5

Incentives of the Offshore Oil and Gas Industry Regulatory Structure

The committee’s Statement of Task asks it to “consider how the regulatory structure motivates or incentivizes technological, environmental, organizational, and process changes that could decrease the systemic risks of offshore oil and gas operations.” This chapter provides the committee’s response to this element of its charge. It builds on a framework developed in the Transportation Research Board (TRB) report Designing Safety Regulations for High-Hazard Industries, a previous National Academies report that addressed how different types of regulations affect the risks of hazardous materials production and distribution (see NASEM, 2018). The committee that authored Designing Safety Regulations provides insight into the incentives that four different types of regulations provide and apply offshore. Based on this framework, the first section describes the general attributes and incentives ascribed to the different types of regulations that apply offshore. The second section summarizes the advantages and disadvantages of different regulatory types. In the third section, we offer conclusions about how the incentives for systemic safety risk management that these different types of regulations provide affect systemic risk, and how these incentives sometimes conflict.

REGULATORY FRAMEWORK

Many discussions about regulations and how they motivate regulatory and private industry behavior use the dichotomy of “prescriptive” versus “performance” regulation to distinguish types, but the authors of the Designing Safety Regulations report show that there is considerable

ambiguity and confusion about which regulations qualify as being either prescriptive or performance (NASEM, 2018). Rather than distinguish regulations by classifying them this way, the 2018 TRB report identifies four basic types of regulations in terms of whether they require an explicit goal to be achieved (“ends”) or require that a particular strategy be pursued (“means”). It also categorizes regulations by their scale—whether addressing individual components of the system (“micro”) or the system as a whole (“macro”). This results in the four-way matrix illustrated in Table 5-1, which also provides examples of safety regulations that fit within each category.

The 2018 TRB report also points out that the regulatory structure of most hazardous industries includes multiple types of regulations, which can give industries different and sometimes conflicting incentives, as described later (NASEM, 2018).

For the 2018 TRB report, the regulation requiring offshore safety and environmental management systems (SEMS) (30 CFR Part 250, Subpart S) put in place following Macondo would be defined as a macro-means

TABLE 5-1 Four Basic Types of Offshore Regulations with Examples

NOTE: BAST = best available and safest technologies; SEMS = safety and environmental management systems.

SOURCE: Adapted from Coglionese (2010).

regulation because it specifies the processes to be followed to reduce risk but does not specify a numerical goal to be achieved. Rather, the regulation specifies that the goals is to “promote safety and environmental protection by ensuring all personnel aboard a facility are complying with the policies and procedures identified in your SEMS.”¹ One could argue that the intended goal of SEMS is a generalized notion of safety, as well as continuous improvement toward it, as is a commonly described goal of safety management systems, but neither the SEMS regulation nor RP 75 states this specifically. Another principal regulatory reform following Macondo was the Well Control Rule (WCR; 30 CFR Part 250), which has both micro-means and micro-ends requirements, as discussed later. We expand on the advantages and disadvantages offered by SEMS and other offshore regulations in the next section after providing examples of how the various regulations that apply offshore fit within this four-way matrix.

Micro-means

Micro-means (“prescriptive”) regulations that apply to specific components would include the WCR’s (30 CFR Part 250) requirements that apply to blowout preventer (BOP) performance and testing; circumstances when real-time monitoring of deepwater wells during drilling must be used; and the specific pressure balance that must be maintained during drilling (0.5 pound per gallon drilling margin). Other aspects of the WCR would fit in other categories, as mentioned below. Regarding micro-means design and specification standards, BSEE regulations incorporate more than 125 standards developed by standards organizations such as the American National Standards Institute, the American Petroleum Institute, and others that cover topics as diverse as design of fixed and floating platforms; component piping design; inspection, maintenance, and testing; and so forth.² Many of these are micro-means regulations. On its face, the requirement in the Outer Continental Shelf Lands Act (OCSLA) that the Secretary of the U.S. Department of the Interior require the use of best available and safest technologies (BAST) would appear to be a performance regulation. However, since the industry must employ those

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¹ See https://www.ecfr.gov/current/title-30/chapter-II/subchapter-B/part-250/subpart-S/section-250.1901.

