Can more regulations solve the problem of failed regulations?

I’ve been highly critical of Big Energy, which is the term I use to refer to what the Left calls Big Oil. But Big Oil stopped being Big Oil, the moment the Left started pushing subsidies for “alternative” energy. Profiting from subsidies is often more lucrative than profiting by actually doing something productive. And, as I have argued, they can use the regulator process to force competitors out of certain areas, and redistribute wealth to themselves. The big example of this was ethanol, which I have covered on this blog many times.

Big Oil, or Big Energy today, has always used its cozy relationship with Big Government to secure for it things it could not have in a depoliticized market. Historically one of the worst offenders has been British Petroleum. Their history of using state power is well known and shocking.

The oil rig blowout in the Gulf is not something easily blogged about, not if one really wants to offer something pertinent and useful. That doesn’t stop a lot of people, but it did stop me. The problem for me is that one has to do some reading of the technical, engineering problems associated with oil rigs. Any “simplistic” response I could give would be rather useless if I don’t know the facts. Of course, that didn’t stop others from giving simplistic advice. Either saying, “let the market take care of it” or saying “there ought to be a regulation” is a simplistic, unthinking response. Most comments I’ve read from the Left and Right suffer from such simplism.

I don’t have a lot I can say with assurance because of the technical issues. But I can make some broad comments that might be helpful. And they are open to adjustment as I broaden my knowledge.

The first thing I can say with some assurance is that the government has limited liabilities to oil companies for damage done by accidents like the one that is causing such devastation in the Gulf. In the quest for progress it is necessary to take risk, but the cost of the risks ought to be fully covered by the risk-taker. Anything else distorts incentives.

But somewhere along the line the politicians, in their infinite wisdom, decided it was a good thing to subsidize risk. Sometimes this is done directly, sometimes indirectly. In the case limiting liability it is an indirect subsidy. It tells risk-takers that they won’t have to cover all the costs of their risk taking, that they can pass it on to others. In this case the politicians decided the risk takers could pass on costs of a disaster to the victims of the disaster. However, the politicians have also decided that the profits from such ventures belong to the risk-takers. They have privatized profits but socialized risk. We see this same, flawed strategy used in field after field. If there are risky credit applicants who want to buy houses the government promises to cover the losses while the banks get the profits. Bad loans are bad by the boatload and when something goes wrong there is a huge wave of defaults creating a crisis that spreads from there. Take away the downside risk, but leave intact the upside profits and you are asking for disaster. I would actually argue that disaster, under those circumstances, is inevitable, it is merely a matter of time.

So off the bat, I knew that the limitation on liabilities that government handed over to Big Oil/Big Energy was a bad thing.

The second thing I realized, that was a problem, is that industries regulated by government tend to capture the regulatory agencies and have undo influence on them. This is, I think, inevitable. Obama actually criticized the cozy relationship between the oil companies and the regulators. The problem is that this can’t be solved by more regulations. At all times the regulators who deal with oil drilling in U.S. waters will be of more interest to oil companies than they will be to us. You aren’t going to lobby them for what you think ought to be done, but the oil companies will. The law of capture means that eventually the regulators will be useful idiots to the companies they regulate and that regulations will be more likely to limit competition, and raise profits, than to do anything useful for the average person. And the politicians won’t say much about it because the same companies donate more to their campaigns than does the average resident of the Gulf region.

At the same time BP very successfully influenced major environmental organizations. BP has been one of the biggest funders of the environmental lobby around. Certainly donations to groups pushing for subsidies for ethanol proved very lucrative to BP. They had environmental groups literally begging politicians to take money from taxpayers and give it to BP. BP didn’t mind that at all.

The third thing I had to wonder about was that oil rigs operate in U.S. waters, which are exclusively and totally under the control of the federal government. No oil drilling takes place without government permits and contracts with the oil companies. When a contract is involved they can pretty much ask for what they want as a condition for using “public” waters to drill for oil. That is, you don’t need to wait for regulations to be passed. Like any landlord you can put stipulations into your agreement as to what must be done, or can’t be done, with the property you control. So, what would legislation add to the process that can’t already be done in the contract stage? Perhaps someone can give me information I don’t have which will tell me why this is not possible. If so, I will have learned something. This part is more a question than a statement, but it is one worth exploring.

In reading some material in the Wall Street Journal it was quite clear to me that BP officials on site took short cuts. The Journal outlined several concerns people had along the way with how BP was acting. If a fraction of what the Journal exposed is true BP deserves to have the pants sued off of them. This is precisely why liabilities must not be limited for risk-taking. It encourages unwarranted risks.

