Making Sense in the Arctic Political Climate

An Environmental Economist's Argument Against Drilling in Alaska

Jesse Alan Gordon and Andre Meade, 1994

In last Fall's issue of Environmental Reporter, Alexander von Bismarck wrote an article which concluded that drilling in the Arctic National Wildlife Refuge (ANWR) makes economic sense. The editorial staff is to be commended for their openness to contrary opinions, and they lauded Mr. von Bismarck's scientific approach to the issue. I would like to use the same "clear lens of science" to make the case against drilling in ANWR. Generally, articles such as Mr. von Bismarck's hurt both economic science and environmentalism, because one is misled into assuming that we must choose between the two. Specifically, Mr. von Bismarck is a very poor economist, who distorts scientific methods and economic reasoning, and hence reaches false conclusions.


Science versus Emotion

Environmental economics is a "scientific lens" through which we can resolve issues in which both sides have legitimate claims. Cost-benefit analysis (CBA) allows us to consider both sides of the argument in the same terms -- dollars and cents -- and hence avoid "emotion-filled name-calling," as the editors point out. The central concept of CBA is to "monetize," or assign dollar values to, the costs and benefits of both sides. Mr. von Bismarck says of the arguments on both sides of ANWR that "to numerically compare them is as unnecessary as it is difficult." On the contrary, numerical comparison should be the core of any economic analysis. And it is not so difficult -- I'll make a rough cut at it below. Indeed, Mr. von Bismarck's non-numerical analysis is just emotion-filled name-calling with a thin veneer of science. I will strip away the veneer here, by doing the analysis which Mr. von Bismarck should have done, and expose his pseudo-science for what it really is: a justification for oil profits, apologism for short-sighted energy policies, and a pretext for further destruction of our remaining wildernesses.

Yes, I admit, I'm emotional about this issue. I'm emotional about a claim that destroying one of America's most pristine areas is a benefit to America. I'm emotional about compromising our ethics, our politics, and our wilderness, in exchange for a few barrels of oil. I'm emotional about the claim that America must forever be a hostage to a reliance on oil, regardless of the cost. But mostly I'm emotional about Mr. von Bismarck using environmental economics -- my environmental economics -- to justify the destruction of the ANWR. But I'll put my emotion aside for a while -- let's get to the science.


Financial Benefits of Drilling

When calculating the chances of finding oil, one does not consider only the chances that oil is in the ground. What counts is whether the oil is "economically extractable," which means, whether it can be sold for more than it costs to get it out of the ground. That's the distinction between "oil stocks" and "oil reserves:" the stock is the amount that's sitting in the ground, and the reserves are what can be extracted at a profit. The amount of oil reserves is sensitive to the price of oil, and the chances of finding extractable oil are similarly based on price. Mr. von Bismarck states that the chance of finding oil in the "1002 area" (a coastal wilderness section of ANWR) is 46%. But that 46% is based on an oil price of $33 per barrel. The Department of Interior, who made the 46% estimate, also made an estimate of a 19% chance of finding economically extractable oil at a price of $20 per barrel. The current price of oil is $13 per barrel, and is expected to fall as Iraq and Kuwait continue to recover and re-enter the world market. The chances of finding oil at $13 per barrel are therefore in the range of 10% to 15% (I'll use 15% in my CBA, to allow for oil driller's optimism).

The primary benefit of drilling ANWR is the financial gain due to oil sales. Mr. von Bismarck multiplies the estimated oil reserves (3.75 billion barrels) times an outdated price ($20 per barrel) to get a financial benefit of $75 billion (he got $71 billion, but I'll correct his math). The estimate of reserves should be decreased to reflect the decrease in price, since the marginal cost of extraction would rise as the oil is extracted, and hence would have a smaller total yield before it became uneconomical. But even using the 3.75 billion barrel estimate, we should use the current price. Indeed, since drilling ANWR will take 10 years before oil is shipped, we should use the expected price of oil in 2004. Except for OPEC's mid-1970s monopoly pricing, the price of oil has been consistently falling, as substitutes are found, and as modern technology allows for greater energy efficiency and cheaper extraction. Hence, I'll use the current price, $13 per barrel, as a very optimistic prediction of oil prices in ten years. Furthermore, the $75 billion of gross revenue is not a sure thing -- even Mr. von Bismarck says that there's only a 46% chance of seeing any revenue at all -- and I'll use the more realistic 15% from above. The total financial benefit is thus 3.75 billion barrels times $13 per barrel times 15%, or $7.3 billion. That's less than one-tenth of the financial benefits of $75 billion stated by Mr. von Bismarck.

