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.