Another point is that we have no evidence that another regulation would have solved the problem. To say that more regulation is the answer is a faith statement not a rational one. We don’t have evidence that is the case. In fact, the Journal article made it clear that regulators were lax about regulations that were already in place. So existing regulations were ignored. If the law of capture tends to mean regulators will become too cozy with the objects of their regulations then it means that they will themselves tend to ignore certain regulations. That seems to be the case here, at least in part.

Today’s New York Times discusses the failure of certain safety measures that are routinely put in place. One such measure is called the “blind shear ram” which cuts off the supply of oil in a disaster. The ram is supposed to cut off the supply but it repeatedly failed to do so in this case. At this time no one is sure why, and won’t know until they can look at it. But there was too much confidence put into this device and many companies have already taken additional precautions.

Because they assumed that a certain number of these shears fail, sometimes hitting in the wrong spot, for instance, they have gone to installing the device twice, in different locations so if one fails they have a backup. Experts have suggested two such devices are needed. So wouldn’t a regulation forcing it solve the problem? Perhaps, but why wasn’t it done? According to the Times,

The federal agency charged with regulating offshore drilling, the Minerals Management Service, repeatedly declined to act on advice from its own experts on how it could minimize the risk of a blind shear ram failure.

They also said their study showed: “ that the Obama administration failed to grapple with ... the well-known weaknesses of blowout preventers.” Reports were on file showing that there was a problem and the regulatory agencies and the politicians ignored them. Even the company involved here, has been equipping their rigs with double shears as a precaution. This, unfortunately, was not one of those rigs. The Times says that every other rig under lease to BP supposedly has the double shears.

So, it was widely known that double shears were a needed safety precaution, and most rigs already had them installed, the process was on-going to put them into all rigs, and this was one of the unfortunate exceptions. And all this was being done prior to the feds actually mandating it. I fully expect this mandate to be put into place, consistent with my theory that most reforms pushed by government are instituted ONLY after the private sector has already primarily implemented the reforms voluntarily. If the Times is correct, most rigs already have the double shears. And no doubt the politicians will take credit for what has already been done privately, for the most part. Those who cherish regulations for their own sake will no doubt give all the credit to the public sector and ignore the fact that the private sector has already implemented this reform on most new rigs, without a regulation requiring it.

Blowout preventions sometimes fail but government tests of blowout preventers almost always approve them. Out of 90,000 such tests conducted by the government they gave passes to all but 62, which the Times says “raised questions about the effectiveness of these test.” I’m not sure that the regulators would actually do a better job merely by being given more regulations to work with.

The Times notes that MMS did institute a new regulation which said that all companies had to provide test data showing the blind shear ram would work in each well. This was supposed to be a requirement for a drilling permit. Yet the regulator “approved BP’s permit without requiring proof that is blowout prevent could shear pipe and seal a well 5,000 feet down.” The regulator who authorized the permit, in violation of regulations that already existed, said: “When I was in training for this, I was never, as far as I can recall, even told to look for this statement.” So, not even a basic regulation that already existed was being enforced. Would another layer of regulations change that?

In confirmation of my theory that reforms by government take place after the reforms are no longer needed, the Times notes that the federal agency ignored a report about there being two blind shear rams in each rig. “The agency made no such requirement. Indeed, it waited until 2003 to require even one blind shear ram. By then, the industry had already started moving to two blind shear rams....“ By the time the government regulators required one blind shear ram virtually all rigs actually had one and one-third of the rigs had already moved to two. In other words the regulation had almost no impact.

As the Journal noted BP cut corners repeatedly. Rep. Henry Waxman pontificated on this in Congress. But the Times notes that, “Tony Hayward, BP’s chief executive repeatedly told Mr. Waxman’s committee last Thursday, many of these decisions were approved by the Minerals Management Service.” In other words, “federal regulators did not see any problems” with the corners that were being cut, even if employees on the rig did see problems and complained. With federal regulators giving BP the go-ahead guess what happened? So why exactly is this only blamed on a failure of private industry? Why isn’t the fact that regulators failed being talked about as much? Surely this is a case of regulatory failure in spades.

Even bad politics got in the way of the clean-up efforts. Wendy McElroy brought to my attention that Voice of America reported that US companies are now using “sweeping arms that attach to a boat and help gather large amounts of oil.” These devices, however were offered to the US by “a Dutch company with years of experiences in such operations, but instead of using the Dutch ships and crews immediately, when The Netherlands offered help in April, the operation was delayed until U.S. crews could be trained.”

