Some Implications of Tightening Regulation of U.S. Deepwater Drilling

Can markets, the legal system, and current regulatory policy provide the proper incentives for producers (and consumers) to consider fully the possibility of oil spills and the risks that could ensue while drilling in deepwater offshore areas?

That’s a key question examined in a new paper, “Some Implications of Tightening Regulation of U.S. Deepwater Drilling,” by RFF Nonresident Fellow Stephen P.A. Brown, Co-Director of RFF’s Center for Energy Economics and Policy.

“If such risks are not taken fully into account, offshore oil and natural gas production will be too great; oil and natural gas prices will be too low; and the consumption of oil and natural gas will be too high,” Brown writes. “Are tighter controls or a permanent ban on deepwater drilling in the United States a reasonable response to such externalities – or an overreaction?”

Brown assesses the implications of a permanent tightening of U.S. government control on deepwater offshore drilling through three scenarios. The first case represents business as usual. The second imposes additional regulatory safeguards that would increase the cost of exploration, development, and production in U.S. deepwater and ultra-deepwater areas by a combined 20 percent. The third case examines the implications of a permanent U.S. ban on drilling in deepwater and ultra-deepwater areas.

By raising U.S. safety standards for deepwater and ultra-deepwater drilling to those set by such countries as Brazil, Canada, Norway, and the United Kingdom, costs could increase by as much as 20 percent – which would have relatively small impact on world oil prices, Brown estimates. These changes would translate to gains in the price of gasoline of about one-half cent per gallon in 2011 and eight-tenths of a cent per gallon in 2035.

However, a total ban on such drilling would have much larger effects, Brown notes. Projected oil prices would rise by about $2.58 per barrel (3.54 percent) above baseline in 2011 and by about $4.03 (3.03 percent) above baseline in 2035. Projected gasoline prices would be about 7.2 cents per gallon higher in 2011 and 11.3 cents per gallon higher in 2035.

Excerpts from the paper

“We can expect to see new industry standards pertaining to safety equipment and procedures used when drilling in U.S. deepwater and ultra-deepwater areas. Such changes can be expected to increase the out-of-pocket costs of drilling in deepwater and ultra-deepwater areas.

“Nonetheless, there can be a tendency within any industry to dismiss low-probability, catastrophic events such as the Deepwater Horizon disaster as a one-off occurrence, resulting from poor judgment or human error. That tendency could mean that industry standards would not tighten by as much as society deems appropriate. In such a case, society will want higher safety standards than the industry would adopt on its own accord.

“Whether the result of industry or government action, higher safety standards could raise the costs of U.S. deepwater and ultra-deepwater drilling by 10-20 percent. As we have seen, the market will shift some these costs forward to consumers in the form of higher prices. Although the anticipated gains are far from a complete environmental pricing, higher prices will assure that those using oil and natural gas face at least some of the environmental costs associated with production, and at the same time provide incentives for conservation.”