The True Cost of Nonrenewable Energy Production

The True Cost of Nonrenewable Energy Production

A Paper by Jamshid Damooei, Professor and Chair of Department of Economics, Finance and Accounting, California Lutheran University, delivered at the 10th Rhodes Forum on October 5, 2012

There is a common misconception about the cost of energy. Fossil based energy such as oil and gas are considered as the least expensive form of energy, whereas solar, wind and other form of renewable energy extraction are considered expensive and hard to afford. This paper tries to ask some basic questions about the way we look at cost of energy and to the extent possible give some answers that are plausible and defendable based on the existing principles of the market economy:

• Can a market allocate resources efficiently when externalities are ignored?

• Can one generation make decision about their lives irrespective of how their decisions may impact other generations?

• Are there any national boarders for environmental pollutions?

Externalities and Economic Efficiency

We should ask ourselves that why markets are capable of allocating resources efficiently. Decisions on production and cost determine a significant proportion of our relation with the physical environment. Efficiency in general and productive efficiency in particular is the most important issue in this relationship.  Mainstream economics makes a clear distinction between the implicit and the explicit costs and argue that the prices should fully incorporate both. Market often fails to internalize externalities and therefore in all such cases the existing production levels are in excess of the social and ecological optimum level of production. Since governments are now often the supporters of capital (at time unconditionally) any real prospect that such costs will be internalized is not a realistic option.  

Environmental problems such as pollution and depletion and degradation of natural resources arise because of market failures and government failures. Market failures occur because markets for the environmental goods and services either do not exist or when the markets do exist, the prices underestimate their social values.

Traditional and existing economic analysis believe that markets can exist and function efficiently only when property rights on goods and services exchanged are well defined and transaction costs of exchange are small. Such school of thought does not put any significant reliance on the importance and the functionality of commons.

However even within a narrow perspective of the traditional market based economics, we find that based on the existing arguments, property right cannot often be defined for the environmental resources such as clean air, water in river and springs, oceans and atmosphere. Indeed in most countries these resources are in public domain, where they may rightly belong. According to market based economics, users of these resources consider them as “free” goods or “unpaid” factor of production. Therefore they impute zero prices for using these resources in their private decisions even when their social scarcity values are positive.   Looking at conventional economics there are two important reasons for non-existence of the markets in such circumstances; they are:

• Difficulty in defining, distributing and enforcing property rights

• High costs of creation and operation of markets.

The first and the second reasons are interrelated and in essence they make it clear that market failure is an inevitable outcome when it comes to appropriation and allocation of environmental resources.

An equally forceful argument which has been around for a long time but recently found greater momentum is the ability of market to allocate environmental resources even when there is a defined market. The counter argument is the role of commons versus property rights. A third possible consideration is the place of state ownership of environmental resources. Each one of these three possibilities has its own specific arguments.

Most conventional economists argue that private property rights is the essential factor in making sure that resources are allocated efficiently, simply because the interest of owner (making profit) prevails and that in their opinion, inevitability lead to preservation of the natural environment. It is hard to believe that such argument holds when we are witnessing the devastation of our natural environment by a rapid pace in many places around the world. The core of the argument is presuming that profit seeking will always lead to preservation of an environmental asset. The proponents of such belief do not make any allowance for the perverse incentive of corporate managers and the existence of agency cost, which suggests the interests of owners and managers, might be in conflict. They do not allow for the existence of moral hazard and firmly believe that market always behave efficiently.

Many economists reject the ability of commons to allocate resources efficiently. In their views each user will be in a position to exploit the situation and make every effort to use the resource without any consideration to maintain and take care of the property. According to them the problem of free riders will emerge and imposing any rules will be too expensive and a source of inefficiency. 

Professor Ostrom, 2009 Nobel Laureate in Economics takes a different view. She believed that:

“The debate about the relative merits of private and common property has been clouded by a troika of confusions that hinder scholarly communication.”

The presumption of not paying attention to the condition of the natural resource and the lack of concern for the continuation of its existence appears to be thin when the reality of the existing evidences are closely looked at. At the same time the assumption of profit seeking within the environment of modern corporate structures that decisions are made by managers (often with short term interest) is unrealistic and exaggerated. One does not need to go further than merely observing what has been going on in many areas in where companies have been exploring and extracting oil and gas. Their lack of concern for the environment has caused many disasters in many parts of the world.

