I don’t update this blog much now, as most of my writing goes to Maclean’s – please check here for the latest - as well as occasional posts at the Globe and Mail here.  I hope to post move back to posting more technical analysis here in the near future.

Thanks for checking-in.


Do Oil Spills Boost the Economy?

This week, Press Progress and the Vancouver Sun’s Peter O’Neil reported that Kinder Morgan had quantified the economic benefits of oil spills in its application to expand the Trans-Mountain Pipeline from Edmonton, Alta. to Burnaby, B.C.  Yes, the benefits of oil spills—they create jobs in the communities where the spills occur. Beyond being a public relations disaster for the company, this should lead us to re-examine what we accept as proof of the economic benefits of projects in general.

Companies facing regulatory hearings like Kinder Morgan, groups promoting events like the Vancouver Olympics, or politicians justifying public expenditures like the new hockey arena in Edmonton generally talk about the benefits of their projects using a tool called economic impact analysis. This technique takes spending, runs it through a statistical model, and predicts impacts of that spending on both GDP and employment.

There are, basically, two issues with this method, and both are wonderfully illustrated by the oil spill example. First, the method is agnostic as to what the money is spent on, so money spent cleaning up an oil spill looks remarkably similar to money spent building a new hospital or school in terms of economic impact.  Second, the technique generally does not account for where the money comes from, or how it would otherwise have been spent. Money spent on a hockey arena in Edmonton might otherwise have been spent on light rail or tax reductions, both of which would also have economic impacts. In the case of an oil spill cleanup, the costs are likely to be directly incurred by an insurance company, but the premiums paid for that insurance come at the expense of the value of the oil transportation service—the higher the expected clean-up costs from oil spills, the higher insurance premiums will be, and this will mean higher pipeline tolls, which in turn implies lower profits, taxes, and royalties on the products shipped. Simply-put, there’s no free lunch.

Read more at Maclean’s Magazine.


How Canada’s incoherence on climate is killing Keystone

There’s no shortage of blame being passed around in the wake of another delay in the U.S. regulatory approval process with respect to TransCanada’s Keystone XL pipeline which, it was announced last Friday, will now drag on for at least another six months. Among other reasons cited for the decision, the Calgary Herald’s Deborah Yedlin and others have cited a lack of greenhouse gas policies applied to Canada’s oil sands. Yedlin is direct, saying that, “the evidence to date suggests (that the Harper government hasn’t listened to what is being said in Washington) because the Harper government has not moved on anything resembling a policy on greenhouse gas emissions.” I think she’s right, to a point, but I think the problem is not that we haven’t been listening, but that our governments, both in Edmonton and in Ottawa, have yet to establish a coherent vision on anything which includes the words climate change and oil sands.

This post previously appeared at Maclean’s magazine.

Continue reading “How Canada’s incoherence on climate is killing Keystone”

My Twitter Account

Many of you have noticed that I suspended my Twitter account over the weekend.  I expect that this will be a temporary decision, at least in some respects, although I am not sure what my re-engagement will look like. I’ve used Twitter for many years now, and I love the medium for news, learning, and interacting with people whom I’d have never had the chance to meet without it. I am not sure that I can balance all that I like about it with the feeling of always being in an argument.  This decision has nothing to do with abuse, trolls, or the like – it’s exactly the opposite.  Those who bring nothing to a discussion are easily blocked or ignored, but it does not make sense nor is it my wish to ignore those who challenge my ideas, push my thinking in different ways, and force me to defend my position against rational, reasoned arguments.  Unfortunately, I’ve done a poor job of balancing my engagements with all of you on Twitter with the other things that matter in my personal and professional life.  I’m going to try to fix that, and hopefully I’ll be back @andrew_leach sometime in the next 29 days.

Thanks for the kind words.


* My account is re-activated so you can use lists again if you had been doing so.

Finite Resources and Infinite Growth

Today’s Globe and Mail featured a column by Gary Mason on a world without oil.  ”If you believe that the economy is structured in such a way that it needs to grow continually in order to survive,” it states, “then it will take an endless supply of energy to feed it. ” The article then raises the question,  ”How does an economy grow exponentially forever if the one element it needs more than anything to flourish is contracting with time?” This is a common refrain from environmentalists such as David Suzuki (here, here, here and likely a thousand other places): “it’s absurd to rely on economies based on constant growth on a finite planet.” But, is it? I’ll have more on this at Macleans in a couple of days, but this will serve as a technical primer.