This $7.3 billion benefit won't occur for ten years, however. It should be "deflated" to current ("real") terms, using the discounting methods described below. At a 5% discount rate, $7.3 billion in ten years is worth the same as $4.5 billion now. That's the number that goes into my CBA.


Employment Benefits of Drilling

Mr. von Bismarck then claims a benefit of 700,000 jobs which would be created directly by drilling. In the world of Cost-Benefit Analysis, jobs are a cost, not a benefit. Paying for labor is just like paying for machinery. You count the beneficial side-effects that the machinery produces (like the benefits to the machinery manufacturer) and the costly side-effects (like smoke, noise, and injuries), but you subtract the cost of the machinery itself, since it has to be paid for. Similarly, jobs themselves are a cost to be paid, and only the side-effects of employment are counted as benefits. There are only beneficial side-effects of employment if there is a high unemployment rate. The situation in Alaska, for many years now, has been full employment (we define "full employment" as 5% unemployment; Alaska's unemployment rate has been generally below that). The state pays people $1,000 per year to move to Alaska (via a negative state income tax), to fill the needs of employers.

Furthermore, the 700,000 jobs are temporary -- they last only as long as the drilling goes on, which is a few years. After that, the number of jobs declines a lot, since only a small crew is necessary to run producing wells. The number of jobs declines to zero once the wells stop producing, which in the case of ANWR should be a few decades at most. If 700,000 people are attracted to Alaska for the purpose of drilling, they will become unemployed when the drilling is done. Or, they'll return home, which is why only permanent changes in employment count.

And the 700,000 workers will have to be attracted, since the population of Alaska is only about 500,000 people. The most likely source of skilled oil workers is from other oil areas, like Kuwait, for example, since the Egyptians who once worked there are temporarily unemployed. Egyptian workers would be paid whether they worked in Alaska or in Kuwait, and hence their employment has no net benefits (it has a benefit to the Egyptians, but not to society as a whole, which is what we count in CBA). That's why jobs in general do not count in CBA -- jobs are just transferred from one place to another. Jobs could count if they are permanently created, but they're not here. Jobs could count if they're creating some new technology, but drilling is old technology and relatively unskilled. The net benefits are what count -- and the net benefits of job creation due to drilling ANWR are zero.


Macroeconomic Benefits of Drilling

Mr. von Bismarck next cites that drilling ANWR would reduce the trade deficit, reduce OPEC power, and increase national security. Here, he is sort of right, but only in the short run. These benefits will last for the duration of ANWR production, about 10-15 years. Then we're back where we started -- importing oil, empowering OPEC, and damaging national security. We can then choose another short-sighted solution, like drilling another ANWR, and 15 years later, another one, and another and another every 15 years. Or, somewhere along the way, we can choose a long-sighted solution, by addressing the underlying problem of oil dependency. The Oil Minister of Saudi Arabia has said, "America could become self-sufficient in energy in 5 to 10 years, if they put their minds to it." He recognizes that we could, in a short time, develop alternative technology that would make Saudi oil obsolete. That's why he keeps his oil prices low -- to maintain our dependence on his oil. Oil itself does not cause the trade deficit, nor does oil itself empower OPEC, nor does oil itself put our national security at risk -- our dependency on oil does all those things.

Now let's look at what ANWR does, in those terms. Indeed, we could drill ANWR and get some macroeconomic benefit and some marginal gains to our national security. ANWR could replace about 5% of our imported oil during its operation -- about the equivalent of one year's total imports. We could probably find a few more ANWR-sized fields after ANWR dried up, too. The ANWR oil would contribute to keeping the domestic price of oil low, too. What does that do in the long run? It maintains our dependency on oil! That is, in the long run, drilling ANWR perpetuates the source of the oil component of the trade deficit, maintains the empowerment of OPEC, and maintains the risk to national security.

