The Gulf Oil Leak—Posner

British Petroleum’s drilling accident in the Gulf of Mexico this past April is the latest of several recent disastrous events for which the country, or the world, was unprepared. Setting aside terrorist attacks, where the element of surprise is part of the plan, that still leaves the Indian Ocean tsunami of 2004, Hurricane Katrina in 2005, the global economic crisis that began in 2008 (and has been aggravated by Greece's recent financial collapse), and the earthquake in Haiti last year.

The reaction to the latest accident has been surprising. Oil spills and underwater drilling accidents are common, and despite the media hype it is too soon to tell whether this one will prove to be the biggest yet. The amount of oil leaked so far is substantially less than the amount spilled or leaked in previous accidents, including at least one in the Gulf of Mexico.

It is also surprising that so much criticism has been directed at the Obama Administration, and indeed against Obama personally. Most of the criticism is absurd—his failure to react emotionally, and his inability to “just plug the hole,” are not personal or professional failings. The Minerals Management Service in the Department of Interior does seem to have been asleep at the switch, but Obama unlike his immediate predecessor cannot be criticized as being hostile to regulation—if anything, he has too much faith in it. MMS is a small and obscure agency far below the horizon of a president’s supervision. No president can eliminate all pockets of incompetence in the vast federal government.

It is possible that the number of recent disasters has created a public sense that something is wrong with government: that it ought to be able to prevent all disasters. But this is an unrealistic expectation. Everything conspires against a government’s being able to protect its people against disasters, whether natural or man-made. A factor that retards prevention of man-made disasters is the rapid and relentless advance of technology. Regulation lags innovation. The Federal Reserve, Treasury Department, and SEC were no more able to keep abreast of advances in financial engineering than MMS was to keep abreast of advances in drilling for oil at very great depths under water. Slack regulation encourages private companies to adopt a high-risk business model. Risk and return tend to be positively correlated, in finance because risky loans command higher interest rates and in underwater drilling because risk abatement is costly. Business is particularly reluctant to take preventive measures against unlikely disasters because they do not pose a serious near-term threat. If there is a 1 percent annual probability of a disastrous drilling accident or financial collapse, the probability that the disaster will occur any time in the next 10 years is only 10 percent. Business managers have finite planning horizons just like politicians.

Of course, if the consequences of a disaster would be very grave, the fact that the risk is low is not a good reason to ignore it. But there is a natural tendency to postpone taking costly preventive action against dangers that are only likely to occur at some uncertain point in the future (“sufficient unto the day is the evil thereof,” as the Bible says), especially if prevention is expensive, if the probability and often the consequences of disaster cannot be estimated with any confidence, if remediation after the fact seems like a feasible alternative to preventing disaster in the first place—and because there is so much else to do in the here and now than worry about remote eventualities. The overcautious business will lose profits, investors, and staff to its bolder competitors; the overcautious regulator will be harassed by politicians pressured by business, labor, and other interest groups.

All the factors that I’ve identified came together to enable the economic crisis, despite abundant warnings from reputable sources, including economists and financial journalists. Risky financial practices were highly profitable, and giving them up would have been costly to financial firms and their executives and shareholders. The Federal Reserve and most academic economists believed incorrectly that in the event of a crash, remedial measures—such as cutting interest rates—would suffice to jump-start the economy. Meanwhile, depending on how they were compensated, many financial executives had a limited horizon; they were not worried about a collapse years down the road because they expected to be securely wealthy by then. Similarly, elected officials have short time horizons for policy; with the risk of a financial collapse believed to be low, and therefore a meltdown unlikely in the immediate future, they had little incentive to push for costly preventive measures, and this in turn discouraged the appointed officials of the Federal Reserve and other regulatory agencies from taking such measures. Finally, with no reliable probability estimate of a financial collapse available, it seemed prudent to wait and see, hoping that with the passage of time at least some of the uncertainty about risks to the economy would dissipate.

The BP oil leak reveals a similar pattern, though not an identical one. One difference is that the companies involved must have known that in the event of an accident on a deepwater rig prompt and effective remedies for an oil leak would be unlikely—meaning that there was no reliable alternative to preventing an accident. But the risk of such an accident could not be quantified, and it was believed to be low because there hadn't been many serious accidents involved in deepwater drilling. (No one knew how low; the claim by BP chief executive Tony Hayward that the chance of such an accident was "one in a million" was simply a shorthand way of saying that the company assumed the risk was very small.)

