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Drill, drill, drill?: the economics of drilling
Matthew Kotchen and Nicholas Burger have done a real study of the economics of drilling in ANWR (ungated, published version here). Ben Muse reports some of their results:
What are the benefits? Kotchen and Burger estimated that the oil had a value of $374 billion (writing in July 2007, they assumed a long-term price of $53/barrel), but that it would cost $123 billion to extract and market. The net return of $254 billion is divided consists of industry rents of $90 billion, Alaska tax revenues of $37 billion, and Federal tax revenues of $124 billion.
Under the authors' understanding of incidence, consumers wouldn't benefit much at all because oil prices would not fall noticeably. Still, drilling makes economic sense if the loss of environmental amenities is valued at less than $1,141 a person (per American, not per Alaskan) and that was with a price of oil roughly half of today's price.
At today's price of oil, a rough estimate of the benefit -- not counting environmental costs -- is over $600 billion. So the whole issue seems much more important than I had thought just one hour ago. Some approximation of taxes and transfers and auctions are available, so these gains can be redistributed to some extent if you wish.
That's a lot of wealth.
Posted by Tyler Cowen on September 4, 2008 at 11:31 PM in Economics | Permalink
Comments
Another big benefit is pushing the oil producers farther down the learning curve on drilling, producing, and transporting in very challenging, environmentally sensitive areas- where more and more big oil deposits are likely to be found.
Posted by: Tom Kelly at Sep 4, 2008 11:49:06 PM
Tyler, the key question for me is "how many more of these have we got?"
If the answer is low, it's money in the bank. We might see another $300B appreciation, or two.
Posted by: odograph at Sep 4, 2008 11:49:14 PM
And of course if the number is low, we face downsides from coming up empty.
That is not really a Peak Oil argument. It is a Domestic Oil argument.
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Posted by: Patrick at Sep 5, 2008 12:31:21 AM
1. I wonder if any organization quantified the environmental "costs" of this drilling? What relevance does $1,141 have to the local and global environmental impact?
2. $123 billion to extract and market (ex environmental costs?). What could a $123 billion investment in alternative energy sources bring us?
Posted by: jc at Sep 5, 2008 12:40:18 AM
What could a $123 billion investment in alternative energy sources bring us?
An economic loss? And that is not counting opportunity cost.
Posted by: happyjuggler0 at Sep 5, 2008 12:52:36 AM
I could never get excited about drilling in ANWAR when oil futures were at $40, but if they are over $100, why not? Let's just make sure the federal treasury (i.e., us taxpayers) gets most of the increase in value instead of the oil companies or the state of Alaska, who were both willing to do it when oil was worth $40.
Posted by: Steve Sailer at Sep 5, 2008 12:58:48 AM
odograph: The numbers released to the public are always on the low end of possible values. 9 times out of 10, the ultimate output is far greater. The estimates are from the USGS, the same guys who said that the Bakken shale had only 100-125 million barrels of oil in it. After 125 million+ barrels were pumped out of it, with no end in sight, they revised their figures to 1 billion plus barrels in the Bakken. Don't be fooled. There is a lot of oil in Alaska. A heck of a lot.
Posted by: Jason Armstrong at Sep 5, 2008 1:17:10 AM
For a blog titled "marginal revolution", one should also note that the increased benefit from higher prices would be affected by likely increased costs to extract the oil, and possibly substantially so.
Posted by: GA at Sep 5, 2008 1:39:19 AM
GA:
Profits are always convex in prices. Therefore the benefit increases at least linearly with respect to the price of oil.
Posted by: at Sep 5, 2008 1:51:56 AM
Some further numbers and discussion based on a higher price scenario available in an OpEd titled "What would environmentalists do with ANWR?":
http://www2.bren.ucsb.edu/~kotchen/links/anwroped.pdf
Posted by: at Sep 5, 2008 2:09:51 AM
"the loss of environmental amenities is valued at less than $1,141 .. per American": since almost no Americans will ever go anywhere near the place, an approximate value of zero might be fitting.
Posted by: dearieme at Sep 5, 2008 6:28:28 AM
By the way, here's a Harbor Seal in Alaska:
http://www.fakr.noaa.gov/protectedresources/seals/harbor.htm
Posted by: at Sep 5, 2008 7:06:34 AM
Steve Sailer said,
I could never get excited about drilling in ANWAR when oil futures were at $40, but if they are over $100, why not? Let's just make sure the federal treasury (i.e., us taxpayers) gets most of the increase in value instead of the oil companies or the state of Alaska, who were both willing to do it when oil was worth $40.
