Having reached the first anniversary of the Gulf oil spill, we must take a reasoned look at the reality of energy production. Energy production entails risk, as does nearly every economic activity. The decision to drive to work today entailed risk. About 33,000 people are killed annually in motor vehicle accidents.
This does not mean that we should all stop driving. In general we should take the optimal amount of risk in the sense that the benefits from any activity exceed the expected costs of the activity, including the potential costs of an accident.
Unfortunately, the response to the environmental damage caused by the tragedy of the Deepwater Horizon has been an overreaction to risk on the side of the federal government. While the moratorium on drilling was lifted in October, only six new deepwater (over 500 feet) well permits have been issued since then.
Given that the Gulf accounts for a third of the nation’s domestic oil supplies, about 1.7 million barrels per day, and 10% of the natural gas, mostly from the deepwater region, it is important to examine carefully what economists call the opportunity cost of not drilling, as well as the expected losses from an accident.
Oil is now in excess of $100 per barrel and gasoline is at $4.00 per gallon. The political turmoil in the Middle East has created uncertainties in world oil production, creating demand for oil production from politically stable areas.
At the same time, several drilling contractors have pulled their rigs out of the Gulf to use them for offshore drilling in Brazil and West Africa. The opportunity cost of restricting oil drilling in the Gulf region is now more costly than it was a few months ago, and it is likely that regulatory constraints will become even more costly in the future.
The expected losses from drilling in the Gulf have been reduced substantially from a year ago. A positive effect of the Deepwater Horizon blowout was a better understanding of the environmental risks of different types of drilling operations.
The oil industry has created a new Houston-based Center for Offshore Safety to ensure rigorous audits and the use of best drilling practices by all companies drilling offshore. All oil companies have an incentive to make sure the other companies abide by best practices and keep risks to a minimum since any accident will limit the ability of all companies to continue and expand drilling operations.
The Bureau of Ocean Energy Management, Regulation, and Enforcement (BOEMRE) will gain little recognition if it approves permits and the increased supply of oil results in a decrease in the price of gasoline.
It will also not likely be blamed for increases in the price of gasoline due to the Bureau’s restriction of permits. However, if it does approve a permit and there is an accident, then the bureaucrats will find themselves in a political bind.
Thus, the incentives of the bureaucratic system are to overweight potential risks and underweight potential benefits, with the result that we end up with less oil production, and higher prices for crude oil and gasoline. These higher energy costs feed throughout the economy since energy is an input into a vast array of goods and services, so prices are higher and output generally is lower.
This is not to say that we should ignore potential threats to the environment from deepwater drilling, or from any other activity. We cannot, however, ignore the costs to the economy from prohibiting risky activity nor overestimate the threats.
While not minimizing the environmental disruption of 4.9 million barrels of oil entering the Gulf, scientists have found that microbes have digested most of the oil and methane that remained in the water.
John Kessler, an oceanographer from Texas A&M was quoted by Time as being surprised at how quickly the levels had returned to normal. “It looks like natural systems can handle an event like this somewhat on their own,” he said.
Deepwater drilling is now safer than it was prior to the experience of the Deepwater Horizon and the opportunity cost of delaying and denying permits to drill in the Gulf are greater. The Obama administration needs to allow the oil industry to use its new-found expertise and organization to meet our current and future energy needs by restoring the ability to return to drilling in the Gulf.
Gary Wolfram is the William Simon Professor of Economics and Public Policy at Hillsdale College.