If we were to let oil prices rise, by not drilling ANWR or any other sources, we would create an incentive to find substitute technology for oil. We would, as the Saudi Minister predicted, extricate ourselves from oil dependency in short order. Our real national security interest is to move toward that extrication as quickly as possible -- then in the next Kuwait, we won't have to spend lives to maintain low oil prices. We should compare the short-term benefits of drilling ANWR with the long-term benefits of avoiding drilling as part of a national campaign to overcome our oil dependency. We could replace all oil imports in five years (I'll discuss how next). The macroeconomic benefits of drilling last for five years, while the macroeconomic benefits of not drilling, as part of overcoming oil dependency, last forever.

The economic means of comparing five years' benefits to benefits forever is by using "discounting." Today's discount rate (the difference between inflation and the return on investment) is less than 5% (I'll use an optimistically high 5%, which favors my opponent). That means that benefits which accrue next year only count for 95% of those that accrue this year, and benefits in two years count as 91% (with compounding), and so on. Five years of benefits, if we value one year of those benefits at 1 unit, total up to 4.5 units, compared to 20 units for perpetuity. Assuming that we must sacrifice the short-term benefits to gain the long-term benefits, the ratio of benefits is 4.5 to 15.5, or over 3 to 1. That means there's a three-times advantage to our macroeconomic and national security benefits by getting rid of our dependency on oil. I won't estimate dollar values here, but I'll count the benefit as zero because that favors my opponent.

How could we get rid of our oil dependency? We don't even need anything as exotic as solar energy or oil shale technology or clean coal burning, all of which are real possibilities for 2004, when ANWR oil comes on line. We could replace all of our annual oil imports by improving our energy efficiency, using existing technologies. If we were to become as energy-efficient as Japan, which uses 405 barrels of oil per million dollars of GNP compared to our 943 barrels per million of GNP, we would save 2 billion barrels of oil annually, compared to a total import amount of 1.7 billion barrels. That means that we could eliminate all oil imports with current technology, just by becoming as oil-efficient as Japan. I only look at oil efficiency for the Japan comparison -- we do even worse for other forms of energy (we're only 1/4 as efficient as Japan in coal usage, and 1/7 as efficient in natural gas usage).

Mr. von Bismarck dismisses conservation as able to pay for itself but unable to relieve the pressure to further drill. While that's true in the short run, energy efficiency in the long run could remove our dependency on oil entirely, making drilling issues moot. We don't worry at all anymore about importing jute for rope (it used to be a national security issue, when rope was used on battleships), because we invented nylon. Similarly, a policy which promoted energy efficiency would ultimately replace oil altogether -- it's not just conservation, in the long run. A gasoline tax of $2 per gallon would be one such policy -- that's what Japan has, and if we had it, we'd replace gasoline engines in a few years. A gas tax has national security benefits of eliminating our oil dependency that outweigh its cost as a tax, but that's another article.

That all assumes that not drilling ANWR will cause America to decrease our oil dependency, and I'll admit, that's very optimistic on my side. It's overly optimistic because avoiding ANWR will only have a small marginal effect on decreasing oil dependency. CBA looks only at the marginal effects which are directly caused by the policy's presence or absence. The marginal effect of not drilling ANWR will only be felt in how much it creates an incentive to move towards oil independence, and that effect is small, since our realistic policy alternative is just to import a little more oil from Mexico, and not to work towards oil independence. However, drilling ANWR also has only a small marginal effect on national security, since once again, the realistic policy alternative is importing more from Mexico. Buying oil from Mexico causes no national security loss, no empowerment of OPEC, and no loss of benefits due to trade deficit (since under NAFTA, a trade deficit with Mexico is the same as a trade deficit with Texas). But since the realistic policy alternatives are the same for drilling as for not drilling, the net effect is zero, which is how I count it in my CBA.


