Ever Heard of Externality – Oil Companies Have!

May 22, 2010

Unless you are an economics major, most likely you have never heard the term externality.  Regardless, it affects each of us every day in positive and negative ways.  In days gone by, its affects were serendipitous but today corporations go to great lengths to take advantage of externalities to the detriment of the public at large.

Just what is externality anyway?  Here is a standard definition: “An economic side-effect.  Externalities are costs or benefits arising from an economic activity that affect somebody other than the people engaged in the economic activity and are not reflected fully in prices[i].”  To better understand, here are some examples:

A positive externality:

You buy a home in a rundown neighborhood, fix the house, and clean up the yard.  Your efforts not only benefit you but your neighbors as well.  Your efforts, for them, are a positive externality as they enjoy the improved view and your efforts even increase their property value at no cost to them.

A negative externality:

The house you purchased and fixed up is on a lovely stream full of brook trout.  Two years after you move in, a manufacturer builds a facility 30 miles up-stream.  The solvent they dump into the stream goes unnoticed, unregulated, and pollute it.  All you know is the fish are gone and it smells bad.  You have the water tested and it’s full of sulfur and will cost you and your neighbors $100,000 to clean up.  Unless you can trace the pollution back to the company, you and your neighbors bear the cost of a problem created by another.

In the positive example, the actions of one benefit another; in the negative example, the actions of one harm another.  Individuals, corporations, and governments leverage externality.  In the case of individuals they simply may enjoy a benefit, a business might avoid a cost it should rightly pay, governments may demand social programs be financed by both corporations and individuals that receive no benefit from it.

The real problem with externality comes with not recognizing it for what it is.  This lack of understanding lends itself to abuse and corruption on a massive scale.  We need look no further than the Gulf of Mexico for a real-life example.  Even before stopping the leaking oil in the ongoing disaster, the corporation that owns the sunken Deepwater Horizon oilrig, Transocean Ltd (Transocean traces its roots to the Gulf of Mexico but now is headquartered in Geneva, Switzerland[ii]) filed a motion in Federal Court seeking to limit liability to just under $27 million.  An article posted on Law360’s website[iii] by Melissa Lipman gives the details as well as a link to the actual filing.

Transocean seeks to transfer the cost of the oil spill to British Petroleum (BP) and taxpayers in the United States.  In effect, making any additional costs an externality, an externality we must pay and they avoid.  By the way, the 1851 law Transocean sites limits ship owner’s liability to the value of a ship after its loss.  This makes them liable for the loss of cargo only.  Transocean claims the rig had about $27 million worth of crude oil on it when it sank.  If successful, Transocean will keep most of the $533 million[iv] of insurance money carried on the rig.

All the while, BP is relatively happy knowing federal law limits its liability to $75 million, unless they were negligent in maintaining federal safety standards.  BP still faces lawsuits filed in state courts but in the end, they too will avoid the total cost of the clean up effort by transferring much of it to the government and ultimately the American taxpayer.

Externality is the game corporations play to win.  Back in my engineering days, our motto to reduce repair costs was “make it someone else’s problem.”  It was very effective to say the least.  Corporations take this motto and run with it in every aspect of business.  They seek laws that push costs rightly bore by them to taxpayers.  Furthermore, they seek to have unrelated laws interpreted to reduce liability.  The Transocean filing is a perfect example.  They are attempting to use a law that limits a ship-owner’s liability concerning cargo to limit their liability regarding environmental damage of the product they pump out of the ground.

Corporations use the 14th amendment to the US Constitution to define themselves as a person but that does not give them the good judgment or morality that comes with sentience.  There is evidence to suggest if a real person acts like a corporation, society will deem him or her a psychopath[v] if measured by World Health standards.  While that may not be true for all corporations, it does explain much of the bad behavior the news covers almost daily.  Corporations cannot be trusted with environmental stewardship.  It is contrary to their primary purpose to maximize profits for their owners.  That is why we need sensible regulations that require businesses to correct the bad deeds and unintended consequences (giving them the benefit of the doubt) regardless of cost.

