Social costs of oil and gas leasing on federal lands, carefully considered

OVERVIEW: A report filed with the US Department of the Interior recommended that terms governing the leasing of federal land for oil and gas development be updated to reflect social costs associated with such development. While such costs may be policy relevant, I suggest social costs are smaller than the report indicates and the recommended policy changes are not well focused.

The U.S. Department of the Interior (“Interior”) has begun an effort to update financial terms for oil and gas leases on federal lands. These financial aspects – royalties, minimum acceptable bids, annual rental rates, bonding requirements, and penalty rates – are collectively referred to as “government take.” One issue raised in the effort concerns social costs associated with oil and gas development on federal lands. (As noted earlier, Shawn Regan and I have filed a comment with Interior on the issue.)


Social costs of such development are also among issues addressed in a report filed in the Interior rulemaking docket by Jayni Foley Hein of New York University’s Institute for Policy Integrity. The report provides an overview of the legal requirements governing government take and recommends Interior’s regulations be revised to reflect option value and social costs. Here I focus on social costs.

Hein said social costs are imposed by oil and gas development on federal lands both during development and during production. She wrote:

America’s public lands offer millions of people a place to hike, camp, hunt, fish, and enjoy scenic beauty. They provide drinking water, clean air, critical habitat for wildlife, sites for renewable energy development, as well as natural resources including timber, minerals, oil, and natural gas. As soon as energy exploration begins, competing uses of federal land such as recreational enjoyment, commercial fishing, and renewable energy development are impaired, and continue to be foreclosed for the duration of production.

Hein listed the following social costs of oil and gas activity on federal lands*:

  • Loss of use values (including loss of recreational value, renewable energy development potential, timber value, scenic value, and wildlife habitat)
  • Local air pollution (local effects of methane leakage, emissions from diesel or gas-fueled pumps and other engines)
  • Global air pollution (methane leaks, carbon dioxide)
  • Induced earthquakes from disposal of hydraulic fracturing wastewater
  • Potential oil or wastewater spills and subsequent water contamination from wastewater stored in pits and tanks
  • Noise pollution
  • Increased traffic (wear and tear on roadways, traffic-related fatalities).

She recommended increasing rental rates and royalties to reflect social costs associated with development and production of oil and gas on federal lands.


Naïve application of Hein’s list would likely produce significant over-counting of social costs. Regan and I described social costs as “the sum of all future benefits foregone by one or more persons due to oil and gas development activity on federal lands.” We were imprecise. We cannot simply sum up all possible future foregone benefits, but rather we should focus on the difference in benefits between two specific cases: one case with oil and gas resources leased for development, and a second case in which the land is not leased.

The social costs of oil and gas leasing is the sum of the specific incremental differences in the stream of future benefits associated with the land leased for oil and gas development as compared to the best alternative use. Specification of the second case is key. Assume, for example, that if the property is not leased for oil and gas development, then it would be leased for PV solar power development. Leasing the land for PV solar power also involves some loss of timber value, wildlife habitat, recreational value, and so on. In counting the social costs of oil and gas leasing associated with, say, wildlife habitat, we need to focus on just the difference in wildlife habitat between the two cases. If recreational use is impaired equally, the loss of recreation value is not properly counted as a cost of oil and gas leasing.

Consequences, or rather, the differences in consequences beyond the property itself matter too. It is likely holding a specific tract of property out of oil production has no effect on total world oil production and consumption, and therefore there would be no difference in total air pollution, traffic, potential for oil leaks, and so on. Withholding a particular property out of development primarily would affect the location, not the total amount, of these costs. Location can matter: we likely do not want to increase traffic and local air pollution in already crowded areas. But location does not always matter: the greenhouse gas implications are the same whether a methane leak arises from development on federal land or elsewhere.


A careful identification of the social costs of oil and gas leasing associated with specific federal properties would reveal these social costs to be smaller than a naïve application of Hein’s list may suggest. Federal oil and gas policies governing the government take primarily affect the distribution of social costs, not the total amount. Most relevant social costs are highly localized to the area of development, a feature which should make them easier to manage.

Other issues arise with Hein’s proposal to increase rental rates and royalty rates to account for social costs. While charging a higher royalty rate, for example, would discourage development of federal lands at the margin, it would not encourage operators to minimize social costs on properties that are developed. Other policy levers may be more useful.

*NOTE: The list of social costs is my summary drawn from Hein’s report. We might dispute aspects of the list, but for purposes of this post I am more interested in the social cost concept rather than the particular items listed.

