Environmental Economics

I have posted before about oil refining and how environmental regulations have played a role in where we currently are in regards to refining capacity. Typically I am usually called some sort of shill or some such for the oil industry (disclosure: I don’t work for the oil industry directly or indirectly and AFAIK I don’t hold any oil stocks–although the various funds that comprise my 401k might). The problem is that many people who support enviornmentalism and environmental regulations seem to be afflicted with some sort of bizzare malady that they can’t admit to themselves the obvious facts.

What justifies environmental regulations and laws in regards to pollution in general? It is that there are costs that the firms that emit pollution are not bearing. If I own a plant that emits pollution chances are the losses in terms of environmental degredation are not part of the costs that I incur. As such I produce too much of the good(s) in question and there is too much pollution. Laws and regulations to address this concern are ideally supposed to get me to realize these costs and to take them into account in terms of production decisions. The term in economics for this is called internalizing these external costs.1

Now, basic ecnomic theory tells us that internalizing these costs will increase the costs of production. The marginal cost will increase. And increase in the marginal cost for a competitive industry will increase the price. Further, this increase in cost will reduce output. I don’t see why this is questioned since we aren’t talking some cutting edge economic theory here, but standard neo-classical theory of the firm here. Further, since costs are increasing and output declining here it is likely that one or more of the inputs will also be reduced. Thus, it is not inconceivable that labor inputs also decline along with output. Again this is not shocking or controversial. In fact, I’ll go even further here. The reduction in output, some of the inputs and the increase in price are precisely the goals of the environmental regulations and laws.

Now whenever this is pointed out there is usually a respones like, “Oh that is just the industry’s talking points, they are all lies!” While the industry in question might be exaggerating or even outright lying in terms of the magnitude of the impact there will quite likely be adverese impacts in terms of profits, employment, investment and output. To argue against this is to argue against the very efficacy of the environmental regulations and laws themselves. The whole point of the environmental laws and regulations is to have precisely this effect because costs are not being borne by the party that is imposing the costs. Think of it this way, when people dispute the claims that I have laid out above what they are saying is the following.

  1. Prices wont go up.
  2. Input demand wont change.
  3. Output wont change.
  4. Profits wont change.
  5. But because of magic or something there will be less pollution.

Now if your are thinking that sounds irrational that is because it is irrational. It is the environmentalists version of intelligent design. We can’t explain, we don’t know how it happens, and don’t bother us with questions about data, evidence and so forth, we just now a miracle happens in there somewhere.

Now all that being said, this does not mean that environmental laws and regulations are by definition bad. Remember, the reason for environmental laws and regulations is that there are costs that are being incurred by those who are not generating them. What all this does say is that our environmental policy should be based on reason and evidence and not some whacked out religious notions held by environmentalists.
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1These external costs (and/or benefits) are typically called externalities in economics. The reason these costs (and/or benefits) are called external is that they are external to the firm’s cost function and hence are not part of the calculus for production decisions.

FILED UNDER: Economics and Business,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Don says:

    This strikes me as something of a straw man argument. I’ve not heard any reputable environmentalists denounce neo-classical economic theory or maintain that regulations won’t affect prices, inputs or outputs.

    In fact, aren’t environmentalists counting on economic theory to realize their goals? One of their oft-stated arguments is that higher prices will encourage greater conservation, sales of cars with better fuel economy, investments in mass transit, carpooling, etc.

  2. ken says:

    Steve, you are a shill.

    Just as environmental law prohibit refineries from restoring lead to their gasoline blends so does criminal law prohibit soft drink manufacturers from restoring cocaine to their syrups.

    There are lost opportuniites for profit because of criminal and environmental laws. But so what? Hell, even the law of gravity keeps airlines from making the kind of profit they would like.

    Everyone understands that questioning environmental laws is no different than questioning criminal laws. And this makes you, like a mobsters mouthpiece, just another in a long line of emply shills that only the foolish listen to.

  3. Steve Verdon says:

    This strikes me as something of a straw man argument. I’ve not heard any reputable environmentalists denounce neo-classical economic theory or maintain that regulations won’t affect prices, inputs or outputs.

    Really Don? Are you sure about that? Seems to me there is plenty of evidence for my claim.

    In fact, aren’t environmentalists counting on economic theory to realize their goals? One of their oft-stated arguments is that higher prices will encourage greater conservation, sales of cars with better fuel economy, investments in mass transit, carpooling, etc.

    Really, can you produce anything to back that up?

  4. Steve Verdon says:

    Oh and Don, check out Ken’s reply. I knew he’d write that post, it is actually quite typical of him.

    Ken,

    You are a complete nutjob.

  5. spencer says:

    Everything you say is good economic theory.
    Moreover, I do not deny that environmental regulations have had a negative impact on the building of new refineries.

