Friday, May 7, 2010

Regulatory Incentives: A Case Study

A Wall Street Journal (subscription) story caught my eye, "Oil Regulator Ceded Oversight to Drillers":

The small U.S. agency that oversees offshore drilling doesn't write or implement most safety regulations, having gradually shifted such responsibilities to the oil industry itself for more than a decade.
Instead, the Minerals Management Service—now caught up in the crisis of the Deepwater Horizon rig that for weeks has sent crude oil gushing into the Gulf of Mexico—sets broad performance goals for the industry. Oil producers and drilling companies are then free to decide for themselves how to meet those goals, industry executives and former regulators say.
 Let's break this down.  What does it mean, exactly, to say that the agency has ceded its regulatory authority?

In short, it's something called "performance based" regulation.  The agency, in this case something called the Mineral Management Service (MMS), sets performance expectations, but doesn't tell the agency HOW it must reach the performance expectations.  In theory, this should allow for less expensive regulations than the traditional "prescriptive" model (where I tell you HOW you must do something, but generally absolve you from the results if you comply).

MMS has now made clear it will be shifting away from a performance based system to a more prescriptive based one soon after last week's disaster in the Gulf.

I'm not so sure it was the model of regulation, or the fact that industry practices were adopted as the standards rather than rules written by federal regulators, that caused the problems MMS faces.  In fact, the Journal appears to have "buried the lede" (i.e. put the most important part of the story in the middle rather than up front).

Some interesting facts emerge about MMS (which is an agency within the US Department of the Interior): Enforcement of safety rules isn't MMS's "primary responsibility" although it does inspect rigs.  Instead, its to "verify how much oil is being pumped, which is key to another MMS duty, maximizing payments the government receives for oil and gas rights from energy producers."  As a result, the agency, which is funded by fees and rental receipts, faces a "conflict of interest" according to former MMS employees.

Does this make a difference in safety?  Very possibly.

Consider this: fatalities on oil rigs is four times higher in the US than in Europe.  The UK had a similar model, but recently separated its safety function from its revenue collection function.  The result has been an improved safety record.

The story goes on to detail how the MMS failed to follow-up on instances where the industry had failed to meet safety standards, etc.  In short, poor enforcement rather than poor regulations may have been at fault here.

Note: this is not the first time in recent years MMS has come under fire.  In 2008 it was cited for "a lack of ethical culture" after fairly shocking evidence of misbehavior occurred.

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