The main issue in making any comparison between efficiency of commons and private property rights is to be objectives and mindful that there is no overarching conclusion that one can make. The main takeaway from works done by Ostrom and other economists like her is that ordinary people with common interest are capable of setting their rules and regulation for how to utilize the common property and that bring a much better outcome than what may be received by encouraging private property ownership as a means of protecting the resource and its allocation to productive purposes. 

Conventional economics argue that decision to allocate resources to productive means can only be optimum when its marginal cost of production equals its marginal revenue. Let us not forget that this is the rule of profit maximization. Let us say that even within this principle the outcome often is far from being optimal. The core problem is the inability or lack of attention to calculation of real total cost.

Producing energy from oil and gas include a wide variety of externalities that are never mitigated. The outcome is global warming, destruction of habitat, rise of ocean level and flooding of low lands, which bring about destruction of those communities and the list goes on. For long oil and gas companies and their supporters in governments around the world have tried their best to ignore and argue that there is no scientific evidence proving any wrong doing on their part. When the scientific evidence became available, the argument shifted to denying the creditability of the evidences and labeling of scientific communities as unrealistic and anti business. In the United State there is a growing trend that can best be described as environmental denials. The end result is the continuous failure of the world community to build and follow a plan of action that can bring a sustainable environment for the present and the future generations.

Existing studies show that subsides and externalities are far greater in production of both oil and gas than any other form of energy production. Such costs are covered by the oil producing companies and the subsidy they receive is hidden from people. If the true cost of energy production was know both in terms of externalities and subsidy, their production would have been curtailed and that would have opened up possibility for production of a much higher level of energy from renewable resources. Production of energy from renewable resources would have reduced the barrier for greater economic growth and higher level of prosperity in the world. These policies in their final assessment are regressive, outmoded, counterproductive, and destructive and can only lead to creation of greater problems in present and the future. 

Can one generation make decision about their lives irrespective of how their decisions may impact other generations?

Thinking about future generation is an important issue in every society. One can argue if there is any legal ground for the rights of future generation. The argument about the future is not a mere legal argument but it is rooted in the morality and ethical values of every society.

In looking into the human concept of relating various generations into their common human interest one can point out the seven generation rule of Native Americans who lived in peace and harmony with the environment long before been forced by the new settlers to do away with their traditions.  Seven generation sustainability is an ecological concept, which urges that in order for the current generation of humans live in a sustainable relationship with their future generation, every decision should be based on the benefit of the seventh generation into the future.   It originated from the Iroquois tribe-Great Law of the Iroquois - which holds appropriate to think seven generations ahead, which turns into a couple hundred years into the future.  The principle can be seen in the following quote: "In every deliberation, we must consider the impact on the seventh generation... even if it requires having skin as thick as the bark of a pine." 

The issue of whether the future generations have any rights is not as difficult as finding convincing evidence that such rights actually exist in our societies. 

Are there any national boarders for environmental pollutions?

It is a known fact that water and wind do not recognize any national borders. When Tsunami occurred in Japan, people in the shores of California received some of the nuclear radiations from thousands of miles. Borderless environmental hazard bring an important issue which have never received serious attention of the world community. The issue is the responsibility of countries that pollute and what should be done to compensate those who are harmed. There is a similarity between this problem and the damage that we pass on to other generations who come after us.

It’s a natural fact that wind and water don’t respect national boundaries. One country’s pollution quickly can, and often does, become another country’s environmental and economic crisis. Because the problem originates in another country, solving it becomes a matter of diplomacy and international relations, leaving the local people who are most affected with few real options.

A good example of this phenomenon is occurring in Asia, where cross-border pollution from China is causing serious environmental problems in Japan and South Korea as the Chinese continue to expand their economy at great environmental cost. CO2 is well mixed in the atmosphere, so observations of concentrations from a single site like the Mauna Loa Observatory are an adequate indicator of world trends for atmospheric CO2.

