More on ANWR trigger prices ...

In response to some good comments on the trigger price post I've added a ten year wait between drilling prep and actual drilling (with discounting this reduces the future profits and future costs to those who would have enjoyed the caribou) and calculated the trigger price/willingness to pay combo with a 2% discount rate (which makes the future more valuable than with a 10% discount rate).

First, a summary of terms:

1. Trigger price - the price at which it becomes a good idea to drill ANWR; if the market price rises above the trigger price then the oil companies are making money above their costs of production and would be able to compensate all those who like caribou.
2. Willingness to pay star (WTP*) - the household value below which it is a good idea to drill ANWR; if the actual household value of preserving ANWR is below WTP* then people don't care enough about caribou to compensate the oil companies for their lost profits.

Trigger prices rise by about $6 when the net market benefits of oil start coming in after 10 years of setup (with a 10% discount rate). When WTP* is between $2-$3 the trigger price is between $26 and $30. When WTP* is $35 the trigger price is greater than $75. When the trigger price is $60, WTP* must be $15/year to make preservation the recommended option.

When the discount rate is 2% (and oil starts flowing after 10 years) the trigger price at each WTP* is lower. When WTP* is between $2-$3 the trigger price is between $19 and $21. When WTP* is $35 the trigger price is $75. When the trigger price is $60, WTP* must be $26/year to make preservation the recommended option. Here is the full table:

Trigger Price	WTP*	WTP*(r=2%)
$15
$16		$0
$17		$1
$18		$1
$19		$2
$20		$2
$21		$3
$22	$0	$4
$23	$0	$4
$24	$1	$5
$25	$1	$5
$26	$2	$6
$27	$2	$7
$28	$2	$7
$29	$3	$8
$30	$3	$8
$31	$4	$9
$32	$4	$10
$33	$4	$10
$34	$5	$11
$35	$5	$11
$36	$5	$12
$37	$6	$12
$38	$6	$13
$39	$7	$14
$40	$7	$14
$41	$7	$15
$42	$8	$15
$43	$8	$16
$44	$9	$17
$45	$9	$17
$46	$9	$18
$47	$10	$18
$48	$10	$19
$49	$10	$20
$50	$11	$20
$51	$11	$21
$52	$12	$21
$53	$12	$22
$54	$12	$23
$55	$13	$23
$56	$13	$24
$57	$14	$24
$58	$14	$25
$59	$14	$26
$60	$15	$26
$61	$15	$27
$62	$15	$27
$63	$16	$28
$64	$16	$29
$65	$17	$29
$66	$17	$30
$67	$17	$30
$68	$18	$31
$69	$18	$32
$70	$19	$32
$71	$19	$33
$72	$19	$33
$73	$20	$34
$74	$20	$34
$75	$20	$35

Spreadsheet: ANWR-SIM.xls

Comments

[Ben]

According to your formulas (and my intuition) WTP* should go down when the discount rate goes down. Although I dont quite know the details of your calculations I feel theres something wrong.

[ben]

Maybe you could send my the spreadsheet and I could look at it. I'm not an economist, but i'good in math.

[John Whitehead]

Ben, here is what my intuition tells me.

When the discount rate falls the future benefits (net returns on oil) and costs (the lost caribou value) both rise. Since both series of numbers are constant through time (an iffy assumption) the impact there is the same.

However, with a lower discount rate the impact of the upfront costs of production is relatively smaller and the gains from drilling increase.

I'll post a link to my spreadsheet ASAP on 8/3.

[Ben]

I verified the spreadsheet and everything seems to be in order.

Notice that if the Discount rate goes lower than 2%, WTP* starts going down, at 0.1% it is fairly low. With r of 0%, WTP* is 0.

Now this is partly due to the fact that you approximated C by assuming that the damages have an infinite time span. This is however not necessarily a mistake if we assume that some of the damages to ANWR will be irreparable, (e.g. lost species).

There are other philosophical considerations. Who says that the social value of ANWR isn't to grow at the same pace as the economy, which would justify a nearly null discount rate? Scarcity of wild life is forever growing. And the environmentalist assumption is that wild life is necessary to sustain the human race. It is not an unlikely scenario that as it becomes scarce the human race eventually realizes the importance of nature for survival and starts valuing it much more.

Also where in the equation, are the benefits from biodiversity, augmentation of air quality (hence health costs savings) and reduction of greenhouse gases from all that oil staying in the ground? Some would argue that greenhouse gases are so detrimental that we should add the cost of putting an equal amount of carbon back into the ground. Or alternatively add the cost of buying land and planting a forest that sequester and equal amount of carbon to that which would be extracted.

It’s hard to justify all these costs but the fact that they aren’t in the equation assumes that the costs are all null which I greatly doubt.