Assessing risks and regulating safety standards in the oil and gas industry: the Peruvian experience

Environmental regulation has usually focused on controlling continuous sources of pollution such as CO2 emissions through carbon taxes. However, the 2010 oil spill in the Gulf of Mexico has shown that accidents associated to safety failures can also generate bursts of pollution with serious environmental consequences. Regulating safety conditions to prevent accidents in the oil and gas industry is challenging because public regulators cannot perfectly observe whether firms comply with safety laws. Likewise, it involves a complex political process in which different agents such as the government and oil companies interact and compete. This paper studies this problem in the case of Peru, providing a framework to analyze the enforcement of regulations designed to control safety standards in the oil and gas industry. Regulating oil accidents demands a holistic approach, for the paper discusses different contributions from economics and game theory to understand the safety regulatory framework of Peru representing the interactions among the government, oil companies, and public regulators. It characterizes the optimal public enforcement strategy to prevent safety law violations causing accidents. Policy instruments such as self-reporting, monitoring and economic incentives are also analyzed considering the Peruvian experience. It is possible to represent using a simple decision framework the complex institutional system governing safety regulations in Peru. Economic motives in an uncertain business environment drive law infringing behavior that leads to safety violations, so the government finds optimal to apply a law enforcement strategy that attacks these incentives. Oil and gas companies may find beneficial to comply with safety standards to minimize private losses associated to large accidents involving oil spills, gas pipelines leakages, etc. Understanding how to properly regulate the occurrence of oil and gas accidents is fundamental for the legitimacy of the oil industry and governments’ stability in a context where citizens demand improvements in safety standards and environmental quality. The analysis provided here can help oil firms and regulators in different jurisdictions assess the risks involved in oil and gas operations and the optimal ways to diminish them by considering appropriate regulations that balance the interests of companies and the governments’ objective of protecting the environment and human health.