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A few weeks ago I read with thoughtfulness Rick Outzen of the Daily Beast’s post on “BP’s Shocking Memo”.  I thought about writing a blog post about how I didn’t agree with Outzen.  But I haven’t until now because, well, it is a touchy and controversial subject.  However, the reason we started and continue to write Cow Burps is to explain our view of the world through an (environmental) economics lens and to therefore bring greater understanding of (environmental) economic concepts to those reading the blog.  I will cover quite a large scope in this post and I hope that by the end I can convince you, maybe not fully, but at least that there is a valid viewpoint to be had.

So I ask you please to read to the end before making the decision to make me your next steak dinner!  We of course welcome your views and any comments you have.

See, the thing is, I believe that Rick Outzen’s piece on BP’s cost benefit analysis is hugely misleading on three points:

1)     BP does not estimate “the value of a worker’s life”

2)     BP should be congratulated for using the figure of $10 million

3)     The major failure of BP’s cost benefit analysis was not on using the $10 million figure, it was on their estimation of risk.

For example, the large font print reads:

EXCLUSIVE: This internal BP document shows how the company took deadly risks to save money by opting to build cheaper facilities for workers. The company estimated the value of a worker’s life at $10 million.

It is likely that BP did not actually estimate “the value of a worker’s life”, but instead used the value of a statistical life, also known as a ‘value of a prevented fatality’ and ‘value of mortality risk’.  They value the benefit of risk reduction or the costs of risk increases to individuals. The concept is used regularly, not only in cost benefit analyses but also by you in your everyday life.

Consider, for instance, the last time you rode in a car without your seatbelt on. Or the last time you took a shortcut at night through some dark street. Or the last time you didn’t chew properly when you ate something.  In these cases you valued the added comfort of not being strapped in, the quicker travelling time and the convenience of not having to chew (…) over the risk that you could be killed or injured.

It is impossible to put an infinite value on reducing the risk of fatalities to zero. Everyday you and I trade off tiny (and in some of your cases, especially if you are an Alaskan king crab fisher, maybe not so tiny!) risks to our lives to get to work, to have fun, to nourish ourselves.  Similarly, organisations such as BP send workers out to do tasks that could endanger their lives. Just like the Alaskan king crab fishers, the workers accept these high-risk tasks for the higher pay they receive (to compensate for the risk they take) compared to other jobs they could undertake that are less dangerous.  From another angle, governments make decisions about spending money to reduce fatalities such as building better roads to reduce the risk of accidents.  They know that accidents and fatalities will still happen, however the only real way to rule this out would be to ban motor vehicles altogether – a not impossible plan but one that, even if citizens agreed, would be crippling to the economy and would, in most people’s point of views, make everyone worse off.

Outzen’s point is that BP should have housed workers in blast-resistant structures rather than trailers.  However, if we look at the slide he presents, it still shows that blast-resistant structures have a vulnerability of 0.01. If, as is implied by Outzen’s article, Outzen feels that any risk of fatality is too high, he should instead have argued that BP should not have sent their workers out to the oil refinery in the first place, rather than that they should have housed them in blast-resistant structures.

So now that we have established that it is possible and not morally corrupt to use a value of statistical life for cost-benefit analysis, let’s look at BP’s value and ask ourselves whether it is enough. Outzen claims that BP used a value of $10 million per worker. This is actually $2.6 million more than the value the US Environmental Protection Agency (EPA) puts on the value of statistical life, and the EPA traditionally uses the highest value of statistical life amongst all US government agencies.

So what did go wrong?  From reading Outzen’s article, it is clear that with regards to the explosion in Texas, what was wrong with the cost-benefit analysis was the assessment of existing risk, or how frequent “the big bad wolf blows… per piggy lifetime”.  As the benefit of risk reduction measures to society is calculated as the value of a statistical life x reduction in risk x people affected by the reduction in risk, this assessment of existing risk is important, since a reduction in risk is the product of existing risk and the measures you put in place to mitigate against the existing risk.  This benefit calculation directly affects what kind of measures are taken.

For example, if you live on a farm in the middle of the countryside surrounded by farmland where explosions are not very likely (say 1 in a million), you will benefit less from building a blast resistant structure that mitigates your risk by 50% (reducing your risk to 1 in 2 million) than if you lived on an operating oil field where explosions are more likely, say 1 in 500, where it would halve your risk to 1 in 1000 (making the reduction in risk 2000 times more ‘beneficial’ in the oilfield than in the countryside).

Outzen writes “At Texas City, all of the fatalities and many of the serious injuries occurred in or around the nine contractor trailers near the isom unit, which contained large quantities of flammable hydrocarbons and had a history of releases, fires, and other safety incidents.”

From this description it looks like the big bad wolf could blow at any point and as the estimation for the probability of an explosion at the refinery is nowhere to be found, one is left wondering what it was and how it was estimated.

