David Kreutzer on EPA and Oil Externalities

Sometimes in their zeal to exaggerate the “social benefits” of one of its programs, the number-crunchers at government agencies will stoop to absurd arguments that end up coming back to bite them. The Heritage Foundation’s David Kreutzer recently caught a great example of this, concerning the NHTSA’s and EPA’s analysis [pdf] of its new emission standards for light-duty vehicles. As Kreutzer points out, the agencies unwittingly made a great argument for increased domestic oil production.

EPA on Import Externality

Before explaining Kreutzer’s “gotcha,” we have to set up the context. On page 4-33 of its analysis, EPA/NHTSA feature the following table:

TABLE 4-11. Energy Security Premium in Selected Years (2009$/Barrel)

The numbers above show the estimates for the social cost per barrel of imported oil, because of the “energy security premium.” To break down the specific sources:

• “Monopsony” is the demand-side version of a monopoly. The claim here is that the U.S. is such a large buyer on the world oil market, if it could reduce the amount of oil it imports from abroad, then the world price of oil would fall. This in turn would shower benefits on the U.S., because the remaining imported oil would be cheaper. But if reducing oil imports would benefit the country, the flip side shows that maintaining oil imports carries with it a social cost above the price of the barrel itself. The table above shows that EPA estimates this external cost per barrel will be $11.12 in the year 2020.
• The “macroeconomic disruption / adjustment costs” refer to the economic dislocations caused by large swings in the world price of oil. To the extent that the U.S. could wean itself from foreign oil, the EPA analysis estimates that the social savings would be $7.10 per barrel in the year 2020.

We should be clear that the “energy security premium” estimated above does not include funding for the military, even though many people claim this is an added “negative externality” of oil imports. The EPA analysis acknowledged this widely held view, but declined to formally include it because of the difficulty in quantifying how much of the military budget should be allocated to the maintenance of oil imports.

Finally, we should note that although the table above adds up the two factors for a total energy security premium, the EPA/NHTSA analysis of the net benefits of the enhanced regulations on light-duty vehicles does not include the monopsony effect, because this is only a benefit to Americans. What they gain from reduced world oil prices, the net exporting countries (Saudi Arabia, Venezuela, etc.) lose by the same amount, meaning it is simply a transfer. (See page 4-37 of the report.)

To not lose sight of the big picture, let us recall the point of all this: The government agencies are trying to explain why tighter fuel economy and emission standards on light-duty vehicles are a good idea. So they are touting, among other alleged benefits, the “energy security premium” flowing from reduced oil imports when the American fleet becomes more fuel efficient.

Kreutzer’s Insight

Now that we know the context, we can quote Kreutzer’s simple yet damning point:

While the EPA does not explicitly say we should subsidize domestic petroleum production, the benefit of cutting imports—which are separate from whatever benefit there may be from cutting consumption altogether—can come from either cutting consumption or increasing domestic production.

The point is undeniable: If EPA is going to credit conservation programs with an “energy security premium” for every barrel of oil the U.S. no longer needs to import, then to be consistent they should do the same for proposals to expand drilling on federal lands. Yet, we don’t recall ever seeing such an “energy security premium” when the government analyzes the impacts of expanded drilling in ANWR or the Outer Continental Shelf.

Kreutzer takes matters further, and calculates what the “social cost of carbon” is, per barrel of oil, according to the government’s own numbers:

The whole purpose of (and legal underpinning for) these most recent CAFE standards is to cut CO2 emissions and the external costs they supposedly impose. Though far from a universally accepted number, according to the EPA, the external cost of CO2 is $22 per metric ton. So how much would this be per barrel of petroleum?

On page 4-45 of the JTSD, the EPA lists its estimate of CO2 released per gallon of gasoline (19.6 pounds) and diesel fuel (22.5 pounds). After adjusting for the greater use of gasoline, we get an average of about 20.4 pounds of CO2 per gallon, or 858 pounds (0.39 metric tons) per barrel.

Therefore, the perceived externality that so motivated the EPA, NHTSA, untold environmental activists, lobbyists, and legislators—and led to the 1,230-page regulation (not counting supporting documents)—works out to $8.58 per barrel (0.39 metric tons of CO2 per barrel times $22 worth of damage per metric ton of CO2).

Thus we have a very interesting juxtaposition. The EPA’s own numbers show that the negative externality from climate change (i.e. the social cost of carbon) is only $8.58 per barrel of oil, while increased domestic production of oil (which reduces imports, other things equal) has positive externalities to the whole world of $7.10 per barrel, and $18.22 if we focus just on Americans. In other words, according to EPA, even if we include the costs of global warming, America is better off by about $10 for every barrel of oil we produce domestically rather than importing. This benefit does not include the economic benefits to Americans that everyone knows about—increased jobs and increased American production, but comes just from EPA’s own estimates of the “positive externality” of an “energy security premium” more than offsetting the “negative externality” of climate change from greenhouse gas emissions.

As Kreutzer points out, the alleged negative externality from carbon emissions has been one of the motivating causes of our time, inspiring countless government regulations and public service campaigns. Yet the apparent “energy security premium” from enhanced domestic production is comparable or much greater, depending on how one frames the group.

Conclusion

In this post, we are not endorsing the calculations of an “energy security premium” nor are we arguing that there is a “positive externality” from domestic oil production, justifying a government subsidy. Rather, we are following Kreutzer in simply pointing out the hypocrisy of the government’s statistics and selective uses of economic theory. If the government thinks it makes sense to restrict car and truck producers and consumers by imposing tighter fuel economy and emission standards in order to reduce oil imports, then surely it makes sense to allow American firms to expand domestic oil production and reduce imports through that mechanism. After all, according to EPA there is an $18 a barrel “energy security premium” for Americans for each additional barrel of oil produced domestically.