Keystone Economics

It feels at times as if opposing the XL pipeline requires one to give up their keys to the Energy Institute executive washroom. Chris Knittel has argued that stopping XL would yield  little to no reductions in emissions. Severin Borenstein sees the issues much like I do, but concludes that trying to combat climate change by blocking the pipeline doesn’t seem like a winning strategy. Even Meredith Fowlie appears non-comital - and she hangs out with Yaks!. The arguments many economists (and others) have made include the following.

  • Even the large reserves of the oil-sands region are small potatoes in the global carbon budget.
  • Oil-sands production has grown cleaner and more efficient, so that emissions from new production may not be much worse than that from conventional oil production.
  • Oil is pretty fungible, so if we don’t buy it someone else will.
  • Oil is pretty fungible, so if we don’t buy from Canada, we’ll buy from Venezuela, and their oil is worse.

Each of these points are valid in at least a narrow sense, but also convey the true nature of the challenge facing us in trying to reduce greenhouse gas emissions. Climate change is a global problem and GHG emissions are a global “public bad.”  Many of our efforts to combat GHG emissions locally are undermined by spillovers that ensue as the global economy adjusts to shifts in preferences (say against carbon intensive fuels) in one location. We see this problem all the time. California may decide it doesn’t want to buy from coal plants anymore, but that won’t matter if consumers in other states are still willing to. California may not want to consume conventional corn-ethanol, but other parts of the country don’t share that view so we just consume the clean stuff while they take the rest.

Much of the problem stems from the relationship between CO2 emissions and the consumption of fossil fuels, which are an exhaustible resource. With exhaustible resources, some – maybe a lot –  of the market price reflects the scarcity value of the fuel. Policies targeted at locally reducing the demand for fossil fuels (energy efficiency, renewable energy, biofuels) may shift demand in one place, but also lower prices of this scarce resource in other places. The resulting expansion of consumption elsewhere can greatly undermine the effectiveness of the demand-reducing policies.

What the XL pipeline debate encapsulates is both the appeal and distastefulness of tackling this problem by trying to limit the supply of fossil fuels, rather than the demand. Policies taken to reduce supply can be more effective in avoiding the spillover trap. No one gets to burn the fuel if it stays in the ground.  What matters is whether reducing this supply leads to more output from some other source of supply – or if the other sources would be used up regardless.

Technically a rejection of the pipeline would not explicitly prevent the oil sands from being developed. It may even have no effect if an alternative pipeline is built, although that seems somewhat less likely now. It could, by limiting access to higher value markets, reduce the value of production there to a degree that investors no longer find it worth the effort (or money) to try.

Many, including myself, have come to think of the climate mitigation problem as one of truncating the global supply curve for fossil fuels at some point where the atmosphere can still recover from the amount that has been (or will be) combusted. Under this view, we may have to write off most if not all the oil in fields that are currently under production. The point would be to prevent, or at least slow down, the development of new sources. Looked at this way, it doesn’t necessarily matter if we would import from Venezuela if we don’t build the XL pipeline if the Venezuela would develop those fields regardless of what happens with XL. This argument is only relevant if the heavy oil in Venezuela gets developed only because we reject the pipeline. The fact that oil-sands oil may be just as “clean” as other oil is also less important. The key issue is whether it has the bad luck to be located in a place where it could plausibly be stuck for a long while.  It may not be a lot in the global context, but I can’t shake the feeling that we’ve got to start somewhere.

This supply-side view of the problem does lead to some interesting ideas, like a nature-conservancy type approach to retiring or preventing fossil fuel development. I’m not sure how serious the pay-us-to-ban-drilling proposal in Ecuador ever really was (it would have worked out to about $3/ton of CO2, counting the forests), but
the concept of this kind of mechanism that holds some real promise.

Unfortunately, a supply-side view of mitigation also clearly highlights the conflict between so-called energy security goals,  economic benefits, and climate policy. A couple years ago, Erin Mansur and I wrote out a model of where in the supply chain countries should target their reduction policies.  Its a bunch of math behind a couple basic ideas, one of which is that if your country exports a lot more CO2 than it consumes (yes I’m talking to you, Australia) then it is more effective to put the CO2 charge upstream – in this case on fossil fuel production.  This raises some difficult or – dare I say – inconvenient truths. California is currently on the leading edge of US climate policy, as its AB 32 goals could reduce CO2 emissions by about 75 mm tons in 2020, and maybe 200 mm tons over the next 7 years, relative to business as usual. There is also a lot of excitement about the economic potential of the Monterrey shale formation yielding up to 15.4 billion barrels of oil, or about 6 billion tons of CO2. Put these together for a moment. The carbon content of the oil contained in those reserves is about 30 times the amount that will be “saved” under AB 32.

Wealthy countries and jurisdictions have focused on reducing their consumption of fossil fuels because, for the most part, they consume more than they import.  It’s also easier to sell those policies as helping consumers save money. The fact that producers lose money is a lot easier to swallow if those producers live somewhere else. If we really want to be consistent though, opposing the XL pipeline means feeling very uncomfortable about binging on the Monterrey Shale. If we are capping the CO2 from the oil we are bringing into California, we need to apply the same policy to the oil that would be shipped out.

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