    But, the question is how much did regulation contribute to the problem and the objective answer is that it played an insignificant role.

    The point is that during most of the 1980s and 1900s it was a business with excess capacity and extremely poor returns and this was the dominant reason that no new refineries were built.

    Try the counter-factual. Over this period many refineries were shut down because they were unprofitable. If refining had been a profitable business and capitalist knew that regulations precluded new supplies they would have bought the existing refineries and continued to operate them.

    Another question. In 1999 Sun applied for permission to build a refinery in Yuma, Az..
    They requested an exemption to some pollution standards. The request for exemptions was denied. So Sun did nothing until 2004 when they reapplied without requesting the exemption. The new request was approved in just a few months.
    Why did Sun wait 5 years? Because the approval process took too long — not likely. Rather they waited 5 years because it was not worth building the refinery without the exemption until the supply-demand balanced tightened and refining margins improved.

    We keep hearing the application process is too long and this refinery in Az. is often cited as an example. But is was not the application process that caused Sun to do nothing for 5 years.

  6. odograph says:

    Don’t overseas refineries provide a safety-valve for too-high environmental regulations in any one country?

    If country A sets their standards too high, they’d see a flight of refineries, an increase in imports of refined product, and … who knows prices might be a little higher, lower, or a wash … but the free market would certainly be in play.

    “Regs” would only restrict refineries if one set of “Regs” ruled worldwide.

  7. odograph says:

    By the way, in another comments thread I explained that I thought it was possible that world-wide we had a shortage of light sweet crude, and a world-wide shortage of refineries for the heavier stuff.

    That would mean that the “problem” is broadly a “peak oil” phenom for light crude, and a lack of “pre planning” for the heavy.

    This bloomberg story seems to support that:

    http://www.bloomberg.com/apps/news?pid=10001099&sid=a2am.HjIsRxE&refer=energy

  8. Don says:

    >In fact, arent environmentalists counting on >economic theory to realize their goals? One of >their oft-stated arguments is that higher >prices will encourage greater conservation, >sales of cars with better fuel economy, >investments in mass transit, carpooling, etc.

    >Really, can you produce anything to back that up?

    I didn’t think that was a controversial point, but if you need proof that there are those that make such arguments, then how about this, from the “Resources for the Future” website.

    http://www.rff.org/rff/Documents/RFF-Resources-148-gasoline.pdf

  9. Steve Verdon says:

    Don,

    Oh God, not the gasoline tax thing again. Frankly I find those arguments to be a sign of near mental retardation. I admit that gasoline has a strong negative externality associated with it, but some of the things people love to throw in for justifications for raising the gasoline tax are simply too stupid to even qualify as stupid. Things like the economic cost of using foreign oil. The section on the equity of gasoline taxes was amazingly bad.

  10. ken says:

    Steve, What is it about a clean healthy environment that you do not understand? It wasn’t the free market that cleaned up the air and water, it was environmental laws.

    So first, just like you wouldn’t condone Exxon from building it’s refinery on land you own without paying for it (that would be a criminal act) so too don’t even consider allowing them to build a refinery that pollutes our air or water.

    Take pollution off the table, just like you would theft, then talk about building all the legal refineries you want.

  11. Don says:

    All you asked was that I prove that environmental groups make such arguments…I believe I’ve done so! You didn’t ask me to convince you of their soundness, nor would I try to do so!

  12. Steve Verdon says:

    Don,

    No, I disagree. A bad argument doesn’t support your position.

    Ken,

    I don’t have a probelm with a clean environment, that is simply a strawman you have made up since you cannot challenge my actual claims.

    Spencer,

    Your are partially correct. Part of the problem with oil refineries in the early 1980s was that subsidies for small refineries were taken away. Those refineries shut down. That part of the problem has little to do with environmental regulations directly. Although it is also likely that things like the Clean Air Act hastened some of those smaller refineries decision to shut down.

    However you example with Sun in Yuma Arizona proves my point. When gasoline prices were low and refinery profit margins low the refinery wouldn’t get built without the environmental exemptions. Only when the price is much, much higher and profit margins higher does Sun reapply without the request for exemptions. Hence, environmental regulations provide a barrier to entry. A barrier to entry increases the market power for incumbents, which can translate into higher and more volatile prices.

    We keep hearing the application process is too long and this refinery in Az. is often cited as an example. But is was not the application process that caused Sun to do nothing for 5 years.

    Tell me Spencer, where exactly in my post did I say that the regulatory process takes too long for oil refineries? In some cases I think this is the case (CA and refineries and electricity generating plants, but I’m hesitant to extrapolate from CA to the entire country). In short, nice strawman.

  13. Don says:

    >No, I disagree. A bad argument doesn’t support >your position.

