Drilling Like There's No Tomorrow: Bankruptcy, Insurance, and Environmental Risk

When liability is limited by bankruptcy, theory says that firms will take excessive environmental and public health risks. In the long run, this “judgmentproof problem” may increase the share of small producers, even when there are economies of scale. I use quasi-experimental variation in liability exposure to measure the effects of bankruptcy protection on industry structure and environmental outcomes in oil and gas extraction. Using firm-level data on the universe of Texas oil and gas producers, I examine the introduction of an insurance mandate that reduced firms’ ability to avoid liability through bankruptcy. The policy was introduced via a quasi-randomized rollout, which allows me to cleanly identify its effects on industry structure. The insurance requirement pushed about 6% of producers out of the market immediately. The exiting firms were primarily small and were more likely to have poor environmental records. Among firms that remained in business, the bond requirement reduced oil production among the smallest 80% of firms by about 4% on average, which is consistent with increased internalization of environmental costs. Production by the largest 20% of firms, which account for the majority of total production, was unaffected. Finally, environmental outcomes, including those related to groundwater contamination, also improved sharply. These results suggest that incomplete internalization of environmental and safety costs due to bankruptcy protection is an important determinant of industry structure and safety effort in hazardous industries, with significant welfare consequences. ∗Agricultural and Resource Economics, University of California, Berkeley and Energy Institute at Haas. Email: [email protected]. I am grateful to Severin Borenstein, Lucas Davis, Meredith Fowlie, Catherine Wolfram, Max Auffhammer, Hunt Allcott, Ryan Kellogg, Reed Walker, Sol Hsiang, Jeremy Magruder, Walter Graf, Pat Baylis, and Paula Pedro; to seminar participants at UC Berkeley, EI at Haas Energy Camp, and Camp Resources; and to the Railroad Commission of Texas. Funding for this project is from the Energy Institute at Haas and a National Science Foundation Graduate Research Fellowship.