Title: Part III. Exhaustible Resources
1Part III. Exhaustible Resources
2B. Energy
3Introduction
- 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.
4Effects 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
5Historical 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.
6Hotelling
- 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.
7Hotelling 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
8Malthus
- 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.
9Debate
- 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)
10OPEC
- 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.
11OPEC
- 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.
12OPECs loss in power
13OPECs 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.
14Different 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.
15Costs 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
16Costs 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
17Costs 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.
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20Other 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.
21Total 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.
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23Implications 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.
24The 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.
251. 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.
262. 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.
27Episodic 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.
283. 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.
29Portfolio 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.
30These 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
31Portfolio 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
32Portfolio 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
33Conventional 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.
34Nuclear 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)
35Nuclear 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.
36Nuclear 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
37Nuclear 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).
38Hydropower
- 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.
39Hydropower
- 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.
40Hydropower
- 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.
41Alternative 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.
42Alternative 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.
43Summary
- 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.