Coming up in a future post: Everything else BP left out of their cost-benefit analysis.

More information on Value of Statistical Life:
EPA – Value of Statistical Life Analysis and Environmental Policy: A White Paper for Presentation to Science Advisory Board – Environmental Economics Advisory Committee

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Environmental economics principles are in the headlines again today. BP, following meetings at the White House, has promised to meet in full its obligations to those affected by the ongoing Deepwater Horizon oil spill. This ‘obligation’ relates to ‘polluter pays’, a key principle of environmental economics. It makes the party responsible for producing pollution responsible for paying for the damage done to the natural environment.

Traditionally, definition of damage has been limited to commercial losses of others. In environmental legislation in the US and much more recently in Europe [1], this definition has been widened to include wider environmental damage estimated as decline in human welfare. Welfare changes experienced by both those who are directly affected by pollution and those who are not directly (physically or financially) affected but nonetheless suffer a welfare loss, are included.  In the BP case, this extended definition is used.

It’s good to see the polluter pays principle used in US policy making. Hopefully it will remain there, hand in hand with a political principle – consistency. So when the US arrives at the next UN climate change negotiations in Cancun in November, and discussions turn to funding actions to deal with the impact of climate change on the welfare of people around the world, what position will they take: promising to meet in full its obligations to those affected by pollution? Or political hypocrisy?

[1]Environmental Liability Directive, April 2007

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The breaking news this week is that Canada has finally, with less than 2 weeks to go, added climate change to the G8 agenda.  The lateness of this addition is shocking, but perhaps Canada is desperately attempting to avoid having to talk about the Alberta oil sands.

That’s okay Canada, we’ll talk about it for you.

It is probable that you have heard of the term ‘oil sands’ or ‘tar sands’, but you may not know exactly what they are. In short, these are mixtures of sand or clay, water, and importantly, bitumen (a form of dense petroleum).  The bitumen is difficult to extract and in past years when oil prices were lower, this resource was given little thought.  However, as oil prices have risen and known oil reserves start drying up, energy companies such as BP and Royal Dutch Shell have turned their investment sights on extracting bitumen from this resource.

There are two reasons why many people feel this is a bad idea:

  1. Extracting oil from tar sands is energy intensive and more polluting than extracting oil from other sources and therefore extremely damaging to the environment (did I mention plans include removing a standing boreal forest currently on the site?) and population onsite; and
  2. The investments are financially risky, and therefore potentially extremely damaging to Shell and BP (and therefore a majority of pension funds in the UK).
Far less attractive than boreal forests, isn't it?

Tailings pond for tar sands

While extremely valid, many many people have addressed the first point and we do not wish to recap it here (although we will hasten to point out that much can be done in terms of economic analysis of these damages).  The second point, however, is less well-known and possibly brings some much-needed context to recent news stories.

It turns out that:

1) A few concerned investors have undertaken some financial risk analysis and it doesn’t look good (PDF link):

  1. Bitumen extraction is expensive, even given new technologies.
  2. This means that profitability from oil sands is dependent on high oil prices and low carbon prices.
  3. Even if oil prices stay high, which fulfils one of the above requirements, there is a risk that these high oil prices could lead to the development of new non-oil dependent technologies replacing current oil-dependent technologies.

2)     These investors have provided information to other investors at BP and Shell shareholder meetings, asking them to stand with them in tabling special resolutions to BP and Royal Dutch Shell to provide more information through a report on investment risks associated with their Canadian tar sands investments.  Both BP and Shell recommended shareholders to oppose the motion. Only 15% and 11% respectively of shareholders voted against the board to oppose the motion. This means that 85% and 89% respectively of shareholders of BP and Shell, including many UK pension funds, do not care enough about the long-term financial viability of their stock holdings to ask for more information!  We have already seen that they blame US President Obama rather than BP for the collapse of their BP shares following grossly negligent behaviour.  I wonder who they will blame when the investments in tar sands go wrong and the shares collapse again?

Information on protecting your pension

Fair Pensions – What you can do

More information on oil sands

Article from The Telegraph on environmental destruction and its effects on the local population

Toxic Fuels – 3 films from 3 different perspectives about the Alberta tar sands

Toxic Fuels Campaign

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On April 20, 2010 an explosion aboard the Deepwater Horizon, a drilling rig, leased by British Petroleum, killed 11 people and set in motion a chain of events that would result in one of the most horrific environmental catastrophes of the past two decades.   Two days after the explosion, the rig sank 50 miles off the coast of Louisiana and crude oil began leaking from a broken pipe attached to a well approximately 1 mile below sea level.[1] The oil began flowing at a rate of 795,000 litres of crude per day and as of 9th May 2010 nearly 13.25 million litres had poured into the sea.[2]

Picture courtesy of Sky Truth

A comparison can be made to the 1989 incident off the coast of Alaska, where the Exxon Valdez oil tanker struck a reef and spilled nearly 50 million litres of crude oil into the Prince William Sound.[3] Studies show that 20 years after the spill, oil could still be found on the beaches and animals of this area.[4] Despite the huge clean-up effort much of the oil was never recovered. If the oil from the most recent disaster in the Gulf reaches the marshes, then the clean up would prove to be even more difficult.[5] In fact, there is already talk of this incident being more damaging and costly than Exxon Valdez.