Energy poverty and clean technology

For the past three years, I’ve team-taught a class that’s part of our Institute for Energy and Sustainability at Northwestern (ISEN) curriculum. It’s an introductory class, primarily focused on ethics and philosophy. One of my earth science colleagues kicks us off with the carbon cycle, the evidence for anthropogenic global warming, and interpretations of that evidence. Then one of my philosophy colleagues presents moral theories that we can use to think about the morality of our relationship with nature, environmental ethics, moral obligations to future generations, and so on. Consequentialism, Kantian ethics, virtue ethics. I learn so much from my colleagues every time!

Then I, the social scientist, come in and throw cold water on everyone’s utopias and dystopias — “no, really, this is how people really are going to behave, and the likely outcomes we’ll see from political processes.” Basic economic principles (scarcity, opportunity cost, tradeoffs, incentives, property rights, intertemporal substitution, discounting), tied in with the philosophical foundations of these principles, and then used to generate an economic analysis of politics (i.e., public choice). We finish up with a discussion of technological dynamism and the role that human creativity and innovation can play in making the balance of economic well-being and environmental sustainability more aligned and harmonious.

Energy poverty emerges as an overarching theme in the course — long-term environmental sustainability is an important issue to bear in mind when we think about consumption, investment, and innovation actions we take in the near term … but so are living standards, human health, and longevity. If people in developing countries have the basic human right to the liberty to flourish and to improve their living standards, then energy use is part of that process.

Thus when I saw this post from Bill Gates on the Gates Foundation blog it caught my attention, particularly where he says succinctly that

But even as we push to get serious about confronting climate change, we should not try to solve the problem on the backs of the poor. For one thing, poor countries represent a small part of the carbon-emissions problem. And they desperately need cheap sources of energy now to fuel the economic growth that lifts families out of poverty. They can’t afford today’s expensive clean energy solutions, and we can’t expect them wait for the technology to get cheaper.

Instead of putting constraints on poor countries that will hold back their ability to fight poverty, we should be investing dramatically more money in R&D to make fossil fuels cleaner and make clean energy cheaper than any fossil fuel.


In it Gates highlights two short videos from Bjorn Lomborg that emphasize two things: enabling people in poverty to get out of poverty using inexpensive natural gas rather than expensive renewables will improve the lives of many millions more people, and innovation and new ideas are the processes through which we will drive down the costs of currently-expensive clean energy. The first video makes the R&D claim and offers some useful data for contextualizing the extent of energy poverty in Africa. The second video points out that 3 billion people burn dung and twigs inside their homes as fuel sources, and that access to modern energy (i.e., electricity) would improve their health conditions.

The post and videos are worth your time. I would add one logical step in the chain, to make the economics-sustainability alignment point even more explicit — the argument that environmental quality is a normal good, and that as people leave poverty and their incomes rise, at the margin they will shift toward consumption bundles that include more environmental quality. At lower income increases there may still be incrementally more emissions (offset by the reduction in emissions from dung fires in the home), but if environmental quality is a normal good, as incomes continue to rise, consumption bundles will shift. If you know the economics literature on the environmental Kuznets curve, this argument sounds familiar. One of the best summary articles on the EKC is David Stern (2004), and he shows that there is little statistical evidence for a simple EKC, although better models have been developed and if we tell a more nuanced story and use better statistical techniques we may be able to decompose all of the effects.

Gates is paying more attention to energy because he thinks the anti-poverty agenda should include a focus on affordable energy, and energy that’s cleaner than what’s currently being used indoors for cooking in many places.

Building, and commercializing, a better nuclear reactor

A couple of years ago, I was transfixed by the research from Leslie Dewan and Mark Massie highlighted in their TedX video on the future of nuclear power.


A recent IEEE Spectrum article highlights what Dewan and Massie have been up to since then, which is founding a startup called Transatomic Power in partnership with investor Russ Wilcox. The description of the reactor from the article indicates its potential benefits:

The design they came up with is a variant on the molten salt reactors first demonstrated in the 1950s. This type of reactor uses fuel dissolved in a liquid salt at a temperature of around 650 °C instead of the solid fuel rods found in today’s conventional reactors. Improving on the 1950s design, Dewan and Massie’s reactor could run on spent nuclear fuel, thus reducing the industry’s nuclear waste problem. What’s more, Dewan says, their reactor would be “walk-away safe,” a key selling point in a post-Fukushima world. “If you don’t have electric power, or if you don’t have any operators on site, the reactor will just coast to a stop, and the salt will freeze solid in the course of a few hours,” she says.

