Common Tragedies

Thoughts on Environmental Economics

Dirty little secret

Posted by Daniel Hall on July 17, 2008

Jeff Frankel argues that the Democrats are right to oppose off-shore drilling, but for the wrong reasons:

The Democrats have it precisely backwards. The problem with Republican proposals to re-open domestic oil drilling is not that we desperately need the oil right now, whereas new oil discoveries would not come on line for 5 to 10 years. Rather it is that we might truly desperately need the oil in 20 or 30 years, and so don’t want to use it up over the next decade. …

We don’t want to maximize current domestic production. Rather we want to leave the oil underground (or underwater) for decades, until we really need it, until we are so desperate that the economic benefits really do outweigh the costs.

This is the same dynamic that Rich mentioned a couple weeks ago: our decision to leave a bunch of our domestic oil in the ground looks like a pretty good investment decision now that oil is an order of magnitude more expensive than it was a decade ago.

But I am not convinced by Frankel’s argument that oil will march ever upward at astronomic rates and in 30 years we will be happy we left it in the ground. I can imagine states of the world where the price of oil is $20 in 30 years. (Perhaps a result of a battery-powered transportation fleet combined with electricity from renewables, nuclear, and CCS plants.) At the very least economic theory tells us that when both supply and demand are very inelastic that small changes in either can result in very, very large price changes. No one in 1980 thought oil could ever drop to $10 a barrel again. It did.

The dirty little secret of energy policy in the U.S. today is that opening up our domestic reservoirs would almost certainly pass any reasonable cost-benefit test.

The way to perform a cost-benefit calculation is not to assume that you know the future distributions of costs and benefits (as Frankel does). The cost and benefits we measure today are the best estimates we have. We should use them and have an honest debate about whether we want to drill domestically.

This doesn’t mean we shouldn’t try to give our best estimates of the distribution of future costs and benefits. Historically, our preference for environmental quality has risen over time. We should consider that the next generation may place an even greater value on a pristine ANWR or ocean shelf than we do. We should also try to think realistically about what oil prices are going to be.

But recall also that a couple weeks back I pointed readers to a research paper [ungated version here] that found that opening ANWR would lead to benefits of $1141 per person in the U.S., and this was at an oil price of around $53 per barrel. In other words, the environmental costs (or our willingness to pay to prevent environmental damages) would have to be more than $1000 per person if drilling in ANWR were going to fail a cost-benefit test. At current oil prices it seems inevitable that domestic drilling would pass.

This does not imply we should necessarily drill. There are many metrics besides dollar values for making decisions about our environmental management and energy policy. But I have yet to see anyone in this debate honestly state the facts about domestic drilling. The lie Republicans will tell you is that domestic drilling will lower oil prices. The lie Democrats will tell you is that because it won’t it’s not worth doing.

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9 Responses to “Dirty little secret”

  1. [...] while Democrats want more drilling on current leases, in the NYT. Common Tragedies explores the dirty little secret of the economics of drilling, but California senator Dianne Feinstein wont have it: In an L.A. Times op-ed, she slams [...]

  2. Mark Lazen said

    Howdy Daniel,

    Interesting reference to this topic from Lou Grinzo over at the Collective. He refers to a Jim Kingsdale piece about the value of starting the process immediately of accessing oil we will need ten years hence…

    http://theenergycollective.com/blog/LouGrinzo/site/posts/?bid=25059

    Take care!

    m.

  3. azam said

    How much oil is there anyways? I recently read that it’d be a really minute amount.

    And even if there is sufficient oil for a bunch of years, why would the oil companies sell to the Americans with the weakening dollar? why not sell to the asians?

    And by 10 yrs why couldn’t we have diff types of cars? And what about other biodiesels like jatropha?

    I’d rather listen to Amory Lovins on this topic.

  4. Daniel Hall said

    Azam, thanks for you questions and comments. In order:

    The paper I reference above uses a USGS report that estimates the ‘technically recoverable’ oil in ANWR. The mid-range estimate is about 7.7 billion barrels. Another recent CRS report based on the same USGS data has a higher mid-range estimate of 10.3 BBO. Is this a lot or not? I guess it depends on your metric. At current U.S. consumption levels it represents somewhere between a year and year-and-a-half of U.S. consumption. (Of course it will come out in a much slower trickle over a longer period.) But the point of the post is not how much is there per se, but its economic value.

