Asking the Unasked Question About Oil Spill Prosecution

Oil spills happen, and they do environmental damage. Punishing these is a form of internalizing externalities.

But, at what point do we cross a line from regulation to extortion? This is an important macroeconomic question if the way we treat certain industries affects the potential well-being of citizens.

So, here’s the question: how much damage can something cause, as a proportion of its value?

Perhaps the worst case answer for this is a used car. A human life is (variously) valued at $2-10 million. So, a used car may cause perhaps 1000 times its value in damages, perhaps a bit more in a multiple fatality accident.

But, we don’t think most things are in that thousand-fold range, and when they are, as in cars, we don’t expect people to cover all the damages on their own.

Except with oil. When we start talking about oil companies, people get deeply irrational and very greedy. This is because oil companies have had a bad reputation since Rockefeller, and many people view them as licenses to print money. Investors who care about returns know that the returns of oil companies are good but not great … so that view that they are licenses to print money is misguided at best, and childish and nasty at the worst.

So, here’s a thought question: how much damage can be caused by an $84 barrel of oil?

Be careful. A barrel is 42 gallons, so we’re talking about $2 per gallon of crude.

You might reasonably think that you could cause $2 worth of damage with $2 worth of oil. You might even think you could cause quite a bit more: perhaps $200 worth of damage with a $2 gallon of oil. But, this is why I told you to be careful: how much oil is on the floor of your garage? A quart? If so, then you personally have done $50 of environmental damage to your garage. To most people this seems implausible, and so the 100:1 ratio is probably about as high as we can go.

Except if you’re in the government, media, legal advocacy, or environmental movements. Chevron currently faces these groups in Brazil, over a deep ocean spill of 3,000 barrels. For this, Brazil is suing for $11,000,000,000. A little division shows that this is a cost/penalty of a nearly $4,000,000 per barrel. This is something like 50,000 times the value of the oil. Remember the used car case: we let people off on damages of 1,000 times value.

Yes, we can make arguments about indirect, downstream, and unknown future damages. Yes, there should be penalties beyond recurring damages. And yes, treble damages to dissuade future problems are standard. Lastly, hyperbolic claims are common in court, and are often toned down at settlement. But, I suggest it is impossible to argue that 50,000 times value is ever justified. If my assertion is correct, then this is extortion.

This is important from a macroeconomic perspective because industries that produce value-added are a key to growth. Under what grounds is it justified to go after a firm that might make $5 profit on each barrel of oil, while contributing almost $80 to the local economy, for something on the order of $4,000,000? I claim that this is a policy action that is immoral.

And yet this sort of policy action is quite common. And we tend to view it as a moral problem that some people are rich and some are poor. If you believe this, at a minimum you should make sure that extortion like this, that might discourage future growth opportunities, is curtailed.

Skim the whole thing, entitled “Chevron Hits Troubled Waters” in the March 20 issue of The Wall Street Journal.