The VOA says the Obama administration turned down the offer of help to clean up the mess “partly because of the Jones Act, which restricts foreign ships from certain activities in U.S. waters.” So federal regulations in one area prevented the clean-up of a mess caused when regulators ignored their own regulations in another area. However, when Katrina hit “the Bush administration waived the Jones Act in order to facilitate some foreign assistance, but such a waiver was not given in this case.”

So the Jones Act, which delayed clean-up measures in this disaster, was left in place even though the Obama administration could have waived the act during the emergency. In addition the Dutch “offered assistance with building sand berms (barriers) along the cost of Louisiana to protect sensitive marshlands, but that offer was also rejected, even though Louisiana Governor Bobby Jindal had been requesting such protective barriers.” The Dutch embassy says their offer to help still stands. The White House says there are no delays in accepting such offers even though the White House rejected such offers. And the Dutch say that they can do the job at twice the speed of “as the local companies contracted for the work, if allowed to do so.”

Basically Obama is more worried about unions and “protecting” American jobs than preventing damage from the oil. VOA says: “U.S. policy has favored the use of American companies and employees in dealing with the oil spill, even though that may have caused delays in protecting sensitive shoreline.” But U.S. firms have little experience in these areas, so regulations meant to encourage jobs creation in the U.S. do so by preventing more efficient companies from doing the work. Of course, jobs creation measures often mandate inefficiency by requiring jobs be done by less efficient local employees than by more efficient foreign ones. The politicians, who only have to win local votes, often ignore that. But in this case, the tendency toward labor protectionism means great destruction to fragile Gulf shore areas.

Meanwhile, it appears that even local American workers were being prevented from doing cleanup work by another government agency—the Coast Guard. ABC News reports that barges that vacuum crude oil from water "were sitting idle" because the Coast Guard said they "needed to confirm that that there were fire extinguishers and life vests on board, and then it had trouble contacting the people who built the barges." Gov. Jindal has been trying to get the bureaucrats at the Coast Guard to move on the issues but complains: "Every time you talk to someone different at the Coast Guard, you get a different answer." Alabama's governor said there is no one who can give a "yes" or "no" answer. He also said each time the Governors from the area "develop plans with the Coast Guard's command center "things begin to shift when other agencies start weighing in, like the Environmental Protection Agency and the U.S. Fish and Wildlife Service." He described it "like this huge committee down there, and every decision that we try to implement, any one person on that committee has absolute veto power." Welcome to reality of political regulation.

Again, I must wonder, if political control is literally endangering Gulf shore areas, by delaying clean up in order to give U.S. companies a preference, why precisely does anyone think more political control is the solution here?

A private company, used to its cozy relationship with Big Government failed. Laws that limit liability subsidized its failure. It failed because it took short cuts that were approved by regulators. Regulations that were put in place, in order to prevent such problems, were not enforced by the regulators. And the regulations that are in place were only put in place after the safety mechanism had become the typical standard in oil rigs and after many rigs had already imposed a secondary safety mechanism. So regulations followed private safety measures, they didn’t create them. Even now the double mechanisms are becoming common prior to any regulation requiring them. The regulatory system, which is in place already, failed. And no one is explaining why more such regulations will make a difference when the enforcers ignored current regulations. On top of that, cleanup measures have been slowed down significantly because politicians interfered by passing laws meant to protect less-efficient local jobs. Those jobs are being protected,If but the expense of massive damage to the Gulf.

I don’t want to pretend this is be-all and end-all on this matter. It isn’t. It is my thinking out loud on a topic about which I am only now familiarizing myself. And it isn’t meant to be anything more than that. One purpose of this blog is to “think out loud” and this is one example of that.

A look a Oil Politics.

Ronald Bailey, the science writer at Reason, is someone I always enjoy reading. And I find that a good chunk of the time I learn something new. He has a good piece on the current oil situation. Americans are finding themselves facing $4 per gallon gasoline. A fill-up of a not quite empty compact car today cost us $39.00.

Bailey notes that consumption of oil has not been increasing as fast the supply has. You would think that would drive down the price. But there are other factors involved here. And two that he mentions are particularly important. One is rather obvious, that is the destruction of the value of the US dollar. The other less so. Let’s discuss the former one first.