    Regarding where the oil gets sold, it really doesn’t matter. Remember, oil is a global commodity market. The oil companies could sell wherever they wanted. But if the global price is, say, $100 then I guarantee that American refineries can find someone somewhere in the world who will trade them a barrel of oil for $100 cash money. (Yes, ok, the point about oil being a global commodity might not apply if we decided to nationalize all our energy resources and companies but I think the odds of this happening in the near future in the U.S. are very remote. Further, even if it happened then presumably this would be done exactly so that we could keep all our oil resources for ourself and ignore the opportunity costs that a private business would consider.)

    Of course in 10 years we could have very different cars. This is indeed the major problem that I had with Frankel’s post: just because oil is really expensive now does not mean it will be for all time. But I think that most people would agree that our car fleet (and oil demand) is more likely to be radically transformed in 20 years than in 10 (or indeed generally in X+10 years rather than X years). Like Rich mentioned in his previous post that I linked above, you could think about the oil like a hedge: set up to drill over the next few years, but only allow actual extraction if prices were above a threshold.

    And you are in good (or at least numerous) company in your preference for Lovins. Frankly it is an honor to know I make it onto the same list of “people whose opinions you read about oil”.

  5. Rod Adams said

    Daniel:

    You make an interesting point about the cost benefit analysis. If I was a member of Congress, one of the things that I would be doing when listening to the drilling discussions would be to have a calculator out so I could ask questions of my colleagues like – do you realize how much that “small amount” of oil might be worth to us?

    I would also be pressing my staffers to be tough negotiators to make sure that the current owners of the oil reservoirs – the American people – are well represented in the negotiations over royalties and taxes. That was not the case when we had people in the Department of the Interior who essentially gave our oil in many rich Gulf of Mexico reservoirs to the majors without demanding any cut of the production. That decision is costing our treasury tens of billions of dollars each year.

    WRT Lovins – I think you need to understand a bit about the man before trusting him as an energy prognosticator – he is a self admitted two time college dropout without an earned degree who has called himself a physicist and Chief Scientist for more than 3 decades. He also recently told Amy Goodman on Democracy Now – “You know, I’ve worked for major oil companies for about thirty-five years, and they understand how expensive it is to drill for oil.”

    I respect the technical efforts of oil companies but not their business practices. Anyone who has worked for them for 35 years probably understands that their product is more profitable when it is most painful for all of the rest of us.

    Rod Adams
    Editor – Atomic Insights
    Host – The Atomic Show Podcast

  6. aaron said

    Sitting on oil would make sense if we could borrow on future value in 20-30 years when it’s desprately needed, otherwise it’s retarded. We run the risk that it won’t be desperately needed in the future and we give up the compounding economic growth that would be produced off its use now.

  7. Scott S. said

    “I have yet to see anyone in this debate honestly state the facts..” Evan, you’re familiar with the general concept of politics right?

  8. John Mashey said

    A friend’s 13-year old daughter asked him:

    “Daddy, are you adults going to leave any oil for us?”
    A: not much, and almost none for your kids.

    Personally, I’d love to see Congress pass a law that effectively metered the drilling so that the production in new areas stretched over the next 100 years, and subject to local state approvals.

    Oil will still be useful 100 years from now, although hopefully, not for burning.

    One friend thinks that Peak Oil is about here, and the #1 priority is increasing efficiency drastically [while we keep getting the oil/gas we can, and doing the huge effort to build sustainable energy supplies to replace that, which won't be short or easy.] Even if I didn’t already think that, I’d listen hard to him, since he used to be Vice-Chairman of Chevron, in charge of all exploration and development…

  9. [...] the bottom-line impact of more offshore drilling. As Common Tragedies pointed out a while back, the dirty little secret of offshore drilling is that it would probably mean economic benefits for all Americans, even if it [...]

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