In the end, we need to prevent corporations from using calculated externality to shift costs they rightly should pay.  It is not a question of their particular product costing more because someone else’s will cost more to make up the difference.  Take businesses’ own axiom “there is no such thing as a free lunch.”  In this case, the big oil companies are eating the lunch but taxpayers are going to pick up the tab.

[i] The Economist Newspaper, Limited. “Economics A-Z.” Economist.com. Web. 22 May 2010. <http://www.economist.com/research/economics/alphabetic.cfm?letter=E>.

[ii] Transocean, Ltd. “Transocean :: Our History.” Transocean :: Home. Web. 22 May 2010. <http://www.deepwater.com/fw/main/Our-History-3.html>.

[iii] Lipman, Melissa. “Transocean Seeks To Cap Oil Spill Liability At $27M – Law360.” Law360 : The Newswire for Business Lawyers. Web. 22 May 2010. <http://www.law360.com/articles/168268>.

[iv] Kahn, Chris. “Transocean Cites 1851 Law to Limit Spill Liability – U.S. Business- Msnbc.com.” Breaking News, Weather, Business, Health, Entertainment, Sports, Politics, Travel, Science, Technology, Local, US & World News- Msnbc.com. Web. 22 May 2010. <http://www.msnbc.msn.com/id/37128693/ns/business-us_business/>.

[v] Hulu – The Corporation –  By Joel Bakan. http://www.Hulu.com. Web. 22 May 2010. <http://www.hulu.com/watch/118169/the-corporation?c=News-and-Information/Documentary-and-Biography>.


  1. hey whats your myspace page.

    • Sorry,I don’t use Myspace

  2. Good article and sound research, Michael. As usual, you have clear vision. I wish the situation wasn’t so dire, though.

    • Thanks Suzie, it is simply amazing we allow them (oil companies in general) to run roughshod over us and the world itself. I guess Noam Chomsky is not that far off base when he talks about how corporations manufacture public opinion.

  3. But the government must immediately get forces in to clean up the spilled oil. And then charge BP et al for the expense (which will result in your oil prices and my oil prices to go up.). But stop the finger pointing and engage the other four + five and get to work.

    • There is no question at all about getting it cleaned up ASAP. It has already gone too long without the government forcing the issue, however much force that requires. As far as blame goes, there is no finger pointing, it is the fault of three companies and a government that let them do this without a plan.

      As an engineer, I can promise you at least one of the companies involved understood the risk they were taking. If we get the drawings out there will be a name with a P/E (Professional Engineer) stamp on it. That is one person that’s on the hook for sure. It comes with the territory.

      As far as costs go, you may be right it will force the price up. That is just another reason to end our dependency on oil in the first place.

  4. In the next four weeks, the Dow Jones Industrial Average will drop at least 300 points upon growing fears of the ongoing economic crisis looming in the United States and abroad as instability in Greece and other European countries suffer the devaluation of the Euro as it tumbles into “no man’s land.”

    BP’s latest attempt to cap the oil pipeline 5,000 feet underwater (a.k.a. “Top Kill”) using robots will fail. They will then come up with a “new plan” out of thin-air in an effort to seal the pipe and to instill confidence in the public. The Obama Administration will finally step in to take control of the operation, adding much needed resources in an effort to assuage the outrage being felt by Americans everywhere over this environmental catastrophe. A team of engineers and scientists will be sent down to the ocean floor, via bathyscaphe, in order to view the damage head-on and to make assessments as to how to repair the damage.

    Is this a future foretold, or just simple deductive reasoning?

    You decide.

    • Well, as the Dow did drop and the federal government is taking more control over things now. As for the prediction of the Top Kill failing, let’s just hope you are wrong on that one. I really don’t care who gets the credit for stopping it as long as they stop it.

  5. Good ‘n MH. One of your most informative posts yet. ‘Externality’ btw is not even in the dictionary. Like a lot of legalese bs.

    the 75m liability limit was enacted after the Exon Valdeze fiasco. what congressmen voted for that?
    It’s out of control. USA Inc has taken over, and Americans have no one to blame but themselves.

    ‘He who sacrifices freedom for security, deserves neither.” Ben Franklin.

    • Thanks J,

      I know. I was researching an article for a newspaper about 2 years ago and come across it. It is amazing how businesses leverage things to their advantage.

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