Energy and the Environment

1. Chapter 14 Energy and the Environment Peter Schwarz Professor of Economics, Belk College of Business and Associate, Energy Production and Infrastructure Center (EPIC) UNC Charlotte Finding a Happy Medium: Part A

2. Outline • Introduction • Growth of the Environmental Movement • Relationship between Energy and the Environment • Applications: Oil, natural gas, and coal • Electricity and Environment • Regulations of 15

3. Introduction • When we choose which sources of energy to use, we must immediately contemplate their environmental consequences • Prices need to reflect the externalities created when we produce energy • This will ensure that entrepreneurs who are able to reduce the social cost of energy will be justly rewarded • A.C. Pigou (1920) • Proposed a tax equal to the marginal external cost at the socially optimal quantity in order to correct market failure due to externalities • Want frackers to reduce their use of underground aquifers? • Increase the price of water use and they will have more reason to recycle or turn to grey water of 15

4. Growth of the Environmental Movement (1) • John Muir (1838-1914) • Early advocate for wilderness preservation • His activism helped preserve Yosemite Valley among other wilderness areas • Founder of the Sierra Club • President Theodore Roosevelt (1858-1919) • Established the United States Forest Service (1905) • Placed approximately 230 million acres of U.S. soil under protection • Includes the founding of 5 National Parks Teddy Roosevelt stands with John Muir at Glacier Point in Yosemite National Park Source: http://www.history.com/topics/us-presidents/theodore-roosevelt/pictures/theodore-roosevelt/theodore-roosevelt-and-john-muir Source: Douglas Brinkley, The Wilderness Warrior: Theodore Roosevelt and the Crusade for America (2010) of 15

5. Growth of the Environmental Movement (2):Rachel Carson’s Book: Silent Spring • Considered by many to be the tipping point for the environmental movement • Released in 1962, she exposed devastating effects of DDT, a widely used pesticide • Experienced strong opposition from the chemical industry • “If man were to follow the teachings of Ms. Carson, we would return to the Dark Ages, and the insects and diseases and vermin would once again inherit the earth.” –Robert White-Stevens, American Cyanamid Neighborhoods and recreational facilities being sprayed with DDT to combat mosquitos of 15

6. Growth of the Environmental Movement (3):The Government’s Response • Heightened public awareness of potentially harmful business practices demanded government response • President Richard Nixon • U.S. Environmental Protection Agency (1970) • Clean Air Act (CAA) (1970) • Clean Water Act (CWA) (1972) • There is debate over whether the benefits have outweighed the costs • EPA can promulgate new regulations as long as there are benefits • Not required to consider costs of 15

7. Growth of the Environmental Movement (4):Govt. Response: Cont. • Resource Conservation and Recovery Act (RCRA) (1976) • Aimed at solid waste • Comprehensive Response, Compensation, and Liability Act (CERCLA) • Passed in 1980, required industry to contribute funds towards cleanup of future abandoned and contaminated sites • Reaction to the town of Love Canal being evacuated in 1978 due to pollution from the Hooker Chemical Company in the 1950s • Most notable CAA amendment (1990) • Introduced incentive-based (IB) regulation in the form of emissions trading • Cap-and-Trade • Traces back to the Coase Theorem (1960) that proposed that clearly establishing property rights would lead to a socially efficient outcome after allowing negotiation between parties of 15

8. Growth of the Environmental Movement (5):The Cap-and-Trade Approach • The favored method of pollution abatement • Much more efficient than Command-and-Control (CAC) • Results in firms with lower abatement costs doing a greater share of overall abatement • Compensated for doing so by selling emissions permits to firms with higher Marginal Abatement Costs (MAC) • 1990s CAA amendments led to markets for sulfur dioxide (), the pollutant behind acid rain, and nitrous oxide (), the main “smog” contributor • Coal-powered electricity generators emit high levels of pollutants compared to other fuels • Under cap-and-trade, firms would have the option to improve emissions of the coal generator, switch to a cleaner fuel (such as natural gas), or do nothing and purchase permits in the marketplace of 15

