Week 9 Renewable and Non-Renewable Economics PDF

WEEK 9 RENEWABLE AND NON-RENEWABLE RESOURCE ECONOMICS ADMN 509 ECONOMICS FOR POLICY ANALYSIS Instructor: Katya Rhodes We acknowledge and respect the lək̓ ʷəŋən peoples on whose traditional territory the university stands and the Songhees, Esquimalt and WSÁNEĆ peoples whose his...

WEEK 9 RENEWABLE AND NON-RENEWABLE RESOURCE ECONOMICS ADMN 509 ECONOMICS FOR POLICY ANALYSIS Instructor: Katya Rhodes We acknowledge and respect the lək̓ ʷəŋən peoples on whose traditional territory the university stands and the Songhees, Esquimalt and WSÁNEĆ peoples whose historical relationships with the land continue to this day. Course outline topics Week 1: Introduction to economics Week 2: Supply and demand Week 3: Market efficiency and market failures Week 4: Economic trade-off analyses Week 5: Mid-term exam + Economic valuation methods Week 6: Policy evaluation Week 7: The problem of sustainability & economic growth & Assignment 1 due Week 8: Economics of environmental pollution + guest lecture on Indigenous Economies Week 9: Renewable and non-renewable resource economics+ guest lecture with BC policy-makers Week 10: Reading break (no class) Week 11: Special topics Assignment 2 due Week 12: Final exam Week 9: Learning objectives 1. Explain and depict the ecological concept of maximum sustainable yield (MSY) for renewable resources. 2. Describe and analyze the main policies available to manage renewable resources like fisheries. 3. Understand the different types of reserves and resources, and why these estimates change. 4. Explain and depict the economic concept of non- renewable resource consumption over time, including Hotelling’s rule. 5. Explain the ideas of scarcity rent and differential (Ricardian) rent. 6. Explain how Hartwick’s rule relates to sustainability. 7. Apply concepts to fossil fuel use and notions of “peak oil.” 1. Renewables resources (fisheries) Renewables and fisheries Which market failure best characterizes international fisheries? a) Public good b) Negative externality c) Positive externality d) Common pool resource e) Monopoly Renewable resources Forestry management Water Food This week: Fisheries Relates to many course topics: Property rights and open access Negative externalities Valuation of market and non-market goods CBA and NPV Weak and strong sustainability Policy analysis (efficiency, acceptability, etc.) Managing renewable resources: What should our goals be? Harvest as much as can be sustained? (maximum sustainable yield) Support biodiversity? How much? Maintain ecosystem resilience? How? Maximize economic efficiency? 1.1. Intro to fisheries Look at this graph. What problem would an ecologist see? What problem would an economist see? “Fishing down the food web”: humans are depleting top predators, reducing biodiversity and moving on to smaller fish (herring, sardines, etc.) Overexploited: about a third of global fish stocks harvested over the maximum sustainable yield (MSY) Why is fisheries management so difficult? Market failure: common pool resource – Open ocean (no property rights beyond 200 miles of land) – Lack of property rights in some lakes and rivers Ecological complexity – Population thresholds and collapse (and uncertainty) – Biodiversity – Genetically distinct sub-groups – Migratory species (e.g. Tuna and Swordfish) – Difficult to “see” the fish (monitoring) Public and political acceptability of policy – Traditions of lifestyle – Clout of fisheries interest groups – Community reliance on income What happened to North Atlantic cod? Renewables and fisheries What do you think was the main cause of the collapse of North Atlantic Cod in 1992? a) Fishing technology became too advanced b) Imperfect understanding of the ocean ecosystem (uncertainty) c) Lack of effective government policy d) Cultural identity was too attached to fisheries e) All of the above, about equally Fisheries in Canada: A history of distorting subsidies Fishery vessel assistance program – Subsidy for boats (~1940-1986) Fishery price support board – Guaranteed minimum price for fish Marketing support – Support for Newfoundland cod marketing (1947-1992) Regional development support for fish processing plants (1977- 1981) Fishing vessel insurance plan – Subsidized vessel insurance (1953- ) Small business low-interest loans (1955-1987) Unemployment insurance (1957- ) – Wage subsidy for seasonal employment Significant investment in processing capacity (~$200M in 1980s for Newfoundland purchase of Fisheries Products International) Retraining and transition programs following cod collapse (~$3B in 1990s in Newfoundland) 1.2. A bio-economic model for fisheries Fisheries bio-economic model (Schaeffer or Gordon-Schaefer) Start with a simple biological model, extend to economic model Assumptions/limitations to start: – Single, non-migratory species, no age dynamics – Density-dependent recruitment function – Static model (just looking at one year) not a dynamic model (over time) Our focus: “sustainable” fishery management, where the stock