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Should California Keep Its Oil in the Ground?

The direct costs would be large. The enrichment of world oil producers would be even larger.

LeaveItInGroundFig1

A few weeks ago, when California happily announced that it had met its 2020 goals for GHG reductions four years ahead of schedule, there was a disappointing part of the story that didn’t get much attention: transportation emissions. While California has made significant strides in renewable electricity generation and building energy efficiency, emissions from cars, trucks, and airplanes have been rising by about 1.5% per year since 2012.

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One policy response that has emerged — and got a boost earlier this year from a report out of the Stockholm Environment Institute (SEI) — is to curtail oil production within California. Versions of this proposal range from banning new drilling to gradually phasing out all oil production in California.

California produces less than 0.5% of the global oil supply, so you might ask what this has to do with reducing California transportation emissions. The SEI report makes clear that the connection is indirect: cutting California oil production would slightly reduce world oil supply, which would slightly increase the world price of oil. Sure, the price effect would be small, but it would apply to the entire world market — not just California’s 1.7% share of consumption – so it might noticeably reduce oil consumption and the associated greenhouse gases.

Some have argued that this wouldn’t work, because California’s reduced output would just be replaced by output from another oil producer. But energy economists recognize that’s not entirely true. The replacement ratio is almost certainly less than one-for-one, because price would have to rise at least a little to elicit additional supply and that price increase would lead to at least some reduction in demand from consumers. How much of California’s production  curtailment would show up as reduced worldwide oil consumption? Well that depends on some pretty geeky arguments about how much price would need to increase in order to bring forth new supply and how responsive to such price increases consumers would be.

SEI makes a range of assumptions about these factors and ends up concluding that for every barrel of oil that California leaves in the ground, world consumption would drop by somewhere between 0.2 and 0.6 barrels. If that sounds like a wide range of uncertainty, it’s because it is very difficult to know what technologies oil producers will be using 5, 10 or 30 years from now, or what alternatives to oil consumers will have in the future.

Still, even accepting SEI’s numbers, the policy raises some serious concerns.

The Big Cost to California Oil Producers

First, there would be real economic costs to curtailing California production. SEI recognizes that one major cost would be the lost income to the state’s oil producers. The report divides these lost profits by the estimated worldwide GHG emissions reductions to come up with an estimate for one Southern California oil field in the range of $110-$330 per ton of emissions saved. One can quibble with some of their assumptions — the oil price forecasts they use is likely too high, which would make the policy look more expensive, while the field they highlight is more costly than most California oil, which lowers lost profits and makes the policy look less expensive — but this is not an unreasonable first-cut cost estimate for the policy.

If you follow debates over GHG reduction policies, these look like very costly reductions. For instance, the most recent estimates of the social cost of carbon (SCC) — which is supposed to represent the incremental climate change damages from releasing one more ton of GHGs today – are in the $40-$50 range. It looks like the costs would greatly exceed the benefits.

Advocates of this policy note that the cost-effectiveness range for keeping oil in the ground is not that different from estimates of the cost per ton of GHG reduction from California’s Low Carbon Fuel Standard or from some of the more early-stage technologies for generating carbon-free electricity. I’m not a fan of the LCFS, but in any case there is a big difference: those policies are also intended to create new knowledge through R&D and development of new technologies. Sure, raising the world price of oil indirectly incentivizes work on alternatives somewhat, but it is a much more roundabout route.

The Bigger Cost to Oil Consumers Everywhere

More importantly, there is a second cost that SEI and the advocates of this policy have not incorporated: the massive transfer of wealth from consumers to producers that would occur from such a policy. Remember, the way that this policy reduces emissions is by raising the price of oil, which means all consumers pay more and all producers (except for those curtailed in California) make more money. SEI calculated only the direct economic cost to California oil drillers per ton of GHG abatement. In a similar way, one can calculate how much more consumers worldwide would pay to producers compared to the amount of GHG abated.

The details of this calculation are not that complicated, but probably not blog-appropriate. You can find them here. What they show — using the middle of the range of assumptions that SEI made – is that if the policy were to reduce California’s production by, for example, 100,000 barrels per day (about 20%), it would raise the $70ish per barrel world oil price, by about 8 cents.

Carrying that increase through to higher consumer payments for gasoline and other refined oil products, and then dividing by the reduced GHG emissions that the higher price would cause, it means consumers would be paying an additional $510 to producers for each ton of GHG emissions saved. That is, every ton of GHG abatement brought about by this policy would cause not just an economic loss to California producers of $110-$330, but also an additional payment of $510 from the world’s oil consumers to the world’s oil producers, nearly all of whom are outside California.

LeaveItInGroundFig3

One could think of this as similar to a very small worldwide carbon tax, except in this case the revenue is not rebated to the population as a whole or used to reduce other taxes, but rather handed to those who own and control the world’s oil production. Where are those producers who would get this windfall? 

LeaveItInGroundFig4

The figure above shows where current oil production come from. Total oil reserves are even more tilted towards OPEC. Either way, this is not a wealth transfer that’s easy to get behind. Most of the world’s oil in the next few decades is likely to come from autocratic regimes, with much of the incremental profits going to a small group of a wealthy oligarchs, officials, royalty and other insiders. Those additional payments would come from people across the income spectrum, including billions of individuals in developing countries (think China, India and much of Africa) where vehicle ownership is just beginning to take off.

Setting an Example for the World’s Oil Producers?

Proponents of keeping California’s oil in the ground argue that not only would the policy have the direct impact of reducing GHGs, but it would also demonstrate leadership for a policy that could spread across oil-producing regions. Really? Take another look at that breakdown of oil supply. I don’t see many big-slice countries that are likely to follow California down this path.

