September 02, 2015
Washington Post editorial writer Stephen Stromberg told Post readers that President Obama is not a climate hypocrite for talking about climate change even as he opens areas in the Arctic for drilling. Stromberg was responding to environmental groups who argued that if we are to prevent dangeorous levels of global warming, we will have to leave large amounts of the world’s oil in the ground. They argue opening the Arctic for drilling is a serious step in the wrong direction.
Stromberg’s response is that the environmentalists are engaged in confused thinking. He cites a column by Michael Levi at the Council of Foreign Relations:
“‘[M]ore oil production in one place generally means less oil production elsewhere — that’s how markets and prices work — which substantially blunts the effect’ that Arctic drilling would have on global greenhouse emissions.”
In other words, Stromberg is arguing that if we drill more oil out of the Arctic, it will be offset by less oil coming from other places. This assertion is largely true, but it leaves out an important part of the picture.
Almost by definition, any restriction on drilling raises the price of oil. No one will drill in the Arctic unless it is the cheapest place to drill. If the industry is prevented from drilling somewhere that is cheaper and instead has to drill somewhere that is more expensive, then it raises the cost of oil. In this way a restriction on drilling has the same effect on oil consumption as a carbon tax, it raises the price to consumers.
A carbon tax would obviously be a more sensible policy for discouraging oil consumption, or fossil fuel use more generally, than a random walling off of areas for drilling. (This is from a global warming perspective, we have other reasons for wanting to protect the Arctic.) But if a carbon tax is not possible for political reasons, randomly walling off areas is a reasonable alternative.
An additional point that is worth noting in this story is that environmentalists often refer to the enormous costs that the fossil fuel industry will be forced to eat if they required to keep large amounts of fossil fuels in the ground. In other words, they will be forgoing a vast amount of money if they can’t have access to all the earth’s oil. This explains their opposition to measures to restrict greenhouse gas emissions.
In this context, it is worth noting that the plunge in world oil prices, from around $100 a barrel to $40 a barrel, vastly reduced the amount of money that the industry will have to forgo. While outwardly that may look like a 60 percent decline, in fact the drop is much larger.
The industry doesn’t care about the money it gets for its oil, it cares about what it gets net of the cost of production. While some oil can be produced at very low cost, much of the oil the industry is now looking to drill is high cost oil. If we mix the two together and say that average production costs are $30 a barrel for all the world’s oil, then the potential profit has fallen by more than 80 percent with the plunge in world prices. (Profit has fallen from an average of $70 a barrel to just $10 a barrel.) In fact, since so much less oil is profitable to drill at $40 a barrel than $100 a barrel, the decline in potential profit would almost certainly cross 90 percent.
In this sense, the plunge in prices should mean the industry has much less stake in drilling everywhere now than was the case a year and half ago. Unfortunately, my crystal ball won’t tell me whether oil prices will stay at $40 a barrel. My guess is that the industry is assuming that future price looks more like the $100 a barrel we saw early last year, and that is why it cares about drilling in the Arctic.
Thanks to Jim Naureckas for calling this to my attention.
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