Environmental Degradation

Now let's move on to the direct costs of drilling ANWR. I won't question Mr. von Bismarck's calculations of "use value," so I'll include in my CBA: 500 people earning their living, at the US average of $20,000, which would be a direct loss if the "1002 area" were drilled. The 1002 area is an important area for wildlife, because it is on the coast, and at the head of the Jago River, where many wildlife go to breed. However, I won't count that value, since it is likely that the wildlife would not go extinct as a result, but would migrate to other areas, as Mr. von Bismarck points out.

Instead, I will focus on the value to non-Alaskans of preserving ANWR. I interviewed some people who have hiked ANWR, in order to get a proper perspective on the area. ANWR is barren, untouched, and stark. It's not beautiful countryside, but it's not wasteland either. Most importantly, there isn't much to see. That's relevant because it means that you can see oil derricks from a very great distance. Oil proponents claim, for instance, that the Alaska oil pipeline occupies an area only 10 meters wide, so it hardly affects its surroundings at all. But the pipeline is visible from dozens of miles away -- indeed, it's a tourist attraction in the more populated sections of the state. In the ANWR region, where only intrepid hikers go, the pipeline destroys the pristine starkness that would otherwise prevail. Drilling derricks and oil wells would similarly destroy the pristineness, regardless of how little area they actually occupy. Think, if you are a hiker, what you feel when you come across a radio antenna on a mountain -- I avoid them and consider the mountain "occupied" when they're there. The 1002 area will be similarly "occupied" by oil wells, even if they physically occupy only a small part.

That's the basis of calculating "existence value," which Mr. von Bismarck mentions but does not quantify. I value the existence of ANWR in its pristine state, as I value hiking mountains which are unoccupied by components of civilization. One means of monetizing how much people value the existence of ANWR is to count how many people would be willing to pay for it. I'll use membership in environmental organizations as a proxy for caring about ANWR, since I think it's a fair assumption that joining the Sierra Club implies that one would value ANWR's pristineness. I'll count their annual dues as the amount which they are willing to pay to preserve ANWR, since I think that most Sierra Club members would support using their dues exclusively for that purpose. The total membership in environmental organizations in America is about 7 million people (that's the sum of the memberships of the top ten largest environmental groups). That's about 3% of the adult population, discounting duplicate memberships. The weighted average of the largest groups' annual dues is $23 (Greenpeace charges $30, the Sierra Club charges $35, the National Wildlife Federation charges $16, for examples). My CBA existence value is 7 million people times $23 per year, or $161 million per year.


Environmental Destruction

Mr. von Bismarck discusses at length the technologies available for minimizing the environmental damage of drilling. The political realities of Arctic Alaska speak otherwise. ANWR would be drilled by Alyeska, which is a consortium of oil companies that has effective monopoly power in Alaskan oil operations. They built the Alaska oil pipeline, and they are responsible for operating the harbor at Valdez, where the Alaskan oil spill occurred in 1991. Applying stringent regulations might alleviate the threat of serious damage, as Mr. von Bismarck suggests, but stringent regulations are considerably more difficult to apply in a monopolistic situation. There were many technologies available to minimize the damage of the Exxon Valdez spill -- using double-hulled oil tankers, keeping "oil booms" handy to contain a spill, maintaining stocks of oil-eating bacteria -- but these technologies were not made available. That technologies exist to minimize ANWR damage by no means implies that those technologies will be used. Mr. von Bismarck trusts the Alyeska consortium, implicitly, to use the best available environmentally-friendly technologies, when there is plenty of evidence of Alyeska doing exactly the opposite.

The relevance to our CBA is that there is a possibility of a major oil spill in ANWR, regardless of the available technology. If Alyeska operates wells in ANWR, and they will, there's a chance of an environmental disaster of the size of the Exxon Valdez spill. The existence value of such a spill affects many more Americans than the existence of ANWR itself. After the Exxon Valdez spill (the largest in US history), many Americans felt that we were sacrificing our natural heritage for oil. The bad feeling that millions felt is the basis for monetizing the existence value of a major oil spill in ANWR. I'll estimate the value itself at $27 per affected person, since they spent three or four evenings fretting about Valdez, and our free time is worth $9 for an evening (30% of average US wage for 3 hours). I'll estimate that half of all adult Americans cared sufficiently to fret (this estimate is arbitrary -- everyone I know fretted for many evenings, but that's a biased sample). I'll estimate the chances of a major spill at 2% per year, since Alyeska has had one such spill in 10 years of operating 5 different sites (Valdez, Prudhoe, the pipeline, Beaufort, and ANWR itself). My CBA existence value of a major spill is therefore $27 times 2% times half of 208 million adult Americans, or $56 million per year.