The following chart shows the escalation of Carbon Dioxide (atmospheric CO2) over the last few decades:

Source: http://co2now.org/

The data presented in the diagram has been collected by the Mauna Loa Observatory in Hawaii which is part of the National Oceanic and Atmospheric Administration (NOAA), Earth System Research Laboratory (ESRL), Global Monitoring Division (GMD) in the USA. The safe level according to scientific resources is about 35 ppm (level of concentration of atmospheric CO2). This chart shows that the level has been higher than the safe level since 1988 and it is going up without any sign of reduction.

Carbon dioxide (CO2) is the chief greenhouse gas that results from human activities and causes global warming and climate change. The resulting negative climatic changes are causing numerous problems for people around the world. Rise in the sea level, increase in incidence of cancer, return of diseases  that have long been forgotten, loss of land, migration of people from low land to higher grounds are the early signs of what has been going on. The worse is yet to come. Our inability to process the information and arrive at a realistic picture that puts protection of living entities on the center of our attention is mindboggling.

So the question that begs an answer is “who is responsible for the global warming and what should be done about curtailing it?”

Human activities and some of the natural occurrences such as volcanoes have direct impacts on level of CO2. The existing scientific studies show that some natural occurrences create CO2 and other natural development removes it from the atmosphere.  These studies show that the Earth’s climate for the past 2 million years has been characterized by ice ages lasting close to 100,000 years, punctuated by relatively short (10,000- to 30,000-year) warm periods or “interglacials.” It is important to note that the swing from glacial to interglacial is caused by changes in the earth’s orbit around the sun amplified by natural feedbacks involving greenhouse gases (Hays et al. Science, 194, 1976, pg. 1121). 

According to the current studies the Earth entered the present interglacial about 10,000 years ago. All things being equal (i.e., in the absence of a large human-produced source of CO2) it is highly likely that the Earth will swing back into a glacial period or ice age. But this will not occur for thousands of years. 

The fact that natural changes have resulted into global warming in the distant past does not reduce or eliminate the strength of the reasoning that the current swing of climatic changes towards greenhouse effect is not without influence of human behavior. Indeed while the natural changes are capable of bringing the earth into a global warming, none of them have actually proven to be the reasons for the new round of global warming and that puts the blame fairly and squarely on the human economic behavior which in part is directly related to the behavior of developed economies and most importantly on the United States, which has been the main cause of such development.

 James Wang, and Bill Chameides (2007) believe that all known natural explanations for the current global warming have been looked at and eliminated through research and scientific observations. The human-intensified greenhouse effect provides the only quantitative explanation for the current warming trend.  The Earth’s climate may return to ice age conditions in thousands of years, but this does not preclude devastating effects from global warming over the next few centuries.

What is the conclusion and what should be done to address the insuring problems?

This paper showed that by application of traditional and widely accepted principles of market based economy calculation of cost of energy is deeply fowled. Among many reasons the following two stand out:

• Inability to calculate and internalize externalities.

• Public policies that provide substantial subsidies to producers of fossil based energy. The argument for branding use of commons as inefficient and unproductive method of using and managing utilization of natural resources is flowed and in major part based on the politics in the countries in where decision makers support the interest of polluting energy producing companies. Many economists have long argued and recently have been proven by empirical evidence presented, among others, by two noble laureates in 2009, that human societies are capable of managing their commons in the interests of all and such management proved to be more optimal than private or state ownership.

Changes in environment caused by one nation do not stay in the boundaries of the same nation. Countries such as the United States that by having less than 5% of the world population causes 25% of the world pollution should accept a greater share of the responsibilities. The same argument may be set against all of us and our way of life that bring about greater level of environmental decay and damage.

Thinking about one generation without any concerns about the future generations is below norms of human dignity and morality.

Finally, the fact that Earth goes through the cycle of global warming and climatic changes in thousands of years does not shift the blame from the current generation of human societies that have certainly brought this looming environmental disaster thousands of year earlier.

What should be done?

• Awareness and confirming that our way of life has brought and will continue to create more dire condition for substance of life on Earth is the most important first step.

• Change in our consciousness is very important. We need to define our relationship with earth and all living species differently.

• Activism is very important and that should be manifested in political actions that we take to exercise our democratic rights.

• Education from early age and throughout our lives is very important.

• Building coalitions and creating groups among different people with different demographics within a country and around the globe is vital. Solidarity is the way to move forward.