As far as the effects associated with the oil that is now sitting on top of the water in the Gulf are concerned, marine mammals have severe trouble breathing in these areas, and any oil that gets in the plumage or fur will cause thermo-regulatory issues.  Not to mention the fact that crude oil is toxic and its ingestion has many physiological consequences.[6] In the longer term, the Exxon Valdez experience points to a decline in populations of vulnerable species for several decades. It was found that in the Prince William Sound, “harlequin duck survival was depressed for up to a decade after the spill and wildlife is still being exposed to oil 20 years later”.[7] CBC News looked at a number of species at risk in the Gulf of Mexico:

  • Sea turtles:  five species of sea turtles, four of which are classified as endangered;
  • Whales:  two species of large whales;
  • Dolphins:  nine species of Dolphins;
  • Shrimp and shellfish; and
  • Birds: Brown Pelican, beach-nesting terns and gulls, reddish Erget, and migratory songbirds: including warblers, orioles, buntings, flycatchers and swallows.

A pelican in the process of being rescued. Picture courtesy of News Hour

The timing of the spill has added another dimension to the tragedy, as it is peak nesting season for some sea turtles, peak spawning season for fish and shellfish, and the height of spring migration north for bird species.  Additionally, the Gulf of Mexico contains more than half the coastal wetlands in the lower 48 States of the US.[8] “These areas are vital as spawning grounds for many fish species and are home to other wildlife. More than 97 per cent of the commercial fish and shellfish caught in the gulf each year depend on estuaries and their wetlands at some point in their life cycle”.[9]

The cost of the spill could be as high as US$20 billion some experts argue – very early and likely incomplete assessment focusing mostly on the cost of clean up including the actions that are aimed to stop oil reaching the shore and cleaning up on the water and once on shore[10].

This amount is probably ‘nothing’ compared to what the total environmental cost of the spill could be. In addition to clean up, the total costs will include:

  • Lost revenue (now and into the future) from commercial fisheries and shellfisheries;
  • Lost revenue (now and into the future) from tourism;
  • Costs associated with reorganizing the economy in the affected areas if the spill is damaging enough to end these sectors for the foreseeable future; and
  • Loss of habitats and species, informal (unpaid for) recreation, lifestyles – as people care about environmental resources not only because they use them directly but also because they may want them to be available for others, for the benefit of future generations and for the sake of their existence. This group of motivations gives rise to the so-called ‘non-use’ values. In cases like this, there will be more people who hold non-use values for the habitats and species than there will be those who live in the area and will be affected directly by the spill.

Habitats and species affected have economic value, and hence their loss is a cost but there will be no data from the markets that will make it easy to estimate the cost.

In the case of the Exxon Valdez a large scale contingent valuation study was undertaken to assess the value of the damages caused by it.  Contingent valuation is a survey based ‘economic valuation’ method. Amongst other questions, it presents a scenario to a large and representative sample of the affected population. For example, in this context, the scenario will present the extent of the damage and ask respondents how much they are willing to pay to, say, avoid similar damage happening again, or their willingness to accept compensation for the damage[11].  The study conducted for the Exxon Valdez case was used in the compensation court case against the company in determining the level of damages to be paid.

Due to the wealth of biodiversity associated with the Gulf of Mexico, and President Obama’s statement yesterday that there will be no limit to the compensation that can be required, it is likely that a similar study will be needed to assess the total damage associated with this most recent disaster. Unfortunately.

Elsea

[1] New York Times (updated 10th May 2010)

[2] CBC News (10th May 2010)

[3] CBC News (updated 5th May 2010)

[4] CBC News interviewed Dan Esler, a research associate at the Centre for Wildlife Ecology at Simon Fraser University in British Columbia, who led an international research team that measured the prolonged exposure of animals to oil in this area CBC News (14th May 2010).

[5] Ibid.

[6] Ibid.

[7] Ibid.

[8] CBC News (3rd May 2010)

[9] Ibid.

[10] http://news.bbc.co.uk/1/hi/world/americas/8680460.stm

[11] The results of the Exxon Valdez study are reported in Carson et al. (2003) Contingent Valuation and Lost Passive Use:  Damages from the Exxon Valdez Oil Spill, Environmental and Resource Economics 25: 257–286.

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