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The Gulf Spill and the Polluter Pays Principle

May 20, 2010

Another lesson from the Gulf oil spill for Canada – think twice about subsidizing industries that deal in dangerous substances by limiting their liability for catastrophic accidents. Let me explain.

If you have been paying close attention to the oil spill in the Gulf of Mexico, you may have heard that there are legal questions about whether BP will be required to pay for the damage caused by the spill. At issue is the United State’s Oil Pollution Act of 1990, enacted shortly after the Exxon Valdez spill in Alaska. The Act makes oil companies responsible for the clean-up of oil spills, but limits their liability for the damages caused by the spills to $75 million. The Oil Pollution Act also created an Oil Spill Liability Trust Fund of $1 Billion of public money which can be used to provide some compensation for oil spill clean-up costs, but the damage caused by the Gulf oil spill will likely far exceed that amount.

Given that BP is making profits in the billions of dollars, the limit of $75 million has Washington reconsidering. The White House has thrown its support behind calls to raise the limit:

BP is responsible for -- and will be held accountable for – all of the very significant clean-up and containment costs. They will pay for the mess they’ve made.

Beyond clean-up and containment, BP must be held responsible for the damages this spill causes. To help make sure of that, the Administration – in the context of a comprehensive energy bill which would help move us to a clean energy future -- strongly supports efforts on Capitol Hill to raise the Oil Pollution Act damages cap significantly above $75 million.

Democratic party lawmakers are proposing raising the limit from $75 million to $10 billion. There are questions, however, about the constitutionality of a law that imposes liability on BP after-the-fact.

Why limit liability?

It is a recognized principle of environmental law that polluters should pay for the harm they cause. The Supreme Court of Canada has described the purpose of this principle as follows:

To encourage sustainable development, that principle assigns polluters the responsibility for remedying contamination for which they are responsible and imposes on them the direct and immediate costs of pollution. At the same time, polluters are asked to pay more attention to the need to protect ecosystems in the course of their economic activities. [para 24].

The courts have also recognized (in what’s referred to as the rule in Rylands v. Fletcher) that people dealing with inherently risky substances should be held responsible if those risky substances escape their control – a concept known as strict liability (although courts have also created many, many exceptions to that general rule).

To be fair, the Oil Pollution Act contains some good provisions, aimed at expanding the role of the U.S. Environmental Protection Agency oversight of oil pollution. But capping the liability of an industry goes against the polluter-pays principle. Any harm suffered over and above the amount of the cap would need to be paid either by the people who suffered the harm, or by tax-payers. So why would a government cap the liability?

On one level, it may have been seen by some as a quid quo pro for the industry accepting new regulations and for paying money into the Oil Spill Liability Trust Fund. But at a practical level the reason for caps of this type is to promote private investment in industries that are prone to catastrophic events. Similar caps exist for the nuclear industry, where there is explicit recognition (from the American Nuclear Society) that such caps facilitate private investment:

The Price-Anderson Act … has removed the deterrent to private sector participation in nuclear activities presented by the threat of potential liability claims following a large accident. … Many of these companies, support services and equipment suppliers likely would not have participated in the nuclear industry without some liability limitation. … The Act has enabled insurers to provide stable, high quality coverage for nuclear risks.

In other words, investors might be scared off from industries where a single mistake might bankrupt the company. As such, limits on liability for risky activities can be viewed as a subsidy to the industry – one which only becomes visible to the public when a catastrophic accident occurs, such as BP’s in the Gulf of Mexico.

This is more or less the explanation that Republican Senator, Lisa Murkowksi, gives for refusing to back the proposal to raise the cap to $10 Billion:

… [W]hat this would do is give all of America's offshore oil resources to the biggest of Big Oil. It would be impossible or perhaps close to impossible for any energy company that is smaller than the super majors, smaller than the national oil companies, to operate in the OCS. $10 billion in strict liability would preclude their ability to obtain financing, to obtain the bonds or insurance for any exploration, and look at who is producing in the offshore? It's the independents. They produce two-thirds of natural gas, one-third of the oil.