is in equilibrium  Growth curve (biological model) Maximum Sustainable MSY Yield (MSY)- the largest average catch that can be captured from a stock under Annual existing environmental conditions Growth Rate Natural Unstable Equilibrium 0 Extinction Stock (total population) Data suggests MSY is typically between 25-50% of maximum stock  Adding in the economic model; Fishing revenue = Total benefit (TB) Benefits and Costs ($) Total Benefit (Total Revenue, TB or TR) 0 (low) (high) Fishing effort  Fishing cost = Total cost What is an efficient level of fishing effort? Benefits and Total Cost (TC) Costs ($) Total Benefit (Revenue, TB or TR) 0 (low) (high) Fishing effort  Efficient fishing cost ≠ MSY Economic efficiency occurs where profit (resource rent) is maximized (TB – TC) Benefits and Total Cost (TC) Costs Max ($) Profit Total Benefit (Revenue, TB or TR) 0 (low) EEff EMSY (high) Fishing effort  Where do fisheries operate? Open access fisheries: “Tragedy of the Commons” Benefits and TC Costs ($) TB 0 (low) EEff EMSY (high) Fishing effort  Open access fisheries: high effort level Open access fisheries: “Tragedy of the Commons” Benefits and TC Costs Each new boat causes an ($) externality on other boats Resource rents are “dissipated” (no profit in TB fisheries) 0 (low) EEff EMSY EOA (high) Fishing effort  What happens when fishing technology improves? Benefits and TC Costs ($) TCtech TB 0 (low) EEff EMSY EOA (high) Fishing effort  As technology improves (lowering TC), more fish are exploited Benefits and TC Costs ($) TCtech TB 0 (low) EEff EMSY EOA (high) Fishing effort The Schaeffer model does hold in some empirical examples (e.g. open-access Philippine Fisheries) This is a stylized model (i.e. simplistic and illustrative). Ecological (and economic) systems are way more complicated! Real-world ecological complexities: Multiple fish species, which affect one another (predator-prey, etc.) Other ecosystem interactions (plants, etc.) Other ecosystem services Migratory species Measuring resilience? (Including biodiversity) Feedbacks and non-linear effects (thresholds) 1.3. How to regulate fisheries? How to regulate fisheries? Objective: sustainable, efficient fishing 1. Open access regulations (manage effort) – Technology restrictions (boat size, gear limits) – Size and weight limits for fish – When fish are caught (season limits) – Where fish are caught (location limits) – How many fish are caught per boat 2. Limited entry regulations – Individual tradable quotas (ITQs) – Fisheries cooperative (Self-government) – Exclusive spatial harvest rights  Open access regulations TCReg Regulations increase the cost of fishing Benefits and TC But… Costs Economically ($) inefficient TB 0 (low) EEff EMSY EReg EOA (high) Fishing effort Limited access regulations Individual tradable quota (ITQ) – Entitles owner to catch a proportion of the total annual catch – # of ITQs determined by fish biologists – # of ITQs = economically efficient catch level – ITQs are enforced, can be traded Allocation creates political controversy Trading can create political controversy Potential problems: high grading, monitoring, exclusion Is ITQ right for salmon? (migratory, 8000 distinct stocks, huge variation from year to year) 2008 study found 121 fisheries that used ITQs ITQ use has increased in BC fisheries Pros and cons of ITQ policy Pros – Can be effective: reduces likelihood of fishery collapse – Is efficient: established property rights, incentivizes careful/efficient fishing, – Achieves equi-marginal principle among fishers (due to trading) Cons – Equity—how to allocate permits/quotas? – Administratively complicated—how to set catch, and monitor/enforce quotas? – Does it work for cases with complex ecology? (E.g. migratory species, species with many sub-stocks) – Can lead to “high-grading” – Does it hurt local fishers? (E.g. if investors buy up all the quotas) 2. Non-renewables resources Non-renewable resources Which fossil fuel is most abundant worldwide? a) Oil b) Gas c) Coal d) The quantities are about equal Non-renewable resources When are we likely to “run out” of oil? Within the next… a) …10 years b) …11-20 years c) …21-50 years d) …51-80 years e) …80+ years 2.1. Reserves, resources and the “carbon budget” Non-Renewable eesource Consider a non-renewable resource According to neoclassical economists, which of the following is an “optimal” consumption plan for that resource? a) Use the entire resource right away b) Save the resource for a future generation c) Consume the same amount each year d) Consume an increasing amount each year (more and more each year) e) Consume a decreasing amount each year (less and less each year) Some definitions Exhaustible (non-renewable) resource Once used, it is not available for future consumption Coal, oil, gas, uranium, slow-recharge groundwater Mineral reserve (economic supply) Resources that have already been discovered and measured and that are economically viable to extract at current prices and technology Mineral resource (physical supply) All resource, including undiscovered resources, as well as resource that is currently not profitable to extract with current prices and technology Classification of non-renewable resources How do estimates change? 