How long would the damages of such a disaster persist? For that matter, how long will the damage caused by normal drilling persist? If you've ever visited the top of Mt. Washington, the highest point in New England, you'll see the leftover damage from when the auto road was constructed decades ago. The top of Mt. Washington is an Arctic biome, similar to ANWR; damage there heals very slowly. The construction tracks will last for about 100 years after construction -- I'll use that as my estimate of the longevity of ANWR damage. Even if drilling goes perfectly, with no oil spills, the damage left by the construction activities will last for a century. ANWR oil will be gone in 15 years. That's the trade-off that Mr. von Bismarck recommends.


Environmental Options

Very few people visit ANWR. One reason is because Alyeska disallows people from entering the area -- the road goes from Prudhoe Bay to Dead Horse, and then Alyeska requires that visitors get a permit to proceed on foot. They do this, presumably, to ensure the continuing secrecy of their test wellheads in ANWR's "1002" area (Alyeska won't reveal publicly how productive those wellheads are). Presumably, more people might hike ANWR if it were allowed and encouraged. But even if it's not, people value the possibility to hike there -- in CBA terms, that's called "option value." I might go there someday, and I value the option to do so. The analytical method to monetize tourism uses is to count the costs of travel as a proxy for value (this is a very rough version of the Travel Cost Method, or TCM). A trip to ANWR would cost about $2,500, including airfare and special equipment and provisions, and I'll use that as the option value. If tourism in ANWR were encouraged, instead of discouraged by Alyeska, perhaps 11,000 people would visit per year. That number is based on using myself as a representative of an environmentalist American. I know maybe 50 environmentalist Americans, of which 4 or 5 would seriously consider visiting ANWR in their lifetimes (I called and asked all my friends), if encouraged, so I represent 9% of the 3% of Americans who are Sierra Club members and the like: 250 million Americans times 9% times 3% is 675,000 people over an adult lifetime of 30 years, or 22,500 per year. I'll reduce that figure by half to account for a bias in my small sample, so let's say 11,000 people per year would visit if sufficiently encouraged. Multiply that by $2,500 for a total annual option value of about $27 million.

Cost-Benefit Analysis

That's all the components there are for a CBA. I've tallied up the results in the following table. The benefits of drilling are one-time only, so I've expressed them in single dollar terms. The costs of drilling, as discussed above, last about 100 years, which for analytical purposes is the equivalent of perpetuity (the present value of 100 years is almost the present value of forever). All of the costs of drilling are expressed in annual terms, so I've converted those to "present value" from perpetuity by the same means discussed above (the present value of a perpetual benefit is the annual benefit divided by the discount rate). In present value terms, drilling ANWR creates a net loss of $600 million.

Benefits of drilling ANWR (present value over lifetime of wells)

  Financial gain.....................$4.5 billion
  Employment benefits.................0 in Alaska
  Macroeconomic benefits..............0 net effect
  Net national security gain..........0 or negative

Costs of drilling ANWR (annual lost benefits for 100 years)

  Maintaining oil dependency..........0 net effect
  Use value by Eskimos and hunters..$10 million ($20K times 500 people)
  Existence value to Americans.....$161 million ($23 dues x 3% of America)
  Existence value of major spill....$56 million (2% chance x $27 x 50% of US)
  Option value to visitors..........$27 million ($2,500 x 11,000 people/yr)

Present value of 100 years of lost benefits

  $254 million / 5% discount.........$5.1 billion 

Net present value of drilling (benefits minus costs)

  $5.1 billion minus $4.5 billion..$600 million loss

Policy Fallacies

Now I'll return to emotional issues. ANWR is not just a nice part of the country, it's unique. We have only one Arctic Wildlife Refuge, because only one exists. Canada doesn't have one, and Siberia doesn't have one, because they don't exist there. Perhaps the only equivalents anywhere in the world are Lappland in Scandinavia, or the northern peninsula of Antarctica. ANWR is entirely unique in America and in our hemisphere. When we discuss drilling ANWR, it's not the same as discussing another oil well in Texas, where there's plenty more Texas left after the drilling is done, and plenty more places like Texas nearby. We should consider ANWR to be a national treasure, like we consider Yellowstone Park or the Grand Canyon. Indeed, the alternative which Alyeska has been fighting is to declare the entire ANWR area a "wilderness area," which would give it protection equivalent to Yellowstone or the Grand Canyon.