Steve, if you're still checking this, would you mind elaborating? Is there a market failure argument embedded in the above (perhaps because of environmental reasons)? I.e. if people who live hundreds/thousands (I'm guessing) miles away from you want to engage in voluntary transactions, do you often not get excited about them, and, I take it, think it's fine to prevent them from doing what they want to do? Or is there something specific to this operation?
Posted by: Bob Murphy at Sep 5, 2008 7:31:06 AM
I assume that is per American currently alive. No weight for future generations?
Also, if you think oil prices are going to keep rising fast, better to keep it in the ground. Isn't it great we didn't drill in the 90's!
Posted by: a student at Sep 5, 2008 7:42:19 AM
The Net Present Value of drilling in Alaska is the Net Present Value of drilling now MINUS the NPV of drilling in the future.
So if the price of oil rises faster than the real discount rate, then you are justified delaying drilling.
If you think oil prices are going to be higher in the future, you are justified in buying (cheap to produce) Saudie Arabian oil, rather than expensive to produce Alaskan Oil. If you think oil will be scarcer in the future, you do not want to pump it now.
You should also (in both cases) subtract out the cost of environmental damage.
Since environmental damage is in perpetuity, for $600bn of positive cash flows from selling oil, a cost to the neviornment (and to society) of $6-8bn pa (at a real discout rate of c. 1.3% ie the real rate on US government bonds right now) would make the NPV (sum of positives and negatives) less than or equal to zero.
Put it another way, does giving $1000 (or $2000) to every American citizen now, justify damaging the ANWR for all of the future? That's only a once-off contribution you can have, in a country with GDP per capita over $40k.
Posted by: Valuethinker at Sep 5, 2008 8:26:57 AM
JC asks what a $123 billion investment in alternative energy sources would bring us. Why is it 'either-or?' It's not like there is only $123 billion to invest. If investments in alternative energy sources have positive expected returns, the funds will certainly be available.
By the way, who is JC assuming makes the investment? It will be industry. JC's question makes the implicit assumption that industry executives are idiots, and would forgo more profitable investments in alternative energy.
Posted by: gator80 at Sep 5, 2008 8:55:37 AM
I do not know anyone who has been claiming that at current, or even reasonable prices that drilling in ANWR would not be profitable.
Can you show me a quote of some politician saying it would not be profitable?
As far as the impact on supply and/or price this study say roughly the same thing the EIA study said that virtually everyone quotes.
Aren't you doing the same thing politicians do of claiming someone said something they did not say and then disagreeing with the incorrect quote?
Posted by: spencer at Sep 5, 2008 8:56:57 AM
A similar paper came out three years ago, by Conrad and Kotani, in Resource and Energy Economics. See the blog post at Env. Econ:
http://www.env-econ.net/2005/08/trigger_prices_.html
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 ..."
Posted by: Jack at Sep 5, 2008 8:59:10 AM
How could drilling cause permanent environmental damage? You drive in the equipment, drill a well, attach a pipe, and leave. ANWR is 19 million acres, and the wells would only go in a 1.5 million acre part of it.
Cities and farms permanently displace wildlife habitat. Oil wells do not.
Posted by: Jim at Sep 5, 2008 8:59:56 AM
This is the one issue that I have long hated the Republicans most for. Failing it qualifies them, in my mind, as no longer the party of corporate interests, but purely that of corruption.
$600B is a huge wealth gain, but it's probably smaller than the wealth transfer from slight decreases in the price of oil. If US oil imports are 15% of global production and the price elasticity of supply of oil is <1/7 the wealth transfer from oil exporters is larger than the wealth created. Since most oil exporters are belligerent, this is probably a good thing.
Posted by: michael vassar at Sep 5, 2008 9:19:39 AM
The $374B number is a wrong one, only the net 254 B matters, which is less than $1000 a person. And, since I am not an Alaskan, the $37B that they would jack us for has no benefits to me. So, that gives us $214B for 300 million of us, or closer to $700 each. Still not bad, but not $1,100. Am I missing something?
Posted by: liberalarts at Sep 5, 2008 9:22:48 AM
I think I'm with Valuethinker on this one (if the price of oil rises faster than the real discount rate, then you are justified delaying drilling). While Jason Armstrong is somewhat reassuring, it is a discomforting kind of reassurance .. that we needn't trust the numbers.
Posted by: odograph at Sep 5, 2008 9:30:51 AM
I would love for some one to explain to me what exactly is "environmental damage". I am having a really hard time grasping what that means. I would argue that "developing" ANWR could be either positive or negative [or $0] in terms of long term impact. Tossed around loosely the term seems to imply that we do damage by living - existing. My suggestion to those of you that believe this owe it to the rest of us to "leave" [in an environmentally sound way of course].
Posted by: bruce Humbert at Sep 5, 2008 9:54:23 AM