The article goes on to discuss raising funds for lab experiments and a subsequent demonstration project, and it ends on a skeptical note, with an indication that existing industrial nuclear manufacturers in the US and Europe are unlikely to be interested in commercializing such an advanced reactor technology. Perhaps the best prospects for such a technology are in Asia.

Another thing I found striking in reading this article, and that I find in general when reading about advanced nuclear reactor technology, is how dismissive some people are of such innovation — why not go for thorium, or why even bother with this when the “real” answer is to harness solar power for nuclear fission? Such criticisms of innovations like this are misguided, and show a misunderstanding of both the economics of innovation and the process of innovation itself. One of the clear benefits of this innovation is its use of a known, proven reactor technology in a novel way and using spent fuel rod waste as fuel. This incremental “killing two birds with one stone” approach may be an economical approach to generating clean electricity, reducing waste, and filling a technology gap while more basic science research continues on other generation technologies.

Arguing that nuclear is a waste of time is the equivalent of a “swing for the fences” energy innovation strategy. Transatomic’s reactor represents a “get guys on base” energy innovation strategy. We certainly should do basic research and swing for the fences, but that’s no substitute for the incremental benefits of getting new technologies on base that create value in multiple energy and environmental dimensions.

Interpreting Google’s purchase of Nest

Were you surprised to hear of Google’s acquisition of Nest? Probably not; nor was I. Google has long been interested in energy monitoring technologies and the effect that access to energy information can have on individual consumption decisions. In 2009 they introduced Power Meter, which was an energy monitoring and visualization tool; I wrote about it a few times, including it on my list of devices for creating intelligence at the edge of the electric power network. Google discontinued it in 2011 (and I think Martin LaMonica is right that its demise showed the difficulty of competition and innovation in residential retail electricity), but it pointed the way toward transactive energy and what we have come to know as the Internet of things.

In his usual trenchant manner, Alexis Madrigal at the Atlantic gets at what I think is the real value opportunity that Google sees in Nest: automation and machine-to-machine communication to carry out our desires. He couches it in terms of robotics:

Nest always thought of itself as a robotics company; the robot is just hidden inside this sleek Appleish case.

Look at who the company brought in as its VP of technology: Yoky Matsuoka, a roboticist and artificial intelligence expert from the University of Washington.

In an interview I did with her in 2012, Matsuoka explained why that made sense. She saw Nest positioned right in a place where it could help machine and human intelligence work together: “The intersection of neuroscience and robotics is about how the human brain learns to do things and how machine learning comes in to augment that.”

I agree that it is an acquisition to expand their capabilities to do distributed sensing and automation. Thus far Nest’s concept of sensing has been behavioral — when do you use your space and how do you use it — and not transactive. Perhaps that can be a next step.

The Economist also writes this week about the acquisition, and compares Google’s acquisitions and evolution to GE’s in the 20th century. The Economist article touches on the three most important aspects of this acquisition: the robotics that Alexis analyzed, the data generated and accessible to Google for advertising purposes, and the design talent at Nest to contribute to the growing interest in the Internet-of-things technologies that make the connected home increasingly feasible and attractive to consumers (and that some of us have been waiting, and waiting, and waiting to see develop):

Packed with sensors and software that can, say, detect that the house is empty and turn down the heating, Nest’s connected thermostats generate plenty of data, which the firm captures. Tony Fadell, Nest’s boss, has often talked about how Nest is well-positioned to profit from “the internet of things”—a world in which all kinds of devices use a combination of software, sensors and wireless connectivity to talk to their owners and one another.

Other big technology firms are also joining the battle to dominate the connected home. This month Samsung announced a new smart-home computing platform that will let people control washing machines, televisions and other devices it makes from a single app. Microsoft, Apple and Amazon were also tipped to take a lead there, but Google was until now seen as something of a laggard. “I don’t think Google realised how fast the internet of things would develop,” says Tim Bajarin of Creative Strategies, a consultancy.

Buying Nest will allow it to leapfrog much of the opposition. It also brings Google some stellar talent. Mr Fadell, who led the team that created the iPod while at Apple, has a knack for breathing new life into stale products. His skills and those of fellow Apple alumni at Nest could be helpful in other Google hardware businesses, such as Motorola Mobility.

Are we finally about to enter a period of energy consumption automation and transactive energy? This acquisition is a step in that direction.

BP Statistical Review of World Energy 2013

Last week I attended Mark Finley’s presentation in Chicago of BP’s Statistical Review of World Energy for this year. In his role as General Manager of Global Energy Markets at BP, Mark is responsible for this annual analytical survey of world energy production, consumption, and trends. He’s an outstanding economist whose presentations are a master class in public communication of quantitative analyses, so attending his presentation was a real treat for me.