Continue reading “Finite Resources and Infinite Growth”

Can we dismiss this `economists only care about GDP’ crap, once and for all?

Yesterday, the Pembina Institute and Equiterre released a report entitled Booms, busts, and bitumen: The economic implications of Canadian oil sands development.   The report opens with a foreword from University of Ottawa economics professor Serge Coulombe. His opening paragraph states that, “Environmentalists don’t accept gross domestic product (GDP) as a complete measure of well-being in the same way that economists do.”  This statement is astounding for its ignorance of the discipline, not to mention the irony of it having been written by an economist. Worse, it validates a trend among the environmental movement in Canada, spearheaded by David Suzuki, to dismiss economists as the enemy of the environment. I don’t know of a single economist who thinks this way.  We may disagree on the relative values of environmental amenities but I can’t think of anyone who would argue that they have zero impact on welfare or that GDP is the only relevant measure of well-being.

David Suzuki often talks about the Economics 101 course he took which ignored externalities. That certainly didn’t match with my recollection – the second half of my microeconomics 101 course was all about market failures due to monopoly, incomplete information, public goods, or environmental pollution.

If you look at Greg Mankiw’s Principles of Economics, likely the most widely used introductory text, you don’t even get to discussions of GDP until page 491 in the Sixth Edition. Externalities are covered over 200 pages earlier, on page 195. When you get to talking about GDP, there is a muti-page section which begins, “GDP is not, however, a perfect measure of wellbeing…” The section goes on to discuss things such as the value of leisure, the costs of pollution, the value of home production, etc.

On the environment, Mankiw writes that, “another thing that GDP excludes is the quality of the environment. Imagine that the government eliminated all environmental regulations. Firms could then produce goods and services without considering the pollution they create, and GDP might rise. Yet, well-being would most likely fall. The deterioration in the quality of air and water would more than offset the gains from greater production.”

Gee, that almost sounds like something David Suzuki would write himself. David Suzuki is also a strong proponent of evidence-based policy. If you agree, you might want to read this, from Fullerton and Stavins, on how economists really think about the environment.


Update: via Dan Gardner, this piece from the New Yorker is excellent. It quotes Kuznets, who formulated the tools to measure GDP in the US, as saying that, “the welfare of a nation can…scarcely be inferred from a measurement of national income.” I guess Kuznets must have been an environmentalist, not an economist.

Extraction vs Upgrading

The NDP put forth a motion in the House last week which states that, “the Keystone XL pipeline would intensify the export of unprocessed raw bitumen and would export more than 40,000 well-paying Canadian jobs, and is therefore not in Canada’s best interest.”

This motion provided me with the motivation to dig into a question – if you had a given amount of capital to spend in the oil sands, would an oil sands mine alone or an integrated project with an upgrader generate the largest value-added return on investment, including total wages, royalties, taxes, and profits, and how would these be distributed?

To tackle this question, I ran two iterations of an oil sands project model based loosely on Suncor’s Fort Hills project combined with upgrader assumptions based on Suncor’s now-cancelled Voyageur project.

Continue reading “Extraction vs Upgrading”

Fort Hills tale of the tape

This morning, Suncor held an investor conference call to discuss the decision announced late last night that it would proceed with the development of the Fort Hills mine – a joint venture with Total and Teck. Everything associate with this project is huge – it’s expected to produce 180,000 barrels per day and to cost 15 billion dollars up-front to build. This morning, CFO Bart Demosky laid out Suncor’s financial analysis for the project, and stipulated that their internal analysis found an internal rate of return of 13% – respectable for an oil sands mine.