² Standards incorporated by reference in BSEE regulations are listed in 30 CFR § 250. 198, https://www.ecfr.gov/current/title-30/chapter-II/subchapter-B/part-250/subpart-A/subject-group-ECFR5497b5f3f229fb9/section-250.198.

technologies that meet the legal test of BAST,³ the Designing Safety Regulations committee considers it a micro-means regulation since the means, once a technology is designated as BAST by the Secretary, are prescribed (NASEM, 2018, p. 67).

Micro-ends

Perhaps the easiest-to-understand performance regulations are some of those used in environmental regulation, which set limits on the amount of pollution as numerical standards for air and water (parts per million or billion per unit of measure), but do not specify how the goal is to be achieved. BSEE’s WCR has provisions that are micro-ends, including its requirement that the BOP blind shear rams must be capable of sealing the well in the event of a blowout (BSEE, 2019). There are also a number of micro-ends regulations that require components or designs to meet more general requirements, such as platforms and related structures that must be designed to ensure structural integrity for the specific environmental conditions where the structures will be used.⁴ Other examples include welding that must be done to ensure resistance to sulfide cracking⁵ and provisions in the WCR that require casing and cementing programs to use “adequate centralization.”

Macro-means

SEMS would be the primary example of this regulatory type in the United States, as described above. Another oversight process used by BSEE is the Deep Water Operations Plan (DWOP; 30 CFR §§ 250.285-250.295). As described on Chapter 2, the DWOP is akin to a safety-case approach in which the operator proposes a system for producing oil or gas in deepwater

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³ The BAST requirement is stated in section 21(b) of the OCSLA Amendments of 1978 as follows: “(b) In exercising their respective responsibilities for the artificial islands, installations, and other devices referred to in section 4(a)(1) of this Act, the Secretary, and the Secretary of the Department in which the Coast Guard is operating, shall require, on all new drilling and production operations and, wherever practicable, on existing operations, the use of the best available and safest technologies which the Secretary determines to be economically feasible, wherever failure of equipment would have a significant effect on safety, health, or the environment, except where the Secretary determines that the incremental benefits are clearly insufficient to justify the incremental costs of utilizing such technologies” (https://www.govinfo.gov/content/pkg/STATUTE-92/pdf/STATUTE-92-Pg629.pdf).

⁴ 30 CFR § 250.900, https://www.ecfr.gov/current/title-30/chapter-II/subchapter-B/part-250/subpart-I/subject-group-ECFR02237cde39821db/section-250.900.

⁵ 30 CFR § 250.490, https://www.ecfr.gov/current/title-30/chapter-II/subchapter-B/part-250/subpart-D/subject-group-ECFR121d2f36895c7d4/section-250.490.

(depths of 1,000 feet or greater) and explains production design and operation based on comprehensive risk and barrier assessments.

Macro-ends

BSEE has a few macro-ends regulations specified in OCSLA. According to 30 CFR § 250.107, among them are that operators must:

• Perform all operations in a safe and workman-like manner;
• Maintain all equipment work areas in a safe condition; and
• Use recognized engineering practices that reduce risks to the lowest practicable level.

In addition, under the Oil Pollution Act of 1990, as amended, offshore oil and gas facility operators face unlimited liability for spilled oil cleanup costs and liability for damages of up to 133 million (as of 2015 amendments) (Cameron and Matthews, 2016). (Note that BP estimates its total past and future payouts related to the Macondo spill at $67 billion, including criminal and civil penalties and individual damage payments under its settlement agreement with the federal government [see Sledge, 2019].)

REGULATORY INCENTIVES AND DISINCENTIVES⁶

This section summarizes the attributes of individual regulatory types and lists their pros and cons.

Micro-means

Table 5-2 lists a set of advantages and disadvantages of micro-means regulations. As a general summary of this table, the principal advantages are that they (a) provide clear instructions and (b) make obvious what companies must do and how regulators can assess compliance. For regulators who perceive their responsibility as one of strictly enforcing prescriptive regulations and penalizing operators who do not fully comply, such regulations provide precise requirements that will stand up in court. Similarly, for companies that approach safety with a compliance mentality, prescriptive regulations give them specific guidance, although this is mostly limited to equipment and certain operating and testing procedures.

