Case Study: BP's Oil Spill in the Gulf Should the government require deep water oil companies to spend whatever it takes to reduce the chance of future spills to zero?
Reference Case Study:
BP's Oil Spill in the Gulf On April 20, 2010, the Deepwater Horizon oil rig exploded in the Gulf of Mexico in a drilling accident that killed 11 workers and hospitalized many. Both BP and the government initially underestimated the size of the spill, and neither had a response plan in place. Though the oil industry had experienced blowouts at shallower depths, an accident a mile down was new and devastating. Federal regulators seemed lax prior to the accident, perhaps captives of the industry. The size of the Gulf spill combined with live video of the gushing well and photos of oil-soaked birds marked this tragedy in the public's mind. President Obama called it the worst environmental disaster in U.S. history.
The explosion and resulting oil spill, accidental byproducts of BP's efforts to supply oil, threatened the livelihood of tens of thousands around the Gulf and could impose lasting damage on the habitat. BP spent billions on cleanup in the first three months, but that was peanuts compared to the costs company owners have and will face. More than 150 class-action lawsuits named BP as a defendant. Hoping to attract more clients, law firms purchased domain names such as offshoreinjuries.com and bigoilspills.com and advertised with billboards along the Gulf Coast. Environmental groups filed suits of their own. President Obama warned BP against "nickel and diming" the economic victims of the accident. And the Justice Department opened a criminal probe against BP for possible violations of the Clean Water Act and other environmental laws.
Here's a question: Was this oil spill a negative externality? Was this an unpriced by product that affected neither buyer nor seller but third parties? The buyers in this case were customers for BP gasoline and the seller was BP. Market competition may make it difficult for BP to pass along its spill-related costs, so BP consumers may not be much affected. How about BP?
If this were truly an externality, then the accident would have had little impact on the supplier, BP, or the company BP hired to drill the well, Transocean. But both have been profoundly affected. Because BP has been reviled by everyone from President Obama on down, the company's brand name will be tarnished for a generation, becoming the poster child of polluters in the public's mind, in the media, even in textbooks. Lawsuits will likely cost the company billions and may take years to settle (some Exxon-Valdez suits from the 1989 Alaska spill took more than two decades to resolve). For its part, Transocean, the owners of the rig, saw 11 workers die in the explosion and many more hospitalized. The drilling rig itself, which cost Transocean $375 million, sank two days after the explosion.
Although lawsuits may be in the courts for years, share owners of BP and Transocean didn't have to wait long to see their losses reflected in stock prices. Within six weeks of the accident, the share price of each company sank 50 percent. In BP's case, that meant a loss in the market value of the company of about $90 billion. Because Transocean was a smaller company, its market value fell about $15 billion. Although the exact amount of the spill may never be known, let's say the total turns out to be about 200 million gallons, a figure higher than any reported estimate. This would imply that BP and Transocean stockholders together lost more than $500 in market value for each of the 200 million gallons of crude oil spilled into the Gulf. There remained some question whether the companies will survive. For example, BP established a $20 billion fund to compensate those affected by the spill. The company was forced to sell rights to some oil fields to pay for the cleanup and was expected to issue bonds to raise more money. No question, many in the Gulf region have been harmed by the spill, and some of the damage could last for years. But many people will be compensated for their losses. The legal system, the government, the media, and the stock market have placed much of the cost of this accident squarely on BP and Transocean, and to that extent, most of what otherwise would have been external costs became internalized.