Spill Logic

Sandeep at Cheap Talk clips this from an upcoming David Leonhardt piece (out online) in the NYT magazine:

The people running BP did a dreadful job of estimating the true chances of events that seemed unlikely — and may even have been unlikely — but that would bring enormous costs.Perhaps the easiest way to see this is to consider what BP executives must be thinking today. Surely, given the expense of the clean-up and the hit to BP’s reputation, the executives wish they could go back and spend the extra money to make Deepwater Horizon safer. That they did not suggests that they figured the rig would be fine as it was.

Sandeep comments:

But this does not prove the case.  You may buy a stock given the odds of it going up or down.  If it goes down you will regret your investment.  This does not prove it was wrong to invest in the first place.  It might have been right given your initial assessment. The same logic applies to BP.

This is a simple point: regret does not imply that the ex ante decision was bad.  Leonhardt is a great economics commentator and journalist.  The fact that he makes this elementary mistake shows how easy it is to make.

He’s right on. It is possible that BP analyzed the risk and decided that the money it would take to make the rig extra safe was not worth it, given the probability of rig failure. But going further, it’s also possible that BP did, in fact, correctly estimate the probability of a failure. Extreme right tail events happen.

What I think this shows is the importance of strict safety regulations on oil companies (and nuclear power companies, and any other companies that could have very low-probability, catastrophic failures). Now, over-regulation isn’t good; you don’t want to stifle growth by making it impossible to run your business. But heavier fines and much more oversight are crucial to keeping these companies honest. You need to tip their cost-benefit analysis towards safety.

As Jon Stewart highlighted on the Daily Show last night, BP’s US refineries accounted for 97% of all “willful egregious” violations given out by OSHA in the last 3 years. An OSHA rep told the AP that “BP has not adequately addressed the issues, despite being fined more than $87 million.”

$87 million. Sure sounds like a lot. Ha ha. We’re talking about an oil company. Guess how much many BP made in just the first quarter of this year? $6 billion. That $87 million makes up slightly more than one percent of their 1st quarter profits.

As Sandeep makes clear, BP might have made the ex ante “correct” decision not to spend lots of money on safety upgrades. But that’s only because the costs of not upgrading were far too low.

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1 Comment

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One response to “Spill Logic

  1. Pingback: More Spill Logic « Eisenhood

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