    You didn’t challenge me to take a position. I had posted that one of the “oft-stated arguments” of environmentalists “is that higher prices will encourage greater conservation, sales of cars with better fuel economy, investments in mass transit, carpooling, etc.” You had asked me to “back that statement up,” and I did so…I provided an example of an environmental group making such an argument.

    I’ve taken no position on whether their position is a sound one…they can defend their positions on their own as far as I’m concerned!

  14. spencer says:

    My point is not that the regulations imposed costs that were a factor that prevented refineries from being built.

    My point was that the dominant reason was poor profits and that regulations played a very minor role.

    Maybe I did assume something you did not mean,
    but my main conclusion is that the regulation argument is a red herring. The dominant reason we did not build refineries was a classic example of markets overshooting. First, building too many and second not building enough. This is typical market behavior, and has always been.

    I just am tired of this argument being made by
    people who want to blame the government for everything that goes wrong. Yes, govt makes mistakes and does bad things. But so do private markets. And the shortages of refineries is much more a failure of private markets then a failure of government.

  15. ken says:

    I don’t have a probelm with a clean environment, that is simply a strawman you have made up since you cannot challenge my actual claims.

    Steve, what the hell are your ‘actual claims’ if not:

    “The problem is that many people who support enviornmentalism and environmental regulations seem to be afflicted with some sort of bizzare malady that they can’t admit to themselves the obvious facts.”

    Steve, you are a moron. Doesn’t this imply that you have a problem with the laws that have given us a clean environment?

    The ‘actual facts’ are that environmental law, like criminal law, contract law, and SEC regulations, all put a limit on what corporations, in this case oil companies and refineries, can do to make money.

    But so what?

    To be taken seriously in your obsession you must show that the ‘actual facts’ about environmental laws impact on our economy is substantially different, in an onerous way, than say the ‘actual facts’ regarding the impact of SEC regulations.

    I submit to you that environmental laws are as much a given as are SEC regulations, contract law, criminal law, etc. and that their impact is as fully understood and accepted by the american people, environmentalist included, as are the impact of the other laws we live under.

    Not a single proposed refinery has ever been left unbuilt due to environmental laws. Now that it may make economic sense to finally build a few new ones you want to exempt them from environmental laws? Why? That is just plain dumb.

  16. odograph says:

    “The dominant reason we did not build refineries was a classic example of markets overshooting. First, building too many and second not building enough. This is typical market behavior, and has always been.”

    I agree, and there are various types of overshoot going on at once. Europe now has a suprlus of gasolie production and a shortage of diesel because of the “unexpected” shift to small diesel cars.

    And as I showed earlier, there is a world-wide shortage of heavy crude -> gasoline refining capacity. They certainly can, and will, build some of that capacity in the Gulf Region … our Regs won’t stop that.

  17. Steve Verdon says:

    Don,

    You have one example about higher prices and their effects, however, it is my contention that many environmentalists tend to argue the exact opposite. In short, one example isn’t that big a deal. Let me put it differently: I am pretty sure there are people out there who understand the impact of higher prices, enviro regs/laws and see the point I’ve raised. One example that I’d point to is Prof. James D. Hamilton.

    Ken,

    Steve, what the hell are your ‘actual claims’ if not:

    Try a remedial reading course.

    “The problem is that many people who support enviornmentalism and environmental regulations seem to be afflicted with some sort of bizzare malady that they can’t admit to themselves the obvious facts.”

    Uhhh…yeah. And what the f*ck does this have to do with clean air? I’m talking about how many environmentalists have this kooky notion that environmental regs and laws have no impact in regards to price. How you go from that to I like dirty air highlights your own dementia.

    Steve, you are a moron. Doesn’t this imply that you have a problem with the laws that have given us a clean environment?

    No. I explicitly pointed that out in the last paragraph of post. That you can’t seem to grasp this again highlights that you are either insane or mentally deficient.

    To be taken seriously in your obsession you must show that the ‘actual facts’ about environmental laws impact on our economy is substantially different, in an onerous way, than say the ‘actual facts’ regarding the impact of SEC regulations.

    Why? Why should I do this loopy boy? I’m not arguing that there is a different effect, but that there is an effect, but that environmentalist often want to deny the effect.

    Not a single proposed refinery has ever been left unbuilt due to environmental laws. Now that it may make economic sense to finally build a few new ones you want to exempt them from environmental laws? Why? That is just plain dumb.

    Ken, you have got to be one of the stupidest people on the internet.

    1. I have not argued that refineries should be exempt from anything.
    2. I have not argued that enviro regs/laws totally prevent the building of refineries.
    3. I can’t for the life of me see how a rational person could come up with the above two arguments from my post.