But the Gulf oil spill has American commentator and Reason magazine editor Jesse Walker wondering about the “effects of this system on how oil companies approach risky behavior.” Economics Professor Steven Horwitz expands on this thought:

Walker's implication, and it's probably right, is that with a liability cap (beyond the clean up costs), the costs of any spill are less than they would be otherwise, giving firms reason, at least on the margin, to be willing to tolerate more risk of such a spill and reducing their expenditures on prevention measures, again at least on the margin.

A Canadian commentator, National Post columnist Lawrence Solomon, not generally viewed as a friend of environmentalists, has made the same point.

I blame the U.S. government not because an accident happened but because it failed to ensure that BP — along with every other firm drilling off the U.S. coast — had every incentive to avoid an accident. To the contrary, the federal government told the firms drilling in submerged lands under federal jurisdiction that they needn’t be unduly troubled about the consequences of a worst-case scenario on their bottom line.

“Do your best to avoid an accident,” the U.S. in effect said, “but don’t worry about going the extra mile. If the worst occurs, we’ll backstop you. You’ll never have to be fully accountable for the damage an accident does, your shareholders will never need to worry that an accident will bankrupt you.”

Limited Liability in Canada

So what’s the situation in Canada? Canadians would rather not wait for a catastrophic oil spill to learn first-hand about the problems of limited liability.

Section 26 of the Canada Oil and Gas Operations Act and the Oil and Gas Spills and Debris Liability Regulations govern claims arising from oil spills. It specifies that an oil and gas company operating under the necessary approvals will be liable “without proof of fault or negligence” for up to $40 million (and less in some regions of the country) for clean up and damage resulting from the oil spill.

However, the Act also says that claims of more than $40 million are possible if a person, through “fault or negligence” has caused the spill. By contrast, companies operating under the U.S. Oil Pollution Act are only liable for more than the $75 million cap if the accident is the result of “gross negligence or willful misconduct” or an actual violation of an applicable law. While the limited liability provisions of the Canada Oil and Gas Operations Act do raise questions about who would be on the hook for a massive spill in Canadian waters, those provisions do not provide the industry with as much protection as the US legislation. It does provide some protection to companies against claims based in nuisance, the rule in Rylands v. Fletcher, or other strict liability claims.

However, Canada has other examples of liability caps for hazardous industries. Relevant to the oil and gas industry is the cap on liability from tanker spills under the Marine Liability Act (implementing internationally agreed upon limits on tanker liability). This Act, which also implements international provisions regarding a fund for compensation, limits liability for oil spills to between about US$38 million and US$76.5 million, depending upon the size of the ship. This limit applies unless the spill occurred as a result of an operator’s “personal act or omission, committed with the intent to cause such damage, or recklessly and with knowledge that such damage would probably result.” This is a very narrow set of circumstances.

Canada’s nuclear industry also has a cap on its liability - $75 million dollar limit on the total liability for a nuclear accident (under s. 31 of the Nuclear Liability Act). And this cap does not provide for any exemptions – not even where the operator is at fault.

This limit was actually the subject of a constitutional challenge in the early 1990s brought by Energy Probe (with some financial support from West Coast Environmental Law’s Environmental Dispute Resolution Fund, in a rare exception to our rule against funding cases outside of BC). While the Ontario Court of Appeal ruled that the Act could amount to a violation of section 7 of the Canadian Charter of Rights and Freedoms (the right to life, liberty and security of the person) if the petitioners could prove that the limited liability increased the risk of a nuclear accident, the trial judge hearing the case found that there was no evidence of such an increased risk.

There have been recent calls for this limit, set in the 1970s, to be raised, but at the moment the $75 million cap for nuclear liability in Canada stands.

What do you think? Do the existing limits encourage unsafe behaviour? Is this a subsidy, and if so, is that fair and reasonable to the public? Is there a point at which the risks of catastrophe mean that we shouldn’t be building these projects, or are these necessary pieces of infrastructure that won’t go ahead without this type of protection?