Thursday, May 27, 2010

My Oil Spill Post: Environmental Liability and Risk

I've posted along these lines at Slashdot a few times, but I've been reluctant to blog about the oil spill without thinking it through a bit. Before I start I'd like to point out that I'm not a lawyer or even all that knowledgeable on environmental law or corporate law. I'm also not an environmental engineer, and I don't have any knowledge of environmental science beyond that of a layman. I'm just a computer programmer with opinions.

Generalities, and an analog with the DMCA

For starters, my understanding of current environmental law is that is basically protects companies that follow it. Establish a standard for what's safe enough, for what's clean enough, and as long as a business adheres to that standard it will be protected from governmental penalties and private lawsuits. I'm sure my understanding is incomplete, but I think it's mostly accurate. As a software guy, the first thing I think of is the DMCA, and how it affects Internet services that host user-uploaded content: if you comply with the procedure for take-down notices you won't be found liable for copyright infringement. The DMCA is a useful analog because it's been the subject of much discussion on the Internet, and because it is similar in concept.

The benefits of this type of law is obvious. In business it's very difficult to do anything without harming someone else. The oft-discussed DMCA makes it possible to operate a website with user-uploaded content without having to perform the impossible task of determining whether each of these clips violates someone's copyright, while not allowing website operators to just violate copyright with impunity. It standardizes the process, allowing businesses to put efficient processes in place to deal with it, and making it possible for them to reason about potential damages they might face. You take on risk only if you fail to follow the DMCA's outlined procedure, and that's something you can control; not the risk that some user will upload the whole Top 40 and get millions of downloads, which is harder to control. It's similar with manufacturing plants. You only have to deal with the risk that you'll violate pollution standards, which is something you have lots of control over; not who's harmed by the legal pollution, which you have less control over. As the DMCA makes “Web-2.0” possible by making copyright litigation risks more predictable, environmental regulations can make industrialization easier by doing the same for environmental litigation risk.

The downsides? Well, everyone hates the DMCA, so we can look at some of the complaints about it. Some website operators complain about time spent on take-down notices generally, and many users complain about bogus take-down notices (including cases where fair-use is ignored) and that often in these cases they lose data as a result. But without the DMCA they'd likely face the same challenges, and they'd be legal threats instead of take-down notices, which take a lot more time and money to defend. Sites like YouTube have struck deals with various rights-holders, and the existence of the DMCA strengthens their stance in negotiations. I think that bogus take-down notices can be a problem, but the website operators should easily be able to put some of the time and money they've saved on legal bills toward working through them correctly or perhaps challenging bad-faith or inaccurate automatically-generated notices legally.

The real downside is for the copyright holder. It's inevitable that infringing material will be uploaded to sites like YouTube and viewed there. And it's inevitable that the sites will make lots of money off of this activity. The rights-holders can request that material be taken down, but at a high-volume site it will surely be re-posted, and in the time between posting and removal the site will make lots of money, and rights-holders have no recourse against this (under just the DMCA — they may have more success arguing on other grounds, or they might instead form a mutually-beneficial partnership with the site, as many rights-holders have with YouTube and Hulu).

I think that in some ways there's an analog to environmental laws. I'd guess that in many cases environmental and safety regulations affect industrial practice more than the DMCA affects copyright practice on the web (at least among legitimate websites). But by protecting polluters within stated guidelines, environmental regulations prevent affected parties from being reimbursed. It's not enough, when going for damages against a polluter, to show that one has been harmed; it must also be shown that the polluter did something “wrong”. Thus businesses that used PCBs before they were banned only pay for a portion of the damage they did — they negotiate with the government from a pretty strong position. Coal-fired power plants in Pilsen and Little Village (lower West Side neighborhoods in Chicago) can operate under pollution standards in place when they were built, though they continue to pollute today at these levels (which would now be illegal), without reimbursing nearby residents for the measurable damage to air quality.

That environmental regulations are even designed with industrial convenience in mind is clear from this fact: that California is the only state allowed to regulate air pollution, and only because it started before the Federal government did. California's Air Resource Board, and its higher pollution standards, are scheduled to be phased out as Federal standards catch up with California's. I'm not intending this as a criticism of them, exactly. I'm just showing that environmental regulations are a two-way street. Polluters give up some rights and gain some conveniences and assurances.