Bailey notes that the US currency has fallen 30% against foreign currencies since 2002. This certainly is driving a lot of the problem. I don’t actually mind. I stopped savings in US dollars sometime ago. I don’t have much but what I have has been increasing due to the complete failure of the Bush administration in fiscal/monetary matters. At least that is one thing I can be thankful to King George for. When I converted my savings into Euros it cost $1.18 per Euro. At this time, when I covert back, I get around $1.55. That is just over a 30% increase in value in just three years. A second account in another currency increased by about 50% since I opened it six years ago.

But Bush decimation of the U.S. dollar is not the entire story by any means.

Bailey does note that political instability is involved but he also notes it is much reduced from what it was a few months ago. Bush’s saber rattling against Iran hasn’t done much to help -- but Bush rarely does anything that actually helps. He is like the proverbial bull in a China shop -- an utterly destructive force.

There is something interesting to consider about the connection between political instability and oil. First, contrary to the ravings of the Loony Left most major oil production is a socialist enterprise. National governments control oil in most countries. And where this is the case there is inherent political instability. Government, like Bush, tends to be be destructive. It is inherently irresponsible. Government is an entity which exists by force. It doesn’t have to supply a need or fulfil a function to stay in place. It can use guns -- and does.

It also tends to be a collective decision making process with large numbers of anonymous bureaucrats and petty officials having vast amounts of power. This collective nature of government means that no one individual tends to feel responsible for what the entire organization does. It is like a mob mentality where the individual players all blame everyone else there for the actions that take place. This lack of individual responsibility means it will act badly.

All the economic incentives of government are perverse. Governments don’t have to satisfy consumer in order to “make a profit”. They don’t sell a product but force consumers to buy products at the point of the taxman’s gun. But this is not necessarily true everywhere. As bad as that is, it is worse when government doesn’t have to rely on taxes to survive.

The Saudi kingdom does not need taxes. Neither does Chavez in Venezuela. The reason is their oil revenue. Oil producing governments are more totalitarian because they don’t need to encourage private production in order to finance themselves. I think this is one reason we have seen Putin pushing Russia in a more totalitarian direction as oil prices went up -- after he basically nationalized oil production again. When governments don’t have to rely on private production to finance themselves they can act in ways that are economically destructive, ie, like a bunch of fascists.

This is one reason the desire by well-meaning, but addled brained socialist to nationalize oil industries around the world is entirely destructive to all freedom where this happens. Destroying the link between government consumption and the private economy frees the government to act in any destructive way it wishes.
Canada, the US, etc., produce oil but this production tends to be private and only a small percentage of the entire economy. But if governments in the West nationalized oil production they too would be tempted by the same totalitarian forces. (Other institutional factors would reduce that but not eradicate it.)

The head of OPEC said that, “What’s happening in the oil market is due to the mismanagement of the U.S. economy.” That is true but in two different ways. One is the fall in the price of the dollar, which we have covered already. The second is something Bailey discussed, which I had not given much though to before. I told you I learn something from him regularly.

He notes the number of oil futures in the market have increased by 364 percent since 2003. And he quotes Tim Evans at Citigroup’s Futures Perspective: “We are seeing investment flows into the oil market that don’t have anything to do with the demand and supply of oil.” Bailey explains what this means, “Investors are treating oil as a hedge against inflation and a falling dollar.”

As the U.S. economy turns to crap before our eyes investors are looking for safe places to invest. Historically they have turned to precious metals and those indicators are rising at a monumental speed as well. Gold has gone from $647.75 a year ago to $981,90 today. Silver followed from $12.97 to $20.05 and platinum from $1203 to $2065. Oil is now being seen as a “hard asset” in which to invest to help preserve wealth.

My problem with such investments is that they depend on rising demand and demand can collapse. What do you think will happen with recession in America? The primary demand for gasoline, for most people, is commuting to work. Increase joblessness and fewer people will be filling up at $3.50 a gallon. Demand declines. When U.S. oil regulations created an “oil crisis” in the 70s prices escalated and consumption dropped. Eventually the price of oil collapsed. The demand curve for oil is relatively inelastic over the short term but over the long term that is not the case. You might have to drive to work today but given the right economic incentives you may well move closer to your job so you consume less. The rising price of oil will stimulate long-term solutions to consumption.

Bailey ends with some predictions by Mr. Evans. He says: “I think that this is the riskiest time to be long in crude oil since 1980.” He’s expect the price to drop by 30 percent to 40 percent. And while this heresy among the hard money crowd I personally wouldn’t be surprised to see the same thing happen with gold and silver. Certainly if I had investments in any of those commodities I would be selling out know.

When the world starts buying an asset that is often a good time to bail out.