Trigger prices for the ANWR

The Energy Policy Act of 2005 (CRS Summary) avoids the Artic National Wildlife Refuge. Why? I understand the politics of ANWR, but isn't this a wonderful "$60/barrel" year to open up ANWR to drilling?

The Energy Policy Act of 2005 (CRS Summary) avoids the Artic National Wildlife Refuge. Why? I understand the politics of ANWR, but isn't this a wonderful "$60/barrel" year to open up ANWR to drilling?

Conrad and Kotani have a forthcoming paper in Resource and Energy Economics, "When to drill? Trigger prices for the Artic National Wildlife Refuge." (First of all this is a great paper. The type that we rarely see in the academic journals: a rigorous analysis that actually informs about a current policy issue. Maybe the new AERE journal will be a forum for more of this stuff.) Their idea is to find the minimum price (i.e., trigger) at which a barrel of oil must be before it is efficient to drill in the ANWR (i.e., when the benefits of oil exceed the costs of nature preservation).

Conrad and Kotani find that

... for variations in [amenity loss] ranging from $200 million to $300 million per year, the trigger price ranged from $ 19.84/barrel to $ 21.26/barrel. With no amenity loss (A = 0) the trigger price was $ 17.01/barrel. If amenity value is exponentially growing ... from ... $200 million, [the trigger price] is $19.99, only slightly greater than P^* = $ 19.84 ...

This result is based on the assumption that the average annual U.S. household willingness to pay (i.e., WTP, existence value) for ANWR protection is between $2-$3. With 100 million households the aggregate WTP is $200 million to $300 million. They conclude that when the price of oil is greater than, about, $20/barrel then the benefits of drilling exceed the opportunity costs (the WTP). With another model the trigger price is about $25 but still well below current prices.

So, go ahead and drill for oil ... ? Not so fast. The analysis depends crucially on the assumed $200 million to $300 million cost of drilling, right? Not really. Big changes in the amenity value don't change the trigger prices by much. Curiouser, when the amenity value is $0/household, the trigger price is only $17.01 (the marginal cost is $15 so the trigger price must be above that). I wondered why.

I decided not to take the derivative of equation 14 to really understand what is going on. Instead, I decided to try to find the trigger willingness to pay (WTP*) for various oil prices using the Conrad and Kotani base case assumptions and a very simple model (several orders of magnitude simpler than Conrad and Kotani's model).[a]

I find that when annual household WTP is between $2 and $3, the trigger price for a barrel oil is about $20. The results are surprisingly similar to Conrad and Kotani's. But in this simple analysis the trigger prices are much more responsive to the willingness to pay values. The trigger price at my "best guess" WTP, $35[b], is $53. The breakeven WTP* when oil prices are at their all-time nominal (unadjusted for inflation) high, $60, is $42.

These are just some silly comparisons. We are absolutely clueless[c] about what the WTP for ANWR might be and, therefore, whether it is a good time to start drilling.

Notes:

[a] The simple model:

• Marginal extraction cost: MEC = $15/barrel
• Output: Q = 100 million barrels for t = 65 years
• Capital investment: K = $2.9 billion
• Discount rate: r = 10%
• Population: n = 100 million U.S. households

The benefits of extraction is the difference between revenues and cost:

B = Σ [[(P - MEC) × Q] ÷ (1 + r)] - K

The social cost of ANWR is:

C = (WTP × n) ÷ r

Net benefits are NB = B - C. The breakeven WTP (WTP*) is found by setting NB = 0 and solving for WTP:

WTP* = B × r ÷ n

In order for extraction in the ANWR to be avoided, the annual household WTP must be above WTP*. If WTP < WTP* then extraction is optimal.

Here is the full table of results.

[b] $35/household is about the mid-point of Larson's range of willingness to pay for preserving wildlife in the Bristol Bay Wildlife Refuge, see Table 24 in An Overview of Alaska's Natural Assets.

[c] In the dark. Ignorant. Without clue. Avoiding the question because we (both sides) already know the right answer.

Comments

[Jim Casey]

There is a major problem with the BCA of when to drill in ANWR that we are forgetting...If we start drilling tomorrow..the first drop does NOT hit the market for at least 9 years. And, nine years is a best guess from a friend of mine in the industry - not from the Sierra Club. How does it change the analysis if we include a 9 year delay???

JC

[John Whitehead]

Good point. Trigger prices rise by about $4 when the net market benefits of oil start coming in after 10 years of setup. When WTP* is between $2-$3 the trigger price is about $24.50. When WTP* is $35 the trigger price is $57. When the trigger price is $60, WTP* must be $38 to make preservation the recommended option.

[Ben]

If I understand correctly the formula and your are summing B over the 65 years, shouldn't your raise the (1+r) to the power of the year?

Also, the results depend *greatly* on the discount rate.

To quote wikipedia: "One of the major issues in economics is what is an appropriate discount rate to use under various circumstances. For example, in assessing the impact of very long-term phenomena such as climate change, use of any discount rate much more than 1% per annum renders long-term damage (occurring in, say, 200 years time) of negligible importance now, and therefore entails (implausibly) that there is no need to take preventative action."

[Jim Coomes]

This is sort of off the main point of the discussion, but;

1962-1973 low oil and gasoline prices, 11 years
1973-1986 high oil and gasoline prices, 13 years
1986-1999 low oil and gasoline prices, 13 years
1999-2012?? high oil and gasoline prices,13??years??

I was told by several Shell Oil people that Shell bought their oil leases, did the sismic survey, drilled, constructed the production facilities, mostly when the price of oil was low!!! It is my understanding that the fastest time to bring a field on line is five years. But, few oil companies have done this, in this short of time. Generaly speaking, 9 years would be about right.

When the price of oil is low, you can do some of the work for about 25 % of the cost in the peak oil price years. So, it takes you 9+ years to bring a field on line, But you do start out with a relatively low production rate,which will increase (with more drilling) in the comming years.

To me, it makes economical sence to start all this in the low oil price years because you are almost right in time the reap the high oil prices, WITH 25% of some of the cost.

This indicates to me, that it is the bean counters that are running the oil companies. Generaly, the bean counters don't have a good comprehension of their industries histories. (Just like the economists who lead us into the economical crash of 2000.)

The price of oil will probably crash around the year 2012. (1999 + 13 = 2012) Or when the next economical crash comes sometime after 2009. Just follow the 13 year business cycle.

[odograph]

that's some powerful math ;-), way beyond me:

"B = Σ [[(P - MEC) × Q] ÷ (1 + r)] - K"

... but i'm afraid the equation really used in congress is much simpler:

"who will give me campaign contributions?"

[Stefano]

Why should only Americans be computed in the loss of amenity from the ANWR drilling ?

If drilling permits where auctioned, and environmentalist organizations were permitted to bid, I suspect that many Europeans like me would be glad to contribute say 10-20 $ to save the ANWR.

[Jim Coomes]

Stefano,

"If drilling permits where auctioned"

They are auctioned, but they call them "leases". If you win the "bid" on an oil field lease, it comes with a time limit and a contract. Usualy the lease is for 5 years. But, to keep that lease longer that that time, you must do X amount of sismic survey, X amount of exploration "drilling"/wells, roads, cleanup, etc. Then, if you find enough oil to make it economical to produce that oil, there are other clauses in the contract.

So, if an enviermental group wanted to buy a lease, and do nothing with it, it would only be for X-5 years. When you don't fullfill the other clauses of the contract, the oil lease reverts back to the original owner.