With the daily reminders that our federal government is now determined to pursue a head-in-the-sand climate strategy, it is certainly important to think broadly and creatively about ways in which sub-national entities can help move the needle. But it is also important to think through all of the ramifications. When I consider the full picture on keeping California’s oil in the ground, this does not look like one of our better options.

Instead of taxing the world’s oil consumers to hand that money to a small group of rich and largely anti-democratic leaders, California should be focused on developing alternatives that make it easier for consumers to break their addiction. A good place to start would be with California’s own growing addiction.

[Final Note: I realize that there are other reasons put forth for curtailing California oil production, such as reducing the local pollution associated with that production, an issue I have addressed with respect to oil refining in another blog. This blog is already too long, and the primary argument of the keep-it-in-the-ground proponents is reducing GHGs.]

I’m still tweeting energy news stories/research/blogs most days @BorensteinS

Severin Borenstein View All

Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. He chaired the California Energy Commission's Petroleum Market Advisory Committee from 2015 until its completion in 2017. Currently, he is a member of the Bay Area Air Quality Management District's Advisory Council and a member of the Board of Governors of the California Independent System Operator.

17 thoughts on “Should California Keep Its Oil in the Ground? Leave a comment

  1. As a starting point, it would be beneficial for this author and proponents of the “leave it in the ground” rhetoric to realize that California is part of the United States of America where private property rights reign supreme. This simple fact would save them from looking like imbeciles.

    In the U.S., neither oil nor water for that matter are public resources but are in fact private resources which are protected by mineral rights and water rights. Leaving oil in the ground would require the State to pay mineral rights owners (oil companies) for the remaining reserves in the ground. Since the government actually has no money, they would have to tax all Californians to pay for this. We are talking hundreds of billions for all remainigng reserves in California!

    A simple comparison is highway construction and eminent domain. The government can’t take private property in the name of creating a public resource (or any self-rightoues cause) without fair market compensation of private property.

    • Not true about water and mineral rights. In California, and most of the Western states, water rights are expressly held by the public in the state constitutions. (Pre-1914 water rights are in a grey area here.) This is an express exception to the standard property rights construct. For much of the oil and gas reserves, these are being extracted from under public lands that are managed by BLM or the MMS, and the reserves are leased to the oil companies. Again, the property rights are held by the public through the government. There may need to be compensation for stranded investment but whether leaseholders are entitled to the future stream of income is an open question.

  2. We (SEI) have a more complete response now up, here:
    https://www.sei.org/perspectives/new-thoughts-california-oil/

    Bottom line: The wealth transfer is only a major concern if you are betting on climate failure.

    We agree that further enrichment of oil producers – not merely those in foreign regimes but also here in the U.S. – can be antithetical to democracy and income equality, as well as to achieving climate goals. However, we would also argue that this wealth transfer is only a significant problem if the world fails to move swiftly to constrain climate change.

    Governor Brown and the State of California are part of an international effort that is actively working to inspire a global, low-carbon transition. If successful, oil markets will contract and investments in new oil production will slow. Both demand and supply of oil will reduce rapidly and in step. Fewer producers will be able to make profit on new oil investments, as they face the lower oil demand of a low-carbon future.

    In fact, those who restrict investment now – especially in higher-cost, higher-emissions oil, such as that found in much of California – could come out on top. They would be limiting their exposure to assets that could be stranded by lower than expected prices in the future.

  3. This ignores the politics of oil. Yes, we also need to reduce consumption in California, but we can’t do that without state policies, and its very hard to get those state policies when California oil producers and their trade group, WSPA, spend enormous sums on lobbying and elections to undercut those policies (more than any other special interest in Sacramento). They have been successful at defeating or watering down every single climate and oil consumption reduction effort in California. Look, for instance, at the gasoline consumption reduction goals they succeeded in removing from SB350. We will NEVER succeed at the tough job of reducing oil use in CA so long as CA oil producers continue making big profits and using them in a laser-focused way to ensure our continued addiction to fossil fuels.

    This also ignores the physical reality of the need to keep oil in the ground. According to Professor David Lee at UCSB who was science adviser to the Obama administration’s delegation at the Paris climate accord, we need net zero GHG emissions by 2050. That is, we need to stop burning oil entirely worldwide if we are to meet international goals. We cannot both increase unconventional oil development worldwide and meet global climate goals, so why should we allow increased production in California? Encouraging future California oil production and expansion projects will lock in oil production well beyond 2050. If we drill it, it will find a way to market. At some point, we have to recognize we simply can’t keep investing in new and expanded fossil fuel production if we are serious about climate action. It also turns out that California oil is among the worst for the climate. It increasingly requires cyclic steam and steam flooding, the most energy-intensive forms of oil production in the world, with the highest associated emissions.

    Lastly, this ignores the cost to Californians of having increasingly intensive, unconventional oil production in our communities. Where there is oil production, there are spills and economic loses associated with those spills, air pollution, health impacts, loss of of water resources, water contamination, heavy industry, truck traffic and other quality of life impacts, less tourism and alternative economic development, and a whole host of other problems.

    California, with the largest GDP of any state and a population supportive of environmental policies, is well placed to lead the nation and world in a transition to clean energy and transportation, but it won’t happen if we double down on oil instead.

  4. Keeping CA oil in the ground is the wrong focus. Keeping foreign oil out of our ports is the right focus. CA imports 1.1 million barrels of oil PER DAY through our coastline endangering all marine life and beach-based tourism. Why should we reduce the oil we produce in CA from American companies with American jobs in favor of foreign suppliers with abysmal human and environmental rights? It makes no sense at all. But pervasive far left ideology in CA prevents rational thought and common sense solutions. So now we just wait for another Exxon Valdez disaster to happen along our coastline while the politicians and academics say nothing. Why?

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