But other causal factors were similar in the leak and the financial crisis. If deepwater oil drilling had been forbidden or greatly curtailed, the sacrifice of corporate profits and of consumer welfare (which is dependent on low gasoline prices) would have been great. Elected representatives did not want to shut down deepwater drilling over an uncertain risk of a disastrous spill, and this reluctance doubtless influenced the response (or lack of it) of the civil servants who do the regulating.

The horizon of the private actors was foreshortened as well. Stockholders often don't worry about the risks taken by the firms in which they invest, because by holding a diversified portfolio of stocks and other financial assets an investor can largely insulate himself from risks taken by any particular firm. Managers worry more about the fate of their company because they often are heavily invested in it terms both of human capital and of reputation. But they rarely are held personally liable for the debts of the firms they oversee and, more important, the danger to their own livelihood posed by seemingly small risks is not enough to discourage risk-taking.

Two final problems illuminate the nation’s vulnerability to disasters. First, it is very hard for anyone to get credit for preventing a low-probability disaster. Because such a disaster was unlikely to occur, the benefits of taking action beforehand could not be assessed unless the preventive action took the form of a dramatic last-minute save. Had the Federal Reserve raised interest rates in the early 2000s rather than lowering them, it might have averted the financial collapse in 2008 and the ensuing global economic crisis. But we wouldn't have known that. All that people would have seen was a recession brought on by high interest rates. Officials bear the political costs of preventive measures but do not usually reap the rewards.

The second problem is that there are so many risks of disaster that they can't all be addressed without bankrupting the world many times over. In fact, they can’t even be anticipated. In my 2004 book Catastrophe: Risk and Response, I discussed a number of disaster possibilities. Yet I did not consider volcanic eruptions, earthquakes, or financial bubbles, simply because none of those seemed likely to precipitate catastrophes.

It would be nice to be able to draw up a complete list of disaster possibilities, rank them by expected cost, decide how much we want to spend on preventing each one, and proceed down the list until the total cost of prevention equals the total expected cost averted. But that isn't feasible. Many of the probabilities are unknown. The consequences are unknown. The costs of prevention and remediation are unknown. And anyway, governments won't focus on remote possibilities, however ominous in expected-cost terms. A politician who proposed a campaign of preventing asteroid collisions with Earth, for example, would be ridiculed and probably voted out of office.

 

Comments

[David Hardman]

An interesting article, but your opening sentence has perpetuated the widespread inaccuracy about the ownership of BP (also wrongly given by President Obama). BP is not a British corporation, nor has it stood for "British Petroleum" since the merger with Amoco over 10 years ago. As there are quite a few Americans writing on the Internet about how the US should be "kicking the British out of the Gulf", or words to that effect, it would be helpful if influential commentators could get this detail correct. BP is a multinational corporation with large British and American holdings; indeed, British share ownership in BP is barely more than that by US investors, and according to the following web page there are more American employees than British: http://hubpages.com/hub/British-Petroleum-Ownership-Who-Owns-BP

[Brian Davis, Austin, TX]

Obama's finest moment as President may turn out to be the $20 Bil bearhug he put on Tony Hayward. If it keeps BP from going bankrupt it SHOULD be enough money for Mr. Feinberg to do his job. I don't know who could be disappointed except some trial lawyers who were angling to cash in on the misery. And I love lawyers, been one all my life. But if I were a Parish courthouse judge in Louisiana I'd be hard-pressed not to ask, "Haven't you been to see Mr. Feinberg? Why not?"

The industry WILL drill deepwater again. The resource is down there to be captured, marketed, and deployed to improve people's lives. It was common knowledge before the blowout on Deepwater Horizon that BP was cutting corners NO other Big Oil (the U.S. majors, Shell, and Total) was willing to risk. If nothing else, there's too much money riding on safe and successful exploration and completion to be penny-wise, pound-stupid. We lost two Space Shuttles but we're still exploring outer space, indeed, transitioning to privately-led efforts. The Macondo 252 wild well is a greater tragedy but we'll get past it. Ironically enough, the Gulf Coast people most immediately impacted AREN'T saying give it up. That'd be unforgivably dumb. Just get it right.