1. Used over time 2. New discoveries 3. Changing price/technology Big technological changes in the past 15-20 years: - Horizontal drilling - Hydraulic fracturing (fracking) Oil reserve estimates change over time BP Statistical Review of World Energy Are we “running out” of fossil fuels? Not in time to stop climate change… Carbon budget: we can only burn so much more fossil fuel to stay within 2C limit Source: Nature, 2012 2.2. “Peak oil” and backstop fuel Compare and contrast perspectives on fossil fuel supply and demand… 1) “Peak oil” perspective (Hubbert’s Curve) – Geologist perspective – Technology static – Once we pass the “peak” of oil consumption, then economic and social catastrophe! Hubbert’s Curve: indicates we’ll run out of conventional oil soon Compare and contrast perspectives on fossil fuel supply and demand… 1) “Peak oil” perspective (Hubbert’s Curve) – Geologist perspective – Technology static – Once we pass the “peak” of oil consumption, then economic and social catastrophe! 2) Neoclassical perspective Argues that “Hubbert’s Curve” doesn’t account for: – Technology change and dynamics (e.g. backstop fuels) – International dynamics (don’t just look at one nation) – Market feedbacks and price signals With higher gasoline prices… …what do supplier do? …what do consumers do? However, there are many sources of unconventional oil (supply curve or cost curve) Backstop fuel: many substitutes for oil as prices rise (including changing definition of “oil”) 2.3. “Optimal depletion” or non-renewable resource consumption over time  With a scarce (non-renewable) resource, what is market equilibrium? Price Typically Supply (MC) ($/unit) $150 something like here PScarcity $100 Here? $50 Demand (MWTP) 0 QScarcity 200 Quantity Demanded “Optimal” non-renewable resource allocation over two periods Key issue: Scarcity With non-renewable resource, we need to think about how to allocate it across multiple periods on known demand curve and supply curve Assume two periods: “present” and “future” Assume that producers are in a perfectly competitive market, assume no environmental externality Start by assuming infinite amount of resource; then introduce resource constraints  Supply and demand for copper Supply (MC) $150 Price ($/unit) $100 Equilibrium $50 Demand (MWTP) 0 200 Quantity Demanded  Representing “marginal net benefit” (MNB) from copper (CS + PS from previous figure) $150 Marginal Net Benefit If resource is infinite… $100 we would produce at 200 units MNB $50 0 200 Quantity Demanded Now add a “resource constraint” Resource is finite – Total resource stock, Q = 250 User cost: opportunity cost to consuming the resource (1 unit consumed today can’t be consumed in future) How to allocate consumption across two periods? Goal is economic efficiency: maximize total net benefit over the two periods (“optimal consumption” or “optimal depletion”) Need to discount period 2 to get NPV, and then can compare with period 1. Discount rate = 7.25% (over 10 years)  Without discounting (r = 0%), we would maximize net benefit by consuming the same Q in both periods (125) $100 MNBPeriod1 MNBPeriod2 $100 Marginal Net Benefit $75 $75 $50 $50 $25 $25 Q in Period 1 0 50 100 150 200 250 Q in Period 2 250 200 150 100 50 0 Quantity Demanded (total units)  Without discounting, we would maximize net benefit by consuming the same Q in both periods (125) $100 MNBPeriod1 MNBPeriod2 $100 Marginal Net Benefit $75 $75 $50 Total Benefits $50 Total Benefits Period 1 Period 2 $25 $25 Q in Period 1 0 50 100 150 200 250 Q in Period 2 250 200 150 100 50 0 Quantity Demanded (total units)  With discounting, we would consume more in the present $100 MNBPeriod1 $100 Marginal Net Benefit $75 $75 $50 MNBPeriod2 $50 $25 $25 Q in Period 1 0 50 100 150 200 250 Q in Period 2 250 200 150 100 50 0 Quantity Demanded (total units)  With discounting, we would consume more in the present $100 MNBPeriod1 $100 Marginal Net Benefit $75 $75 $50 Total Benefits MNBPeriod2 $50 Period 1 $25 Total Benefits $25 Period 2 Q in Period 1 0 50 100 150 200 250 Q in Period 2 250 200 150 100 50 0 Quantity Demanded (total units)  If we only maximize net benefit in the present (Period 1), then we over-consume and cause DWL (opportunity cost of future consumption) $100 MNBPeriod1 $100 Marginal Net Benefit $75 $75 $50 Total Benefits MNBPeriod2 $50 Period 1 $25 DWL $25 Q in Period 1 0 50 100 150 200 250 Q in Period 2 250 200 150 100 50 0 Quantity Demanded (total units) Optimal allocation over time (“optimal depletion”) Saving some of the resource for future consumption increases profits to the firm and increases overall social efficiency Consumption of a unit of the resource today carries an “opportunity cost”: the value of keeping the resource and selling it in the future (present consumption implies a user cost on future generations). If not accounted for (e.g. if a firm is short-sighted), then user cost is a negative externality for future generations In some cases, a resource depletion tax might be needed to internalize the externality  2.4. Hotelling’s rule and allocation over time (infinite time periods) What should happen to the price of non-renewable resources over time? Dynamic efficiency: Hotelling’s Rule Earlier, we looked at the “two-period” model. What about a more realistic look at resource allocation over infinite (n) periods? Hotelling (1931) found that to maximize the benefit of an exhaustible resource endowment, it should be extracted such that its “net price” rises over time at the rate of discount “Net Price” is also “marginal net revenue” or profit Net Price = Price – marginal extraction cost Over many periods, net price rises according to discount rate Hotelling’s rule very simply Optimal resource (depletion) is dictated by the discount rate – High discount rates create the incentive to use resources quickly – Low discount rates create greater incentive to conserve Resource is like a bank account: do you want to withdraw now and invest in the market? Or keep the resource in the ground? Real world oil prices do not seem to follow Hotelling’s Rule. Why? Research: Hotelling’s rule is not usually observed in empirical cases What other factors influence the price of a non-renewable resource? (e.g. oil) – Changing estimates of reserves – Changing definitions of “oil” (inclusion of unconventional sources) – Technological change Lower extraction costs More efficient use of the resource – Changing demand curve (rising incomes) – Cheaper alternatives – Poor foresight by suppliers (lack of investment) – Shortages in the short run (capital constraints, e.g. refineries) – Changing expectations – Unexpected events, e.g. COVID-19  2.5. Resource rents What is “special” about non-renewable resources? Different types of resource rent “Rent” is a special type of producer surplus or profit – applies to natural resources Types: 1. Scarcity rent Result having constrained supply Related to user cost 2. Differential rent Result of having heterogeneity among resources Can also be called: Ricardian rent The basic notion of equilibrium and economic efficiency Price Supply (MC) ($/unit) Consumer Surplus Pe Producer Surplus Demand (MWTP) 0 Qe Quantity Demanded (total units) But if the good is scarce (limited supply), and there is a constraint on entry, then firms can receive scarcity rent Price ($/unit) Supply (MC) Consumer Surplus PScarce Scarcity Marginal user cost Rent Pe Demand (MWTP) 0 QScarce Qe Quantity Demanded (total units) Scarcity rent If there is a constraint on supply (and entry to the market), firms in the market can make “extra” profits These profits are called scarcity rent: reflects the scarcity of the resource (quantity supplied is less than it would be if fully abundant) Examples: – Oil (limited oil) – Mining (limited minerals, e.g., gold) – Agriculture (limited land for agriculture) – Taxis (limited taxi licenses) – Liquor licenses (limited liquor licenses) If the resource has differences in quality, extra rent is collected, called Differential Rent (or Ricardian Rent) Supply (MC) Price ($/unit) Consumer Surplus PScarce Scarcity Rent Differential Rent Demand (MWTP) 0 QScarce Quantity Demanded (total units) Ricardian (Differential) rent: profit or rent that arises due to differences in the quality of the resource Marginal extraction cost (MEC) Government “rent capture” Owners of natural resource are people in country, not just firms that extract resource – In Canada, resources are “owned” by provinces Government aims to capture rents accruing to natural resources Rate of return taxation Tax industry once it becomes profitable Participation Crown takes (partial or full) ownership stake in extraction Auction Permit to extract resource is sold to highest bidder 6. Hartwick’s rule and sustainability What about intergenerational equity? Hartwick’s Rule: Invest resource rents Definition: A nation must invest all of the “rent” earned from exhaustible resources into other capital (E.g. scarcity and differential rent) Why? To keep up the standard of living, for intergenerational equity… Weak of strong sustainability? The Example of North Sea oil… The Example of North Sea oil: Norway vs. U.K. approaches to oil extraction… Norway channels rents into the “Central Government Pension Fund- Global”, or “the Oil Fund” which is financial capital UK provides tax breaks Question You are now in charge of British Columbia. Congratulations! An oil reservoir is discovered in central BC. The economically viable reserve is estimated to be worth $50 billion (net value) and is owned by the Province. Being sweet, light crude, the oil is relatively easy to extract, with minimal environmental impact. What would you do? A) Leave the oil in the ground B) Extract the oil, investing profits in a general trust fund C) Extract the oil, investing profits in renewable energy D) Extract the oil, reducing taxes for BC households and corporations E) Other…