As the press release for the Review indicates,

The US recorded the world’s highest growth in production of both oil and natural gas in 2012, on the back of increasing production of unconventional hydrocarbons such as tight oil, an example of the increasing diversity of energy sources as the global market continues to adapt, innovate and evolve. With rising natural gas output driving prices lower in the US, natural gas displaced coal in power generation, causing the US to experience the largest decline of coal consumption in the world.

Elsewhere, 2012 saw the largest annual decline in world nuclear output. In Japan, where nuclear power generation all but disappeared after 2011’s Fukushima accident, higher imports of fossil fuels including liquefied natural gas (LNG) ‘kept the lights on’. In Europe, where gas prices were higher than in the US, power generators took the opposite course from the US, and substituted coal for gas.

A few of Mark’s insights that aren’t reflected fully in the graphs and data really struck me. Not surprisingly, he talked quite a bit about the increase in oil and natural gas production in the US due to shale, and this change has led to a couple of interesting trade patterns. One is the reduction of US oil imports by one-third in the past five years, and the shift in consumption from the US to China. That’s the “national security-reduce Middle East imports” desired outcome from shale oil, right? Not exactly — oil is not a homogeneous product, and it turns out that North American shale oil is most similar in weight and composition to the oil in Africa, not the Middle East. So the US imports of African oil have fallen, and Chinese imports of African (and other) oil have risen. BP also estimates that China has increased its oil inventories by more than all of the OECD country inventory increases combined.

One reason for the increase in Asian oil imports is the increase in automobile ownership in China and India. The majority of new car sales in 2012 occurred in emerging economies, with much of that activity occurring in China and India.

There were other fascinating insights in Mark’s analysis, but I’ll leave it there for a Friday afternoon!

I also recommend the interactive energy charting tool accompanying the Review — it uses the historical data and generates comparative regional charts elegantly and effectively. You can also export a particular graph, the data underlying the graph, and/or a spreadsheet with all of the data in the Review. I had fun playing around with the natural gas price history graph, which you can scroll through by year and see year-by-year how the price changes, as well as seeing in 2012 the large price difference between US/Canada and Europe/Japan.

Large shale gas potential in the UK

Interesting news — according to this BBC article, the most recent British Geological Survey indicates that there may be twice the shale gas deposits in the UK that were previously anticipated. Such a large potential source of natural gas has substantial implications: “If the estimates are proved correct, that would still suggest recoverable reserves of shale gas far in excess of the three trillion cubic feet of gas currently consumed in the UK each year.”

One of the recent conversations in energy economics and policy has been around whether or not liquified natural gas (LNG) exports from the US would raise natural gas prices in the US. A big driver of the profit opportunity in LNG exports is the relative lack of exploitation of shale gas deposits in Europe, and the natural gas price differential between the US and Europe.

If UK energy companies can bring their shale gas to market, that changes the complexion of global LNG shipments.

UPDATE: I then go do my morning reading and find Tim Worstall commenting on the issue. He links to a Telegraph story that contextualizes the magnitude further by pointing out that even just extracting 10 percent could meet Britain’s anticipated natural gas demand for 40 years.

NYT Energy For Tomorrow Closing Plenary video

Lynne Kiesling

Last week the New York Times hosted a conference called “Energy For Tomorrow”, and they have made video from all of the sessions available; there are several sessions discussing energy efficiency, natural gas, renewables, etc. I watched the closing plenary on Friday, for which the topic was subsidies in any or all energy industries (sorry, WordPress and the embed code aren’t playing well together). Among the speakers it features Rice economist Amy Myers Jaffe  (to whom we have linked here before), as well as friend-of-Knowledge Problem Branko Terzic from Deloitte Consulting.

The discussion was good and very informative, raising many of the aspects of the pros and cons of subsidies depending on their form and how they are implemented. Naturally, much of the discussion addressed solar and the unintended (but easily anticipated) costs illustrated by Solyndra and by Spain, whether subsidies generate more overall net benefits than a carbon tax would, and whether subsidies should focus on driving down costs and getting to grid parity or on R&D. I’ll let you form your own conclusions on those topics.

I found that Amy Myers Jaffe’s comments were the closest to what I would have said if I were on the panel. She critiques the use of subsidies very effectively, and encourages an energy policy focus on “targeting the externality” and pricing it in the market. Branko’s comments highlight the political economy of subsidies and whether subsidies are hidden or in plain sight.

Recommended for easing into your Monday.