Part III. Exhaustible Resources

1
Part III. Exhaustible Resources

• Ozone
• Energy Part 1

2
B. Energy

• Part 1 Chapter 8

3
Introduction

• Chapter 8 energy production and how that impacts
  the environment.
• The production and consumption of energy crucial
  to the health of economies in both developed and
  developing countries, but it is responsible for a
  large portion of the environmental problems that
  these countries experience.

4
Effects of energy production

• Global climate change, acid rain, air pollution
• Drilling for oil and gas, cooling energy
  facilities, coal mining, and underground storage
  of oil all affect water quality
• Oil spills pollute oceans and waterways
• Habitat destruction (strip mining, wetland
  destruction) is also a direct byproduct of energy
  production
• Solid waste from mining and burning coal may lead
  to ground and surface water contamination

5
Historical Development of US Energy Policy

• Formulation of energy policy mostly concerned
  with supply
• 2 authors have had a very strong influence on the
  way we think about energy.
• Thomas Malthus scarcity is inevitable because
  population grows to exhaust its resource
  endowment.
• Harold Hotelling the invisible hand of the
  market would optimally allocate exhaustible
  resources and prevent shortages, because the
  market price of a resource such as oil reflects
  both its current value and its future value.

6
Hotelling

• Fundamental proposition the producer of oil
  must be indifferent between selling a barrel of
  oil today and waiting for future time to sell it.
  
• Recall from chapter 2 if producer expects
  prices to rise in future, wait. Others behave
  similarly, everybody waits, current price up and
  future price down. (and other way around)
• This type of price change will continue until all
  producers are indifferent between selling today
  and selling in future.
• Today's price includes user cost, which is the
  opportunity cost of not having the oil available
  at other periods in the future.

7
Hotelling cont.

• Dynamic efficiency requires that the price at any
  point in time be equal to marginal extraction
  cost plus marginal user cost.
• Because MUC part of price, and MUC reflects
  scarcity, market should efficiently allocate oil
  over time, with MUC reflecting scarcity value.
• If future demand is perceived to be increasing or
  future supply is perceived to be decreasing, this
  will increase present user cost, reduce quantity
  demanded, leaving more oil for future.
• Higher current price will also encourage
  substitution of other fuels for oil, increased
  exploration for oil, investment in more energy
  efficient technologies.
• Market ensures that absolute scarcity never
  happens because price so high - -reduces quantity
  demanded and encourages substitution

8
Malthus

• Believed in the concept of absolute scarcity,
  which suggests that resources are used at an
  increasing rate until they are exhausted.
• Neo-Malthusians have extended Malthus' arguments
  beyond land and food to general resources and
  environmental quality.
• According to neo-Malthusians, growth of the
  economy and population will generate a dependence
  on resources that will eventually exceed
  capacity.

9
Debate

• The debate about whether markets adequately
  address future supply continues to rage, and is a
  motivating factor behind much US energy policy
  (particularly during energy crisis of the
  1970s)

10
OPEC

• The Organization of Petroleum Exporting Countries
  (OPEC) is a cartel of oil-producing countries
  formed in 1960 to counteract the economic power
  of multinational companies.
• OPEC reached its zenith of power in 1973 when oil
  prices quadrupled due to oil embargo imposed on
  the US and other countries who supported Israel
  during Yom Kippur War.
• A cartel is an organization of producers who
  agree to act in concert as a monopolist and
  restrict output to raise prices and generate
  profits.
• In order to have power in the market, the cartel
  must be large enough so that quantity decisions
  affect market price.
• Cartel members have powerful incentives to cheat.
  If one member secretly produces more, that member
  can earn higher prices at greater output.

11
OPEC

• While OPEC was effective in the mid to late
  1970s, its influence declined in the 1980s and
  1990s.
• OPEC lost market power as non-OPEC sources came
  on line in Mexico, the North Sea, and Alaska.
• The dominant firm model of oligopoly can be used
  to illustrate OPEC's loss in power.

12
OPECs loss in power
13
OPECs loss in power

• The dominant firm takes output of remaining firms
  as given, and meets unmet demand at that price.
• OPEC views itself as facing a demand curve that
  is one that subtracts the quantity supplied by
  the competitive fringe from total demand.
• As Figure 8.1 illustrates, the greater the size
  of the competitive fringe, which would be
  reflected as a shift to the right in the
  competitive supply function, the lower the world
  price of oil.
• This was the case in 1980s and 1990s with growth
  in the non-OPEC supply of oil.

14
Different incentives w/i OPEC

• Saudi Arabia more reserves than other members,
  so dont want prices too high (or else, demand
  for alternative energy technologies increase,
  driving price down in future). Also, less need
  for current revenue (sparsely populated, small
  economy)
• However, countries like Nigeria, Venezuela,
  Indonesia large populations, small reserves,
  want high prices NOW.

