Economist proposes creating a new regulatory regime for the offshore drilling industry.
In 2010, an oil rig in the Gulf of Mexico exploded, causing the death of eleven workers and the worst oil spill in the history of the petroleum industry. That a calamity of such magnitude could occur in an industry already subject to regulatory oversight surprised many observers and prompted tough questions about the efficacy of the regulations that failed to prevent it.
Professor Lori Bennear, a specialist in environmental economics at Duke University, argues that the so-called “command and control” regime, which dictates specific actions to regulated entities, is not be the best regulatory regime for offshore drilling. Instead, in a chapter in the new book Regulatory Breakdown, she suggests that adopting “management-based regulation” and a “deposit-discount-refund-system” to complement the current approach would be a step in a better direction.
Bennear describes the current U.S. approach to offshore drilling regulation as a complex system of command-and-control regulations that are designed to mandate redundancies in safety systems. She calls this approach “belts and suspenders,” with the idea being to create a series of fail-safes that back each other up so that the risk of an accident becomes negligible. She also notes that firms face strict liability for spills, with damages capped at $75 million.
The problem with the current regulatory approach is that it decreases the importance of compliance with each fail-safe in the eyes of a cost-conscious firm, Bennear argues. She posits that if the risk of an accident appears negligible due to a long list of fail-safes, why should a firm bother adhering to the letter of the next requirement? This thought process, the argument goes, could cause a problem when employees implementing each fail-safe think the same way, possibly allowing the development of norms that do not properly take safety into consideration.
Additionally, she points out that the fail-safes may not be truly independent because they all tend to be subject to the same human error: they are, after all, implemented by the same personnel.
Both management-based regulation and a deposit-discount-refund-system offer strengths that may be able to mitigate the weaknesses of the current approach.
Management based regulation requires that firms develop a proactive safety plan for review by regulators. A number of regulatory settings already call for such an approach. For example, Bennear highlights the Hazard Analysis and Critical Control Point (HACCP) system, a regulatory regime that attempts to improve food safety by requiring food producers to look at their production processes, identify weaknesses, and state goals for eliminating these weaknesses.
Bennear points out that a management-based regulation approach is theoretically appealing for regulating industries with multiple risk factors, like offshore drilling. She notes that other countries, such as the United Kingdom, already use the approach in regulating offshore drilling. Examining the effectiveness of these systems empirically is extremely challenging, however. When risks are already quite small, improvements may be difficult to detect by simply looking at whether or not a disaster occurred.
Adopting a deposit-discount-refund-system could also be beneficial, according to Bennear. Under such a system, a firm would deposit money into an account that the firm could only recover if it complied with safety regulations. Bennear also notes that deposit-discount-refund-systems can be modified to reward good behavior. For example, the deposit amount could be lowered for firms that have a good compliance record, as verified by a third-party auditor.
Where the presence of multiple firms makes enforcement costly for administrative agencies, such an approach is often put in place. Offshore oil drilling, as the recent spill in the Gulf suggests, is likely such an industry.
While Bennear does not think the belts-and-suspenders approach ought to be abandoned entirely, she does suggest that combining traditional regulation with management based regulation and a deposit-discount-refund-system would be better way to regulate offshore oil drilling.
This post is part of The Regulatory Review’s three-week series, Regulatory Breakdown in the United States.