[NEH]

Once again the Media has shown itself incompetent when it is required to cover News Events that entail highly scientific, engineering, environmental and technical issues and explanations. With that said and done, let's move on to the issue at hand.

As for the company name, B.P., no longer stands for Brit.Pet., but a more modern vision of the Energy Industry, "Beyond Petroleum" (ahh, the Marketers at work). Now let's move on to the Deep Water Horizon Well blowout. Well Blowouts have been a common and regular occurence within the industry since the first well was drilled in Titusville Pa. and the opening of oil fields in Tx. at Spindle Top. hence the rise and development and rise of such contract firms such as Red Adair and Boots & Coots whose specialty has been extinguishing well fires and blow outs. Any one remember the first Gulf War when Saddam blew up Iraq's oil wells in order to blind U.S. and Nato spy satellites? So, Natural Gas and Crude releases on a massive scale have been an ongoing occurence.

So what does the Industry do to mitigate such accidents and potential disasters? It utilizes such techniques known as "Risk Assesment & Risk Management" As all industries do who are involved in dangerous and hazardous operations. Better known as International Standards Organization Guide 73. As for the principles of risk management it should:

1. Identify, characterize and asses threats and events
2. asses the vulnerability of critical assets to specific threats
3. determine the risks and expected consequences of potential events
4. identify ways to reduce those risks
5. prioritize risk reduction measures based on a strategy

This blowout and sinking of the well platform and the following problems with shutting down the well was and is a catastrohic failure beyond all known experince and operations of such technology and for answers we will all have to wait for the "Root cause Analysis" of the event and the "Risk Assesments" and "Risk Management" Programs will have to be modified. Such is the Administration's current approach to the problem. Perhaps then we can mitigate some of consequences of such disastorous events from occuring again. That is, until the next unforseen catastrophic failure occurs.

Remember, Science, Engineering and Technology is not benign.

[Brian]

Most people, unless they are Obama haters, do not blame him for not preventing the leak. Instead, it was the slow, confused, bureaucratic nightmare of the spill response that has caused people to blame the government.

Also, BP has long had a reputation for cutting corners on safety. When he took over from Lord Browne, Hayward proclaimed that safety was the number one priority, after the Texas refinery disaster.

However, actions speak louder than words. Pressure on managers to cut time and expenses rather than work safely showed that it was lip service to safety. As Judge Posner points out, it is very difficult to get people to take precautions for very low probability, but high impact events. It is hard to make the financial case for spending money on preventing such events.

That is what government regulation should be for. In this case, as in many others, we found that the regulator was co-opted by the industry. In the British Civil Service, it's known as "going native". It happened in our financial regulation, and it happened with the MMS.

[NEH]

I hate to say this, but there are some instances where if a job is done according to all of the environmental, safety and health requirements and all of the potential environmental, safety and health requirements, the job could never get done. It's called an Occupational Hazard and occurs in many Industries and Governmental Operations. Such as, Mining, Land and Sea Transport, Construction, Oil/Gas/Petrochemical Operations, Manufacturing, Military/Naval/Air Operations, etc., etc. Such is reality. The world cannot be made completely safe.

Most such jobs have "hazard pay" factored in and most workers are highly trained and knowledgeable in Health/Safety/Security/Environmental aspects of their jobs and are aware of the potential hazards. But you must remember, "Murphy Works Here" and "S*** Happens". This is tied up in the "Risk Analysis and Risk Management" Plans. But since they are created by humans (albeit highly skilled in their fields) errors and omissions can and will result. Resulting in bodily injury and death. Not too mention, damage and destruction to Equipment, Capital and the Environment.

Such is what the modern world is built on. It would certainly be nice if all hazards and risks could be eliminted, but such is not reality.

[Michael Young]

I would agree that Obama doesn't deserve the blame for the oil spill, even if he has recently invited people to view him as personally responsible for the response. (What was the "looking for some ass to kick" comment if not such an invitation?) Perhaps it is wrong or silly to demand that Presidents personally oversee disaster-preparedness and/or disaster response, but to the extent that Presidents accept or make such (silly) demands of themselves, they invite their own scorn when a response seems to be going badly. That makes it hard for me to feel too badly for scorn directed Obama's way, even if, strictly speaking, it may not be completely fair.