15
Costs of foreign dependence

• Domestic dependence on a large number of foreign
  oil producers is not necessarily bad however,
  the U.S. and others are dependent upon a few
  countries with unstable political histories.
• Greene and Leiby analyzed the question of the
  costs of foreign dependence by examining the cost
  of dependence on a foreign monopoly for oil
  supplies.
• It is the simultaneity of the monopoly problem
  foreign dependence that generates costs to US
  society

16
Costs of foreign dependence

• They separate costs into three broad categories
• The transfer of U.S. wealth to foreign producers
• Macroeconomic costs.
• Political and military costs.
• Argue that in absence of an oil cartel, all the
  extra costs of oil imports are a loss to the US
  economy

17
Costs of foreign dependence

• By raising prices through the restriction of
  output, oil producers transfer consumer surplus
  into monopoly profit
• This loss is illustrated in Figure 8.2.
• With competitive market, whole shaded area CS.
  Under foreign monopoly, square transferred to
  foreign profit (because this leaves our economy
  represents pure loss). Additionally, DWL
  triangle.
• The rising dependence on oil imports is
  illustrated in Tables 8.4 and 8.5.

18
(No Transcript)
19
(No Transcript)
20
Other costs

• Macroeconomic losses occur when sudden price
  increases or shortages of oil shock the domestic
  economy and lead to inflation, losses in GDP, and
  losses in employment.
• It is important also to consider the cost of
  mitigating price shocks.
• There are also costs associated with military and
  policy aspects, particularly given the historical
  problems with the region.
• Greene and Leiby (1993) point out that it is
  difficult to ascribe the readiness costs and
  actual costs of the Persian Gulf War solely to
  dependence on foreign oil. In absence of oil
  dependence, the US may have participated in the
  war to help oil-dependent allies.

21
Total social costs

• Table 8.6 indicates that the total social costs
  of dependence on a foreign monopoly for oil
  increased through the 1970s and declined through
  the 1990s.
• Consistent with the variety of factors that have
  weakened OPECs power.
• However, the costs of dependence on foreign oil
  are not trivial 93 billion of total costs in
  1990 compared to GDP of 5513 billion.

22
(No Transcript)
23
Implications for the present?

• Previous analysis showed costs associated with
  dependence on foreign oil sources from
  politically volatile regions
• Today, international terrorism arising out of
  same region, conflicts in Afghanistan and Iraq,
  and continued violence in the Middle East
  social cost of depending on oil from this region
  is likely to be much HIGHER today.

24
The Environmental Costs of Energy Production

• 3 types
• Emissions of pollutants that occur on a
  continuous basis from energy facilities.
• Episodic releases of pollution such as oil
  spills.
• Alteration of natural ecosystems as a result of
  production activities.

25
1. Continuous emissions

• Conventional environmental policy instruments,
  such as MPP and taxes, are appropriate for the
  first type of pollution, either would lower the
  level of emissions in a fashion that minimized
  total abatement costs.
• However, the US has historically relied on direct
  controls (C C) to manage this type of
  pollution.

26
2. Episodic releases of pollution

• The second type of environmental problem,
  episodic problems, cannot be adequately managed
  with economic incentives.
• In this case not only does the magnitude of the
  environmental problem need to be controlled but
  also the probability of occurrence.
• One alternative is to use direct controls which
  dictate basic safety regulations, technological
  requirements, and operating requirements.

27
Episodic releases of pollution

• A 2nd alternative would be to develop a liability
  system.
• Established by the Oil Pollution Act of 1990 and
  the CERCLA, liability systems establish liability
  for damages on the part of transporters of oil.
• If a spill occurs, the company can be taken to
  court and sued for damages.
• Under a liability regime, the company would also
  take steps to have a rapid response program in
  case an accident occurs.
• The idea is that if transporters of oil are
  responsible for damages from spills, they will
  take steps to reduce the likelihood of an
  accident.

28
3. Alteration of natural ecosystems

• Again, difficult to design an environmental tax
  or MPP system that would manage the 3rd type of
  environmental impact, the impact on production
  activities on habitats and ecosystems.
• Direct controls can play a large part through
  specification of how pipelines should be
  constructed or how waste should be handled to
  minimize the impact on the ecosystem.
• An alternative to direct controls would be
  performance bonds.
• Performance bonds require a firm to pay a large
  amount of money upfront, before they begin their
  activities.
• The money is place in an escrow account and is
  returned to the firm after completion of the
  project, if they have met the appropriate
  environmental standards.

29
Portfolio Theory Energy Choices

• Given the insecure availability of energy and the
  environmental costs associated with energy, how
  to design policy?
• Countries such as the US face a set of risks
  associated with the use of fossil fuels,
  especially when a large component of this fuel
  use is oil imported from politically volatile
  areas.