The disadvantage with this regulatory strategy is that it is not suitable to an environment such as the U.S. offshore, where hazards vary for different operations, especially as operations shift from shallow to deeper water,

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⁶ This text draws heavily from NASEM (2018, pp. 30-32 and pp. 89-121).

and technology is constantly improving. Moreover, the specifications for individual components do not fully consider how all of the individual components must work together as part of an integrated design and operation of a complex system. These circumstances require the regulator to regularly revise or add new prescriptive requirements that, in any case, cannot be added in a timely way given the cumbersomeness of the U.S. regulatory process. Such regulations also do not motivate companies to pursue potentially more safety-enhancing efforts or means of producing the same level of safety at less cost, or provide flexibility in doing so, except through a waiver process that can also be cumbersome. Moreover, a long list of prescriptive regulations inhibits the application of a safety-case approach whenever safer technological and process innovations are developing and capable of being applied faster than regulations can be put in place.

The other principal disadvantages are that (a) micro-means regulations may encourage an industry mindset that compliance with regulations equals safety, even though compliance levels set in standards or regulations can be less safe than what is achievable through other means at the same or lower cost and (b) they do not address organizational and cultural issues that are often the root causes of major catastrophes. Thus, micro-means regulations

TABLE 5-2 Micro-means (“Prescriptive”) Regulations

SOURCE: Data from NASEM (2018).

do not incentivize process, organizational, or technological changes that address systemic risks.

Micro-means regulations are also often criticized for inhibiting technological innovation. At least for the U.S. offshore OCS, however, operators have been highly innovative in developing improved designs and technologies required for operations, initially in shallow water, and especially in deepwater, where exploration and production advanced much faster than standards or regulations could be developed (see discussion of DWOPs in Chapter 2). Presumably the vigorous innovation in technology was motivated by profit and desire for efficiency in discovering and producing hydrocarbons, but the technologies put in place also enhanced safety. For example, platforms and rigs were built to withstand severe storms, and robust well casings were designed to not fail despite the enormous heat and pressure of deepwater drilling.

Micro-ends

We list the pros and cons of micro-end regulations in Table 5-3. They have the advantage of focusing on desired end results rather than means of achieving them, but they can be challenging to design and implement.

Federal environmental regulations that restrict pollution to set levels must be based on scientific evidence about their impact on human health. Setting a quantitative performance standard is difficult to do for individual physical components (at the micro-scale) used offshore, except in the limited cases where the performance standard is exact, as it is in the case for shearing drill pipes in the event of a blowout.

TABLE 5-3 Micro-ends (“Performance”) Regulations

SOURCE: Data from NASEM (2018).

Macro-means

Macro-means regulations based on management system concepts have become the preferred approach for offshore regulators in the United States, North Sea, Canada, and Australia because they are well suited to the offshore, where complex risks vary with location and facility type, and the onus for identifying and managing these hazards can be placed on the operator that is generating the risk. See Table 5-4 in this regard. To the extent that operators implement safety management systems in the spirit in which they are intended—to aim for continuous improvement—the flexibility given to operators to identify and manage risks appropriate to circumstances may encourage process and technological innovation in safety. The emphasis of SEMS on management processes and its requirement to identify root causes of incidents and accidents also obligate operators to

TABLE 5-4 Macro-means (Management System–Based) Regulations

NOTE: SEMS = safety and environmental management systems.

SOURCES: Data from NASEM (2018) and TRB (2012).

identify causes of failures, in both technology and human performance, that may trace back to organizational decisions and culture, thereby focusing on systemic risks.

Although the advantages outweigh the disadvantages, safety management systems do require operators to learn about and integrate processes to reduce risk within existing corporate management approaches. The requirements can be burdensome for smaller, less well-resourced operators that lack familiarity with such systems, and which find it more difficult to absorb the additional administrative costs than larger operators with economies of scale. There are many small operators among the heterogeneous industry that operates in the Gulf of Mexico.