Mr. von Bismarck concludes that we should drill ANWR while we are not under pressure, i.e., that drilling should occur now, so that the lack of urgency would "insure responsible development." By that logic, we should utilize our other national resources under non-urgent circumstances as well, so that we don't use them irresponsibly in a crisis. The logical extension of Mr. von Bismarck's reasoning is that we should cap the Yellowstone Geyser, to capture its thermal energy, or build a dam in the Grand Canyon, to generate hydroelectricity. After all, doing so now, without pressure, would insure responsible development.

Now that I've done my science, I'll do some name-calling. Mr. von Bismarck is a toady for the oil industry. He has fallen for their twisted logic, and justifies it with pseudo-science. The reason that the oil companies want to drill the 1002 area is that, once one area is destroyed, they have a claim on all the other areas as well. The pristineness of the entire ANWR will be destroyed by the 1002 drilling, since the roads will all get built, and the environmentalists can no longer claim that the area is undeveloped. That's why Alyeska wants to drill the 1002 area, and that's why environmentalists are fighting them there. Mr. von Bismarck's sycophancy is worse because it is against the interests of America. Just like the Saudi Oil Minister, the oil companies have a strong interest in maintaining America's oil dependency. Of course drilling ANWR is in Alyeska's interests -- as long as America needs oil, Exxon and Shell and Arco stay rich! Drilling ANWR perpetuates our oil dependency and hence perpetuates oil companies' profits!

Even Mr. von Bismarck's analysis, non-numerical as it is, lists oil revenue as the primary benefit of drilling ANWR. A good analysis, unlike Mr. von Bismarck's, should consider equity: Is it right to sacrifice a national wilderness in order to transfer money from citizens to oil companies? Even if my CBA is grossly wrong, and there is a net benefit to drilling, we should consider who benefits (oil companies) and who pays the costs (millions of Americans). Good policy decisions are based on distributional issues like those, not strictly on costs and benefits.

My CBA shows that there is a net loss to America of $600 million. That's a loss of $2.40 to each citizen -- pretty small compared to the $4.5 billion of revenue that the oil companies can expect. In terms of political power, Alyeska is understandably more willing to lobby harder to keep their $4.5 billion than most citizens are willing to lobby hard to keep their $2.40. That's the only reason that Congress is considering drilling ANWR -- because the concentration of money means power, even if that money represents a net loss to the country. That money is the source of propaganda on ANWR, which Mr. von Bismarck has fallen for. If Mr. von Bismarck wants to call himself an environmental economist, he should learn the necessity of attaching numbers to his analysis -- and he should learn to analyze short-term motivations for private gain from long-term national interests. His article is dangerous because it appears to ascribe national interests and lend scientific credence to arguments made in the name of profit.

I have no problem with companies seeking profits, but we should recognize their motivations, and judge their actions accordingly. Oil companies should seek profits, and should want to maintain America's oil dependency in order to continue their profits indefinitely -- that's how capitalism works. We should recognize that America's interests do not match those of the oil companies, and set national policy accordingly. My role as an environmental economist is to point out what America's interests are, as distinct from the oil companies' interests. Those two are clearly divergent in the case of drilling ANWR. Drilling ANWR will create an enormous benefit to the Alyeska oil consortium, but that benefit is outweighed by the costs borne by every American. Drilling ANWR creates a net loss to society as a whole, and should therefore not be done. The Arctic National Wildlife Refuge should be protected as a unique national treasure.


EJSCK Reprinted from The Environmental Reporter (Harvard University), 1994.
All material copyright 1994 by The Environmental Reporter, Jesse Gordon and Andre Meade.
Reprinting by permission only.

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