30
These risks include

• Potential economic impacts from price instability
  or from high prices associated with increasing
  scarcity
• Social costs associated with the national defense
  and homeland security implications of dependence
  on oil from politically volatile areas
• Potentially catastrophic global climate change
  and other sever environmental impacts associated
  with production and consumption of fossil fuels

31
Portfolio Theory Energy Choices

• An effective energy policy would reduce these
  risks
• Current US policy ineffective because it is based
  on fossil fuels (especially in trying to increase
  domestic production of petroleum)
• The primary problem with the US energy policy is
  that it is insufficiently diversified. A more
  diverse portfolio of very different types of
  energy sources would be much less risky

32
Portfolio Theory

• Developed to provide a better understanding of
  financial risk associated with investment
  strategies
• Indicates that the more diversified a portfolio
  of investments, the lower its risk
• A portfolio consisting of foreign and
  domestically produced oil is not very diversified
  (highly correlated economic, national security,
  and environmental risks) thus is associated with
  high levels of risk
• A much more diverse portfolio that includes very
  different types of energy would be much less risky

33
Conventional Energy Alternatives

• Conventional energy sources can be defined as
  those that are already employed at some level.
• If fossil fuels (coal, natural gas, oil and its
  derivatives) are defined as the primary source of
  energy, then the alternative conventional
  substitutes for fossil fuel are nuclear power and
  hydropower.

34
Nuclear power

• Peaceful uses of nuclear power have been
  regulated heavily by the government because of
  the potential for disaster and the national
  defense implications of the use of nuclear power
• It was however also believed that nuclear power
  had the potential for solving the nations energy
  problems (despite its expense compared to
  conventional energy production)

35
Nuclear power liability issues

• One of the biggest obstacles to establishing a
  nuclear power industry is the potential liability
  if there were a nuclear power plant disaster.
• In response to this the Price-Anderson Act
  enacted by Congress exempted individual utilities
  from having to pay damages as a result of an
  accident.
• The claims are paid by consortium of utilities
  (20 liability) and the federal government (80
  liability), and there is a maximum limit on
  claims.
• Opponents claim a limit on liability suggests
  significant divergence between private and social
  optimum with respect to nuclear power.

36
Nuclear power

• A variety of other sources of disparity between
  private costs and social costs of nuclear power
  are presented in Table 8.7
• These costs include construction costs, which are
  not fully represented in the price, and expected
  damages from an accident, which are not reflected
  in current costs
• Although it was predicted that nuclear power
  costs would fall, that has not happened primarily
  due to delays in obtaining permits and
  construction of power plants

37
Nuclear power other risks

• What to do with the nuclear waste and the risks
  that uranium or plutonium that is used in power
  plants could wind up in the wrong hands, where it
  could be used to make a nuclear weapon.
• Some nuclear waste remains dangerously
  radioactive for over 100,000 years.
• While we must develop a way to safely store
  nuclear waste, there is general opposition among
  the public to the construction of a nuclear waste
  storage facility (NIMBY).

38
Hydropower

• Hydropower is often associated with an image an
  environmentally friendly option for power but
  it is NOT without its environmental impacts
• The primary environmental impacts of hydropower
  are associated with the dams and reservoirs and
  include inundation of both terrestrial riverine
  habitat, sedimentation, reduction in aquatic
  dissolved oxygen levels, blockage of fish
  migration and conversion of free-flowing rivers
  into reservoirs.

39
Hydropower

• An interesting economic and environmental
  consideration is that because so many rivers have
  been converted into reservoir systems,
  free-flowing rivers and healthy riverine
  ecosystems have become increasingly scarce
  implying that the opportunity cost of
  constructing dams on free-flowing rivers is
  likely to be HIGH.

40
Hydropower

• In the Pacific NW devastating impact on a
  variety of species of Pacific salmon.
• A series of dams have blocked major river
  systems, preventing salmon from migrating from
  the open ocean to the headwaters of the rivers
  where they spawn and where the fish remain as
  juveniles before returning to the ocean.
• Although fish ladders and elevators have been
  constructed to aid the fish, they have not proved
  effective in preventing the decline in numbers.
• The environmental impacts of hydropower are
  typically controlled through direct means
  involving a federal and state licensing process
  for dams.

41
Alternative Energy Sources

• Unconventional alternative energy sources include
  wind, solar energy, biomass energy,
  co-polymerization, fuel cells, and geothermal
  energy.
• Some of these have been used for centuries, but
  their use in modern times has been relatively
  limited.
• The use of wind as an energy sources is very
  clean and it has the potential supply a small
  portion of our electric power needs.
• Energy from the sun can be used to produce
  electricity through the use of photovoltaic cells
  that convert the suns light into electricity.
• Biomass fuels come from living sources, such as
  plants and waste products.

42
Alternative Energy Sources

• Thermal depolymerization is a process that has
  been developed relatively recently to convert
  carbon-based substances (food waste, agricultural
  waste, human waste, plastic, medical waster, etc)
  into oil.
• Fuel cells produce energy through a chemical
  process that converts hydrogen and oxygen into
  electricity through a chemical process (more on
  hydrogen Friday).
• Which is the best? Portfolio theory argues that
  we should not pick any particular fuel but rather
  it is important to have a mix.
• In addition, technological developments may
  result in greater efficiencies in the future.

43
Summary

• US energy policy is based on the continued
  availability of inexpensive fuels.
• 3 sets of costs associated with fossil fuels are
  important to consider in developing an energy
  policy
• The impact of fossil fuel use on greenhouse gas
  emissions.
• The other environmental impacts of these
  emissions.
• The national security cost of being dependent on
  oil that is imported from regions of political
  volatility.
• Portfolio theory suggests that the US can reduce
  its risk by diversifying sources of energy.