimic floating oil. The paths of the drifting objects were compared with what the model predicted. After 30 days, the average discrepancy was 300 miles. "We have observed differences of some magnitude," a 2003 paper said, summarizing the study.  [emphasis added]

In other words, experiments with drifting targets showed more than 10 years ago that the models were off by 300 miles on average in predicting where floating oil spills would go.  The well which leaked was 48 miles from shore.  The average errors in the model were more than 6 times the distance from this particular well to the shore, but the scientists said the results "do not negate the utility" of the model.  That's no surprise - how could we expect the scientists to criticize the government agency that hired them?

The model wasn't negated until an actual spill showed how utterly worthless it was.  One of the reasons that BP's initial efforts to contain the spill were so ineffectual was that BP had been required by law to base its planning on the model despite its known deficiencies.  It would have been illegal for BP to have used a different method of estimating risk from an oil spill.

If you're wondering why our elected representatives stopped having hearings at which they could preen for the cameras by yelling at oil executives, it's because the boss at Exxon pointed out that much of his company's response plan "is prescribed by regulation, including the models that are used to project different scenarios for oil spills."  It would have been against the law for BP, Exxon, or any other oil company to take a more pessimistic approach to planning for an accident.

Our elected representatives lost their appetite for yelling at company presidents once that was pointed out on national TV, just as they lost their appetite for yelling at company presidents who said that Obamacare was going to cost a lot of money when they found out that Obamacare would indeed cost AT&T nearly a billion dollars its first year.

What's worse than the damage caused by bad modeling, people in the government knew that the models were no good for predicting the effects of spills in deep water and did nothing about it.  Back in 2000, the government agency which is responsible for the model notified oil producers that they planned to introduce new models, but these new regulations never came into effect.

That's no surprise - government regulations which tell how to test the tubes which measure how fast aircraft are flying haven't been updated since 1947.  Airplanes fly just a bit higher and faster than they did in 1947, so these regulations are about as relevant as, say, the oil spill models that failed so disastrously, but airlines are required to follow these inadequate regulations just as oil companies were required to follow inadequate spill models.

Safety Awards

Ironically enough, the Obama administration's inspectors awarded BP and its subcontractors many safety awards before the Deepwater Horizon blew up.  United Steelworkers International President Leo W. Gerard said:

BP, Massey Energy and Tesoro all have hauled out plaques celebrating safety achievements to deflect allegations of corporate recklessness in the aftermath of explosions in April that killed 47 of their workers.

Just last year, the federal Minerals Management Service (MMS) gave BP and Transocean, the owner of the Deepwater Horizon rig, Safety Awards for Excellence -SAFE awards. MMS bestows these on offshore oil and gas corporations for "outstanding safety and pollution prevention performance." Again this year, BP was a finalist for a SAFE award. After the Deepwater Horizon explosion, MMS postponed announcement of this year's winners.  [emphasis added]

The news media reported that several workers had protested unsafe conditions before the accident.  Suppose that's true.  Suppose that a worker somehow managed to get through to the big boss at BP and convince him to look into the matter.

The boss calls the platform manager and asks about the danger; the platform boss tells the BP boss about the government safety award and reads him the citation for "outstanding safety performance."  What does the boss do then?

Nothing!  He's skunked.  He's going to find it very difficult not to rely on the government inspectors who've been visiting his platform at such expense.

BP has been criticized for taking short cuts that saved money but were more risky.  Might it be barely possible that BP managers who weren't safety experts were swayed just a bit by their government-certified "outstanding safety performance" award when deciding whether to go fast or slowly, particularly when each additional day of drilling cost them $250,000 in platform rental alone?

Delaying the Cleanup

Having participated heavily in the events that led up to the leak, the government hasn't covered itself with glory in managing the cleanup, either.  In "Why is the Gulf Cleanup So Slow," the Wall Street Journal pointed out a number of ways in which the government has slowed the cleanup and increased the damage:

Get Out of the Way!

From first to last, our government's fingers are all over this mess.  Given that the government can't organize its data collection efforts well enough to keep bad guys off airplanes, how can we expect them to know enough about drilling for oil to make decent safety recommendations?

The market for people who can catch terrorists is limited, so an American who knows how to catch terrorists would probably rather work for Uncle Sam than for Uncle Osama.  There are many more opportunities in the oil business so anybody who knows how to find oil will be working for an oil company at a much better salary.

America is beginning to learn that when it comes to oil, those who can, do; those who can't, regulate.  Maybe America will finally figure out that the same thing is true for everything else - and remember that we've always been a nation of doers.