What's the problem?

I don't have a problem with accepting some pollution as necessary for industrial development. Similarly, I don't have a problem with accepting some copyright infringement as necessary for the development of the development of the Web. I do have a problem with writing it off completely. This is about economics and incentives. On the Web there's an incentive for site operators to do as little as they can about copyright infringement, because it drives page-views and ad revenue. And there's no incentive to do any better than the letter of the law, in this case the DMCA. In industry there's an incentive to pollute more, or to behave dangerously: it's cheaper. And there's no incentive to do better than the letter of the regulations.

This is why there's an impetus for things like carbon credits and carbon taxes. We've all heard debates about these. The important idea is that you pay exactly for your impact — you save money for reducing pollution and pay for increasing it — even if you're well below the standard accepted levels. Carbon credits and taxes have to do with a global problem, and so they're proposed to be collected and enforced by national governments and international coalitions.

But carbon isn't the only important pollution. If you're going to spew particulate emissions into the air and poison the soil and the water, you should owe the people affected locally. And that's something that national regulations are quick to prevent. If carbon taxes and credits can affect a business' bottom line that business will care about carbon. But that same business won't care a bit about the people it's affecting locally unless local pollution affects its bottom line, too. People affected locally need to be directly reimbursed. The simple solution is to allow lawsuits for damages, but that's probably not fair or efficient. Not fair because of resource disparities among affected communities, not efficient because of all the different lawsuits going on. So there's probably some legislation needed there.

If you think about this in economic terms, the problem is that preventing direct payouts to people and groups affected by pollution is a distortion in the market. Exchanges tend to benefit their players, but often have negative effects for those on the outside (externalities). Often people that are negatively affected can force their way into the exchange through a lawsuit (which may prove that they, unwittingly, became creditors of one of the players, and are thus owed money). I think it would be good to bring these people into the exchange without their having to sue their way into it.

But this is all about the predictable and normal levels of pollution. What about disasters? What about the oil spill?

The Oil Spill

It appears, from what I've read, that BP may have violated some regulations in building or maintaining its failed oil rig. I'm not really concerned with that. I'm concerned with the fact that even if all the regulations are followed, there's a chance of disaster. Humans err, natural disasters occur, crime and sabotage occasionally happen, standards and regulations can be flawed (that is, our knowledge is never complete). In all these cases a plant owner must be held responsible. There may be other parties held responsible (such as the saboteur in the case of sabotage) but the plant owner must always be. I'm saying that, in the case of the oil spill, every person impacted, plus the governments of all impacted states and countries, must be able to fully recover their damages from BP. It's absolutely vital.

That's because building and operating any industrial facility inherently carries risk. In order to correctly bake the costs of the risks of any operation into the various decisions made about it, these costs must fall on the head of the decision maker. Insurance can dull this effect, but the insurer then becomes very interested in the safety of the operation as well.

I'm looking at estimates of just the economic impact of the oil spill. A number I've seen a few times is $12.5 billion. Another says we could have tens of billions in the best case, hundreds of billions in the worst case. It looks like we may avoid that worst case. Anyway, the cost should be at least in the tens of billions. Because “economic impact” figures don't count irreparable non-economic damage to the environment, which BP should be fined heavily for, and also because effects will probably go on for many years in the future, and it's hard to put a dollar value on that, these figures are probably somewhat lower than what BP should actually wind up paying out, in total.

BP's market cap sits around $142 billion now, and about $200 billion before the spill. Even in the best case, they should be paying out a significant portion of the company's total value in damages and fines. Probably over a year's worth of profits.

The total damages figure, whatever it amounts to, is huge and important. It should inform the insurance and capitalization requirements for offshore drilling. If companies are faced with that sort of risk for offshore drilling, you can bet that a lot of them will choose not to do it. And maybe they won't be so cavalier about safety. Unfortunately they won't be faced with that risk. They'll weasel out of their obligation to pay for the damage resulting from their activity. One thing we have to do in the wake of the oil spill is really try to get all that money from BP. Make sure they bear the weight of the risk they took with that rig. As they would have taken the profits had it worked, they must pay the costs as it failed. If we don't the incentive is too great for other companies to take bad risks in the future.

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