A benefit-cost analysis of "full-speed-ahead" drilling

From Robert Hahn and Peter Passel in today's NYTimes (Save the environment):

We found that full-speed-ahead exploitation of the restricted oil reserves would lower prices at the pump by a few cents at most. Nonetheless, it’s equally clear that the failure to develop these oil resources would cost the state and federal governments hundreds of billions of dollars in royalties and taxes.

First, the effect of full-speed-ahead on gas prices is minimal:

Our projections are based on government estimates that some seven billion barrels of oil could be extracted from the Arctic National Wildlife Refuge and a whopping 11 billion barrels could be had from the restricted offshore sites. That translates into an extra million barrels a day in the year 2025 — one-sixth of the total projected domestic output.

A big deal, right? Not in the context of the current political debate. The markets in which oil prices are determined are global, not local, and the extra million barrels would represent less than 1 percent of total world consumption in 2025. Thus we estimate that the million daily barrels would lower the price of crude by just 1.3 percent, which few consumers would even detect against the background noise of the weekly ups and downs of fuel prices.

And here is the benefit-cost analysis:

To many, that’s the end of the story. Why open a fragile ecosystem to drilling if it wouldn’t materially reduce Americans’ fuel bills? A good answer requires a shift in perspective, from the current focus on gas prices to a more comprehensive economic framework for weighing the public and private benefits of drilling against the likely costs.

Assuming that crude will still be selling for $100 a barrel down the road, we estimate that the oil from two new sources would be worth close to $1.85 trillion. Add to that the extra benefit to consumers of paying slightly less for imported oil and economic gains from being less vulnerable to supply disruptions, and the total benefit exceeds $2.1 trillion.

On the other side of the ledger, the expected costs of developing all that oil, including cleaning up environmental damage, would amount to a bit less than $400 billion. So, at a first cut, the decision to drill seems an economic no-brainer.

Why, then, the controversy? Many environmentalists argue that this calculation leaves out the biggest cost of all: the loss of the intangible benefits Americans get from knowing that the Alaskan refuge and outer continental shelf have been left untouched. Indeed, economists spend a lot of time thinking about such “non-use values,” if not much time agreeing on them. Still, our best attempt to get a fix on the non-use value of Arctic National Wildlife Refuge yields a figure of just $11 billion. In sum, this leaves about $1.7 trillion in tangible net benefits, so most people, one would guess, would still find the case for drilling to be compelling.

The last three paragraphs of the article argue that the revenue generated by drilling could then be used to preserve much more (local) wilderness that people actually care more about. The implication is that environmentalists should be in favor of drilling because it could lead to more environmental preservation. This argument seems empty to me, in the same way that revenue recycling from carbon taxes is empty. The policy of whether to drill or not, or whether carbon taxes are better than cap-and-trade without auctions, should be independent of whatever happens to the revenue that is generated. The revenue could be used for all sorts of things, foremost might be dealing with a big government budget deficit. Promising environmentalists that it could go for more protection or promising taxpayers that it could be used for lowering income taxes seems like a bribe that will never be realized.

Comments

[odograph]

I agree with your response John, but also when they say:

"Assuming that crude will still be selling for $100 a barrel down the road,"

I wonder about waiting a little longer, for perhaps $200/bbl

[TM]

Unfortuantely they leave out the long run cost of not putting the money into renewables instead of drilling.

[Rich Sweeney]

I don't really get your last point. Are you saying the revenue redistribution arguments are empty because they're not binding or because the net welfare implications of the program remain unchanged? Either way, I think the distribution of costs/benefits of either program are important, at least politically. If voters stand to lose the non-use value of these reserve areas, clearly they'll need to know what they stand to gain in return.

[John Whitehead]

Rich,

The benefit-cost analysis remains unchanged whether the government revenues are used to (a) buy wilderness, (b) cut taxes or (c) reduce the government deficit.

Your comment identifies the political problem, voters won't know what they stand to gain in return. It might be (a), (b), (c) or something else.

[Pradeep]

"The policy of whether to drill or not, or whether carbon taxes are better than cap-and-trade without auctions, should be independent of whatever happens to the revenue that is generated."

I agree. I see the value of these analyses, but think that they should be only one among many factors driving environmental policy.