Another issue peculiar to the OCS is the reliance of operators on contractors to carry out 80 percent or more of the actual work being done, including the most hazardous drilling operations.⁷ As discussed in Chapter 2, BSEE’s regulatory authority focuses on leaseholders (operators) and not on contractors, although SEMS places some obligations on operators to ensure that they hire competent contractors with appropriately trained workforces. Even so, the integration of contractor safety practices with operator SEMS programs (and across company cultures operating on facilities) is not straightforward.

Effective regulation of SEMS also places additional obligations on BSEE as the principal regulator. Operator SEMS programs cannot be inspected effectively using the same engineers and methods that BSEE, and Minerals Management Service (MMS) before it, have long relied on. They require more skills sets and training than BSEE has had in the past and require a longer time period for inspections than typical BSEE inspections of physical plant (see NASEM, 2021, Chapter 4). As the 2021 NASEM report on BSEE’s inspection program notes, BSEE has expressed aspirations to reorient its inspection activities to be more capable and more focused on enhancing safety through SEMS and other means, but, to date, “BSEE has shown limited ability to adapt its personnel and resource deployments” to this task (NASEM, 2021, p. 129). Even so, the SEMS regulatory structure does incentivize both industry and regulator to modernize their approaches to safety management. If BSEE is permitted to work more collaboratively and effectively with industry in the SEMS context and can enhance its skillsets and information systems to target its efforts accordingly, it would certainly increase the prospects for enhanced safety offshore. We return to this theme in the final section of this chapter.

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⁷ See https://www.bsee.gov/sites/bsee.gov/files/performance-data-table-2010-2020-12-16-2021.pdf.

Macro-ends

Macro-ends, or general duty or liability regulations, may be the easiest for legislatures to require and regulators to write rules for, because they specify the broadest goals that must be achieved. However, discerning compliance by both operators and regulators can be difficult when goals are vague and hard to measure and depend on results from litigation. Table 5-5 summarizes the main advantages and disadvantages of these kinds of safety regulations. In principle, they ought to incentivize firms to address hazards in the most systematic and cost-effective manner and, absent the many existing other regulations described above, firms could do so in the most flexible ways. In practice, however, this type of regulation has considerable disadvantages.

Primarily, the emphasis on avoiding liability drives companies to prefer and focus their efforts on compliance with prescriptive regulations and standards because doing so is a strong defense in tort liability cases. As elaborated more below, the incentives of macro-means regulations can conflict with those in SEMS that are intended to move beyond the mentality of compliance with prescriptive regulations equaling safety. Moreover, given the rarity of major disasters, some top executives may believe that liability caps in federal legislation, insurance, or bankruptcy are sufficient corporate hedging strategies should a disaster occur, thereby blunting the otherwise

TABLE 5-5 Macro-ends (General Duty or Liability) Regulations

SOURCE: Data from NASEM (2018).

desirable incentive of macro-ends regulations that companies design safety programs to address systemic risks in the most effective ways.

CONCLUSIONS

This chapter responds to the Statement of Task element that asks the committee to assess how the regulatory structure incentivizes, or does not incentivize, systemic risk management. The committee made this assessment using a framework developed in the NASEM (2018) report Designing Safety Regulations for High-Hazard Industries.

Conclusion 5-1: Micro-means regulations, often referred to as “prescriptive” regulations, do not incentivize technological, organizational, or process changes to address systemic risk. Micro-ends regulations, often referred to as “performance” regulations, incentivize technological and process innovations, but not necessarily organizational changes. Neither type is sufficient to address the complex and varied hazards that exist in the offshore environment. Macro-means and macro-ends regulations incentivize technological, organizational, and process changes to address systemic risk. The chapter’s overview of the four different types of regulation makes clear that the incentives of the various regulatory types do not necessarily align in practice. The lack of alignment across regulatory types has not inhibited technological innovation offshore.