    So, based on this I have to conclude you are either really, really stupid or completely insane or maybe both. I’ll let you pick which one is the most accurate.

    Spencer,

    My point was that the dominant reason was poor profits and that regulations played a very minor role.

    That is fine, but your only bit of data seems to point to exactly the opposite conclusion.

    Maybe I did assume something you did not mean, but my main conclusion is that the regulation argument is a red herring. The dominant reason we did not build refineries was a classic example of markets overshooting.

    I disagree. The problem wasn’t that there was too much refinery capacity, but that there was refinery capapcity that depended on subsidies to exist. When those subsidies were taken away capacity dwindled. Then enviro regs/laws added to whatever existing barriers to entry there were so what we saw was an expansion of existing refineries to meet refining demands. This, while capable of meeting demand, is not good for competition and can be bad from a pricing standpoint. Now with prices pretty darned high and unlikely to go down anytime soon, now even with the enviro regs/laws we are seeing new interest in building new refineries.

    I just am tired of this argument being made by people who want to blame the government for everything that goes wrong. Yes, govt makes mistakes and does bad things. But so do private markets. And the shortages of refineries is much more a failure of private markets then a failure of government.

    First off, I’m not saying that the environmental laws/regs are wrong ken…err Spencer. What I’m saying is that they have an effeect, and probably a pretty big one. How much extra does it cost to build an electricity generating station because of the Clean Air Act? $50 million? $100 million? That isn’t small potatoes even to a multi-billion dollar company. Especially if they can import what the need from another area that has a surplus of generation capapcity. Of course, in places like CA the lag time in building base load generation could spell real trouble in a few years if load growth is stronger than anticipated.

    My point is that these laws/regs have impacts, sometimes unanticipated ones and ones that can be large. So far you have provided zip in terms of data that counters this claim and have actually, IMO, provided data to that supports it.

  18. spencer says:

    OK, I do not have the data right on hand and am not going to spend the time to find the exact data. So I am just writing from memory.

    Capacity utilization in the refining industry was running in the 70% -80% range throughout the
    1980s and 1990s. Moreover, capacity actually grew throughout that period even though the number of refiners fell.

    The crack spread between refined products and crude was measured in terms of cents per barrel during that entire era, not in the dollars per barrel we see now.

    Moreover, prior to early 2000 when the trend reversed, oil refining stocks were among the worse performing sectors of the stock market.
    Go read some of Valero’s annual reports or what stock market analysts were writing. They were saying exactly the same thing I am saying.

    I am making this data up off the top of my head, but it the right order of magnitude. Take the Yuma facility we were talking about. I do not know, but assume that it would have been profitable to build the refinery if the crack spread was $1 in 1999, but the crack spread was actually only $0.25. Again, I do not know the facts, I am just throwing out numbers. Without the pollution requirements maybe it would have been profitable if the crack spread was only $0.75.
    In this case the difference is market prices were $0.75 to low with pollution control costs but only $0.50 too low without the extra costs. So market forces accounted for two-thirds and pollution control costs accounted for one-third.

    The costs of pollution control is almost exactly the same as who pays a tax. Most of the time business can pass the tax through to consumers and it is just another added costs
    of doing business. But, some of the time demand conditions are such that capital has to absorb the costs. And the conditions that generally make capital absorb the costs of a tax are like those in the oil refining business in the 1980s and 1990s– an unprofitable business.

  19. Steve Verdon says:

    …1980s and 1990s. Moreover, capacity actually grew throughout that period even though the number of refiners fell.

    This is incorrect. Starting 1981 capacity fell through 1994 and then started to increase again.

    The costs of pollution control is almost exactly the same as who pays a tax. Most of the time business can pass the tax through to consumers and it is just another added costs
    of doing business.

    Gadzooks, this is not true save in special cases. Granted, the consumer might pay a larger share or even the largest share, but the idea that the entire tax is passed through is highly dubious, IMO.

  20. ken says:

    I’m talking about how many environmentalists have this kooky notion that environmental regs and laws have no impact in regards to price.

    What bizzaro world do you live in Steve? As I’ve pointed out to you repeatedly, environmental laws are just like any other constraint put on business be they contract law, criminal law, or SEC regulations. Everyone knows they have an impact on price because they impact the way companies operate. But so what?

    That is the point you are missing, peevey Stevey.

    Because environmentalist do not get all angtsy over this issue just like you do you think they are unaware of it? Grow up.

    You seem to think you are privy to some esoteric knowledge called economics and others are not. You make a fool of yourself with each post you write like this.

  21. Steve Verdon says:

    Ken,

    I know they have an effect. My entire post was about the effect. My contention is that environmentalists and those who support these kinds of laws and regs frequently claim no impact or a tricial impact. As an example I offer spencer’s posts.

    In short you have completely missed my point.