9. Growth of the Environmental Movement (6):The Clean Power Plan (CPP) • Proposed in 2014 to reduce carbon emissions • Set state-specific standards that could be met via mass-based standards, rate-based standards, or indirectly through permit trading • 27 states sued the EPA in response • In 2016 the Supreme Court delayed implementation pending settlement of the legal challenge • Elections later that year brought an administration which was less supportive of regulation including the CPP • Puts current and future climate legislation on very uncertain terms of 15

10. Relationship between Energy and Environment (1): Internalizing Externalities: Oil Spills • There are many externalities related to the consumption of oil • This example examines only one: oil spills • In the absence of regulation, oil companies would have limited incentive to take precautions • This will result in a less than efficient number of precautions in place to prevent oil spills • Firms will take precautions up to the point were the marginal cost of further precautions equals the expected value of the additional oil saved • They will not take into account the potential cost of cleanup, fishing revenue lost, habitat damage, etc. • Correcting externalities requires that we first estimate the marginal external cost (MEC) of productionat each level of output • In this case MECs are equal to the increase in probability of an oil spill multiplied by the amount of damage a spill would cause of 15

11. POil ($/bbl) 100 • Demand: • D = 20 - 0.2P • Supply: • MPC = 35 + 1.5Q • MEC = = 15 • MSC = MPC + MEC • If we internalize the MEC: • P1 = • Q1 = • If transporting an extra million barrels of oil increases the risk of a spill by 0.000000001%, what is the expected external cost of an oil spill? DWL S1 = MSC C B P1 S0 = MPC $60 8 P0 = 50 A 35 D0 Q0 =10 Q1 QOil (MMbbl/day) $15 Billion of 15

12. Relationship between Energy and Environment (2): The Coase Theorem • Assumptions: • Clearly defined property rights • Zero transactions costs • Under these conditions, Coase argues we will obtain the socially efficient outcome through negotiations • The efficient outcome will be achieved regardless of who is initially given property rights • Don’t believe it? How about an example? of 15

13. Relationship between Energy and Environment (3): Fracking: A Coasian Example • XTO Energy Inc. operates several fracking platforms just west of Denton, Texas, where the majority of residents rely on well water • Researchers have discovered well water at the far west side of town will soon be contaminated and not suitable for any household use • 5,000 homes will be affected • Potential solutions and associated costs (at PV) : • Connect affected homes to city water, $15 million • Invest in on-site water recycling, $7.5 million • Forbid fracking within a certain distance of town, $50 million • Affected households abandon their homes, $300 million What will happen if city residents are given the right to clean ground water? What happens if XTO is given the right to pollute? of 15

14. Relationship between Energy and Environment (4): Determining External Costs • Two different methods, revealed preference and stated preference • Revealed preference observes what we actually do • Travel cost approach: • Estimates willingness to pay based on distance traveled • Demand curve would have the cost of travel on the vertical axis and number of visitors on the horizontal axis • Hedonic approach: • Estimates the value of an environmental amenity from a complementary private good such as housing • Other things constant, housing prices near fracking sites due to potential water contamination, earthquakes, etc. • represents the price homebuyers are willing to pay per mile of distance between their house and the nearest fracking facility of 15

15. Relationship between Energy and Environment (5): Determining External Costs (cont.) • Stated preference methods can be used in conjunction with revealed preference methods or when revealed preference data is not available • Non-Use Values cannot be measured using revealed preference methods • Ex. - Willingness to pay for polar bear preservation even though you never plan to visit the Arctic or see a polar bear • Contingent Valuation (CV) asks people their willingness to pay to prevent or willingness to accept compensation for damages • Dependent on survey data which is subject to inherent biases • Revealed preferences are the preferred method in determining external damages for use values. of 15