Conclusion 5-2: Macro-means regulations specify that a safety management system process must be followed, but they give operators considerable flexibility in identifying and managing hazards that are unique to their circumstances and address the kind of organizational safety management failures seen at Macondo. Thus, SEMS specifies what must be done, but the offshore operator determines how hazards are identified and assessed and how barriers are applied to mitigate risks specific to their operations. In principle, if industry and BSEE together implement SEMS as intended, the incentives should foster greater attention to identifying and managing systemic risks.

Conclusion 5-3: The regulatory structure that applies offshore includes all four types of regulations, which do not always align and sometimes conflict. One example of how the interacting effects of various regulatory actions affect safety is the mixed incentives of macro-means (especially SEMS) and macro-ends (especially liability) regulations. The use of SEMS to focus on systemic risks would be enhanced by more open sharing of accident precursor data, especially regarding process safety near misses or organizational lapses in barrier management, but most

companies appear to be reluctant to share information that may raise liability concerns established in general duty or liability regulation and appear to worry about regulators being able to maintain data confidentiality because of open records laws, Freedom of Information Act obligations, and the legal discovery process.

BSEE, by operating through SafeOCS, has gone to great lengths to protect companies during the legal discovery process from being identified as the source of near-miss data. Nonetheless, although a few major companies representing 90 percent of offshore production now participate in the SafeOCS ISD program, it has required more than a decade to achieve this level of participation, and the results are only just beginning to be useful for systemic risk management. Industry participation is much higher for the SafeOCS fail-safe systems because provision of data to those databases was made mandatory in the Well Control and Oil and Gas Production System Safety rules of 2016.

The protections from disclosure of sensitive data are considerable for federal statistical agencies, which includes the agency on which BSEE relies for SafeOCS. However, a highly confidential system such as SafeOCS ISD has disadvantages. The results delivered publicly have to be high level and generalized to avoid industry concerns about liability. Doing so, however, does not support good dialogue, collaboration, and interaction between the regulator and individual companies, since the regulator does not know the source of the individual company data shared in SafeOCS.

Conclusion 5-4: As noted in Chapter 2, the offshore industry lacks the legal, regulatory, and policy protections available to commercial aviation that protect providers from having their safety precursor data used against them in enforcement or legal proceedings (if the data are collected, shared, and analyzed for the purpose of enhancing safety). The application of the data protections and policies used in aviation to the offshore is a worthwhile topic for further consideration and research.

Conclusion 5-5: The mixed incentives of the different regulatory types pull BSEE in different directions. BSEE’s history as a regulator has been partly driven by its mandate to inspect every offshore facility at least once per year based on compliance with micro-means regulations, which it enforces through INCs and fines and punishment for operators who do not comply. (Typically, the fines assessed to operators are not large, but the reputational damage could be.) Micro-means regulations, as well as macro-ends liability regulations, fit within a regulatory philosophy based on deterrence theory, whereby detection and punishment

of offenders is meant to send a message to others to comply with the rules. Of course, regulations must be obeyed, but this model places BSEE in a policing role, which can result in an antagonistic and litigious relationship with industry.

In contrast, SEMS macro-means regulations work best when they encourage collaborative problem identification and solving between regulator and operator, as is more common in nations with the safety-case approach. Third-party audits play more of the inspection role in this regime, but they are different. A good audit would focus on how well an operator is carrying out its own SEMS plan. The results provide an opportunity for BSEE’s safety experts and the operator to discuss how the operator can and should improve and it gives both parties metrics than can be used to measure progress. For operators with a culture of safety, this process could motivate continual improvement. Whether BSEE can be perceived by operators as a trusted partner in this process depends in part on how much BSEE is perceived as characterized by its policing and compliance role and by how much it is perceived as being insightful and capable of assisting in effectively managing systemic risk. BSEE is striving to add these capabilities, but it will require (a) leadership by the executive and legislative branches to support it in doing so and (b) expansion of the expertise of its workforce in the variety of disciplines needed for safety management systems. TRB’s 2021 report on reforming the BSEE inspection program has several recommendations that would help BSEE reorient its safety efforts to maximize the benefits of SEMS (NASEM, 2021, pp. 131-149).

REFERENCES