[Sandeep Bhalerao]

The risks here can be quantified, but nobody does that better as it is self-policing mainly on the behalf of an oil company. The same is true with a government who would collectively self-police itself.

The two dimensions of risks quantification are not enough per this article and in general used in many projects or firms. They are probability and impact. A third dimension of detectability needs to be taken into consideration.

3D-Risk = Probability x Impact x Detectability

The probability is high or close to 1 for such projects and especially with the history of 8000+ oil spills on behalf of BP. Secondly, the impact is high to them and to the world. The detectability is usage of incident reporting and monitoring techniques such as radar imaging.
http://blog.skytruth.org/2010/06/bp-gulf-oil-spill-asar-image-june-22.html

This 3 dimensional risk applies to any firm too. The financial crisis did not go undetected. It was ignored.

Probably a healthy balance of Private Public partnership is required here as well. BP should sell 10% of their 300B equity to governments where they have offices and share the profits for government coffers instead of making this an advertisement budget which goes to the media.

With due respect,
Sandeep Bhalerao
Booth 2008

[Bedd Gelert]

"A politician who proposed a campaign of preventing asteroid collisions with Earth, for example, would be ridiculed and probably voted out of office."

How dare you suggest such a thing !!!

http://www.guardian.co.uk/politics/2010/jun/25/lembit-opik-london-mayor-candidate

http://blogs.telegraph.co.uk/news/robertcolvile/100043853/lembit-opik-the-saga-continues/

http://news.bbc.co.uk/1/hi/uk_politics/289733.stm

[NEH]

Bedd, The probability and odds of the Earth's Thermonuclear Core going critical and blowing the entire Planet to "Kingdom Come" is far higher than an asteroid ever hitting the planet. But no one ever seems to bring this little known fact up or suggests a fix. Every day we all sit on the edge of existence and cosmic annihilation. Where's Doctor Who when you need him? Off keeping the Daleks off our backs. ;)

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[speedplane]

"If there is a 1 percent annual probability of a disastrous drilling accident or financial collapse, the probability that the disaster will occur any time in the next 10 years is only 10 percent."

If the probability of a disaster within a given year is 1%, then there is really only a 9.56% chance of a disaster in ten years. 1 - (1-.01)^10. You can't just add them up. Oh probability.

[JLB]

The comments on the meaning of BP, while a side track, are interesting. It is true that the "BP" in BP PLC does not stand for British Petroleum, and it is also true that its shareholders are all over the globe, including large numbers in the U.S. It is taking the point too far, however, to say that it is “not a British corporation.” It is a British corporation. It is organized under laws of the United Kingdom -- unlike U.S. corporations which are organized under state law (Delaware is the most common -- BP has a Delaware-organized subsidiary: BP America, Inc.). Also, BP’s principal place of business is London, England. That's all it takes to be a British corporation.

[JLB]

This passage is baffling:

"The reaction to the latest accident has been surprising. Oil spills and underwater drilling accidents are common, and despite the media hype it is too soon to tell whether this one will prove to be the biggest yet. The amount of oil leaked so far is substantially less than the amount spilled or leaked in previous accidents, including at least one in the Gulf of Mexico."

Is the author seriously suggesting that the BP spill is legitimately categorized as among the many "common" "oil spills and underwater drilling accidents"? The rig blew up in a huge inferno that killed 11, injured others and burned for 36 hours before sinking 5,000 feet to the ocean floor. It then spewed oil in massive amounts for months while oil industry experts repeatedly demonstrated a shocking inability to stop the gusher. While it's true that the major news media generate an endless stream of moronic drivel, the extensive coverage of this situation is certainly appropriate. Also, the talk of remote possibilities and costs of prevention appear to be misplaced -- the investigation is uncovering reckless (perhaps criminal) misconduct in the operation of the rig. The possibility of a rig blowing up when safety procedures are skipped, corners are cut, and workers are not properly communicating is high (they are, after all, playing with oil and gas that is under 6,000 pounds per square inch of pressure).

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Treasury Department, and SEC were no more able to keep abreast of advances in financial engineering than MMS was to keep abreast of advances in drilling for oil at very great depths under water.

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Treasury Department, and SEC were no more able to keep abreast of advances in financial engineering than MMS was to keep abreast of advances in drilling for oil at very great depths under water. Slack regulation encourages private companies to adopt a high-risk business model. Risk and return tend to be positively correlated,

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