Course:ECON371/UBCO2010WT1/GROUP4/Article 5: Busting Big Oil
Busting Big Oil: Sticker Shock at the Pumps Symbolizes the Fossil Fuel Malaise
Summary
The article published in E Magazine titled “Busting Oil: Sticker Shock at the Pumps Symbolizes the Fossil Fuel Malaise” discusses how the basic law of supply and demand not only influences the price of oil, but also has a profound affect on the environment. The article asserts that price hikes seen in the price of oil and inevitably within the price of gasoline has been very profitable for “Big Oil”. The article cites that year over year big oil profits have increased substantially in response to this increase in the price of crude. The main driver of this price increase can be examined within the American economy. The United States is the biggest importer of OPEC oil, which accounts for 56% of the US crude supply. The main driver of this US demand for crude comes from transportation, which accounts for up to 65% of the US crude supply. Since 1998 the growth in the automotive population and the growing demand for SUVs have been the main driver of transportation related fuel demand. Furthermore, the combination of consumer affluence and the apparent willingness to pay for high oil prices have lead to runaway profits for the oil and automotive industries.
As demand increases there is also an increase in incentives for oil firms to expand their exploration of oil to more remote locations. The article depicts that the rise in oil prices is helping the oil companies promote their domestic agenda to expand their drilling operations within the US. These oil companies leverage high oil prices to relax environmental policies that allow oil exploration within the arctic to become more feasible. The article illustrates the problem of drilling within what is known as the “Arctic Refuge,” which is a wildlife refuge home to an unique and fragile ecosystem. Melanie Griffin, director of the Sierra Club states “oil development threatens the refuge’s permafrost, which supports tiny cotton grass that are a critical summer food for the 129,000 Porcupine River caribou”. Oil development within the refuge will also cause massive industrial development and will inevitably led to a major disruption in the caribou migration. Griffin suggests that the only alternative to drilling within wildlife refuge is increasing capital investment in renewable energy.
The need for renewable energy alternatives is the only the way the world can kick its addiction to fossil fuel and end the damage caused by the extraction of oil. The article refers to the steps taken by oil companies to transform themselves from oil firms to energy firms. Shell for example has created a division called Shell International Renewable which is primarily responsible for exploring energy alternatives such as solar, wind and biomass. Furthermore, Shell has also created another division called Shell Hydrogen, which is working closely with DaimlerChrysler on hydrogen fuel-cell vehicles, which is seen to be a very promising technology for ending fossil fuel dependence.
Analysis
Vehicle Emissions Are Not Just From The Tailpipe
Vehicle emissions are commonly conceptualized as emissions that are produced through the combustion of fossil fuel. It is commonly known that as a vehicle burns fossil fuel the byproducts of that combustion produces an array of emissions such as carbon dioxide, nitrogen and other particulate matter which is ultimently released into the air. Evidently, as these emissions are released into the air they affect the ambient air quality and eventually negatively affect human and ecosystems alike.
On an alternative basis vehicle emission also cause other environmental harm which are not associated with tailpipe emissions. Vehicle emissions are caused by peoples demand to drive their vehicles. This demand ultimately requires fossil fuel and this fossil fuel needs to be supplied through the extraction of oil. As oil is extracted from the natural earth, there are numerous environmental problems associated with the extraction of oil. These environmental problems include the degradation of the natural ecosystem through the dumping of toxic residuals into the surrounding ecosystems, the potential threat of oil spills which have immediate and devastating affects on the ecosystem as a whole, and the disruption oil rigs, pipelines, and oil tanker have on the natural environment. Therefore, vehicle emissions not only affect the ambient air quality, but also affect the greater environment as a whole through numerous environmental problems that are associated from oil extraction at the point of production.
The demand for fossil fuel is the ultimate driver within this process. If the demand for cars and the subsequent demand for fossil fuel were nonexistent then there would be no need for oil extraction and no environmental problems associated with the need to find oil. As Fig. 1 points out, the extraction of oil produces discharges into the environment in two ways; first, through the actual production process of extracting, refining and delivering the oil to market, and secondly by the actual consumption of the oil by consumers through the use within vehicles. Overall the affects of vehicle emissions needs to be addressed within a scope that accounts for all steps of the production process from the extraction of the good to the final consumption of that good.
The Economics of Oil Extraction
The economics of oil extraction is ultimately tied to demand for oil. When there is a demand for oil there is inevitably an associated supply. Within a microeconomic analysis, firms operating within a perfectly competitive industry and maximize their profits where price equals their marginal cost of production (P=MC). Basic supply and demand shows that as demand rises the price of a commodity will also rise. This rise in the price of a commodity will cause firms to produce a greater quantity of that commodity because the price offsets the increase in the firms MC. Consequently, with oil extraction, there are some firms that are able to extract oil at a lower MC then other firms (See Fig.2). As the price of oil rises the higher cost firms are able to start producing or produce more because their MC begin to align with the price of oil. This can be seen within the Alberta oil sands. The average MC of a barrel of oil produced within the Alberta oil sands is around $65 a barrel. As the price of oil rises above $65 a barrel it becomes profitable for firms to start extracting oil. This has been seen in the latter half of this decade with the oil boom within Alberta.
Furthermore, as the price of oil increases firms will also be more willing to pursue oil extraction in more remote locations such as the arctic. The more remote a location is the higher the extraction costs will be. This only becomes profitable for firms when they are able to offset the higher extraction costs through higher crude prices. Yet, the environmental impact of this extraction is also greater and not account for within the firms MC. Simply the social cost is not equated within the firms MC. Like the Alberta example provided earlier, the MC of $65 a barrel does not account for the environmental damage that is created when this oil is extracted from the ground. As the article points out the demand for oil supersedes environmental policies, that are designed to prevent environmental damage because we as a society are oil dependent. Therefore, the social costs associated with extracting oil is paid by the consumer in the form of higher prices but the consumer is also the one bearing the social cost of the oil extraction. The argument can be made that the costs and benefits of not taking any action to prevent environmental harm balances out.
Furthermore, some will also argue that as the price of oil rises peoples WTP will decrease causing demand for oil to also decrease. This phenomenon of price elasticity of oil is false under the premise that fossil fuel or gasoline is highly inelastic meaning that as prices rise quantity does not diminish rapidly. Simply put as gas prices rise peoples WTP for gas is not affected. People still need to get to work, they are not willing to quit their jobs or move closer to work to cut their commuting time. Though WTP is tied to income theoretically the argument can be made that their is a ceiling to peoples WTP for oil, but that ceiling has yet to be tested.
Conclusion
The article makes a convincing point that our demand for crude is solely responsible for the environmental damage associated with extracting oil. As we demand more crude, suppliers of crude need to find new reserves in more remote location which cause greater harm to the environment. As pointed out within the analysis our demand for crude not only degrades the environment through reducing the ambient air quality, but is also responsible for the damages related to extracting oil. As crude prices rise the incentives for firms to find and extract more oil become greater and this leads to development of oil projects in areas which were once unfeasible. Therefore, the only realistic solution to mitigate the affects that oil has on the environment is to eliminate our dependence upon it, yet as history has shown this has proven to be a difficult endeavour to undertake.
Prof's Comments
Good job. Your point about a highly inelastic demand is correct in the short run. However, in the long run people can move closer to work, buy a more fuel efficient car, etc.