Here are the basic assumptions Suncor stipulated behind that figure (costs are per bitumen barrel):

  • Oil prices of $100/bbl (Brent) and $95/bbl (WTI)
  • Bitumen prices at 60% of WTI
  • Operating expenditures of $20-24/bbl, in today’s dollars
  • Sustaining capital expenditures of $3/bbl
  • Up-front capital costs of $84,000 per flowing bitumen barrel, or $15.1 billion including cost escalation and contingency
  • Invested 650 million total to-date, not included in IRR calculations
  • Canadian dollars at 96 cents US
  • Royalties of $11.50/bbl

I took these numbers, dropped them into my oil sands model, with the following assumptions:

  • Oil prices of $100/bbl (Brent) and $95/bbl (WTI), AECO-C gas at $3.50/GJ, all increasing at the rate of inflation.
  • Canadian dollar at 96 cents US
  • Bitumen prices at 60% of WTI, which implies a $25/bbl differential between WTI and Western Canada Select, a 30% blending ratio, and a $6/bbl premium for diluent over WTI (differentials increasing with inflation) .
  • Operating expenditures of $20/bbl, increasing with inflation.
  • Sustaining capital expenditures of $3/bbl, increasing with inflation.
  • Up-front cash capital costs of $84,000 per flowing bitumen barrel, or $15.1 billion, spread over 5 years
  • I omitted the 650 million total to-date in capital expenditures, so it’s properly not included in forward-looking IRR calculations, but I added it back in for royalty and tax purposes so that the expenditure is properly counted against project income
  • Debt used to finance 50% of up front capital expenditures at a rate of 7%
  • Production horizon of 50 years, with cumulative bitumen production of 3.2 billion barrels.
  • Build time of 5 years

Using these figures, I can’t replicate Suncor’s IRR – I get 10.2% (after-tax) to their 13%.  Here are my results, in 2013 dollars per barrel of bitumen:

Total Revenue $/bbl          57.08
Capital and Debt Costs $/bbl           8.68
Operating costs $/bbl          19.99
Condensate costs $/bbl               -
GHG compliance costs $/bbl           0.03
Royalties $/bbl          12.06
Taxes $/bbl           4.26
Free Cash Flow $/bbl          12.08

So, my royalty numbers are higher than Suncor’s, which should indicate that the project as I’ve modelled it has higher net revenue. I’ve taken account of Alberta’s oil sands royalty regime, federal corporate taxes (standard Class 41 CCA), Alberta’s SGER maintained ad infinitum. Despite this, I get a lower after-tax IRR.

I know of a few other people with similar figures. So, people of the internet, what am I missing?

Chicken Wings and Beer

My latest at Macleans.

Carbon pricing is not a panacea

Pretty well every economist you talk to will agree; if you want to reduce pollution, carbon or otherwise, the most cost-effective way to do so is with a price on the emissions of that which you seek to reduce. They’ll also tell you that, under some basic assumptions, the cost-effectiveness result holds whether you impose that price through a tax or by fixing allowable quantities of emissions, distributing the rights to emit, and making them tradeable – so-called cap-and-trade regimes.  This is taught in most first year economics classes, and you will test it under every conceivable permutation and combination of assumptions if you take an environmental economics class. It truly is economics 101.

Carbon pricing mechanisms generate cost-effective reductions because they make emissions (or emissions reductions) valuable. If you are facing a carbon tax, you can reduce your tax bill by reducing emissions either through changes in actions or changes in technology. The same is true for a cap-and-trade program, although in that case you might be earning revenue from the sale of unused permits or avoiding the need to purchase them.  Regardless, the price on emissions creates a decentralized economic incentive to reduce pollution. We’ve known this since Pigou in 1924 – Pigou suggested that the government could impose “extraordinary restraints – most obviously taxes,” to reduce pollution.

The reason why carbon pricing is not a panacea also goes all the way back to Pigou, if not earlier: stringency matters.  Carbon pricing is cost-effective because it provides people and firms who are affected by the price an incentive to change behaviour or implement new technology if those changes reduce emissions at a cost less than the carbon price.  That’s great, but no one is going to spend $50 to save $25.   In other words, carbon pricing is cost-effective, but not necessarily effective. Effectiveness is a matter of the level of the price and how broadly it’s applied, not the fact that there is one.

If you’re worried about climate change, your first concern should be effective policy (by how much will this reduce emissions?) and not cost-effectiveness (could the same emissions reductions have been generated at lower total cost to society?).  If you believe the International Energy Agency (IEA)’s 2012 World Energy Outlook, to stabilize global GHG concentrations at or about 450ppm, we’re going to need effective policies, and quickly.  By 2035, the IEA models suggest that we’ll need the equivalent of a global carbon price of $120/tonne, along with some complementary regulations. With the exception of implicit prices on carbon on some emissions in Sweden, Japan, and Germany (see yesterday’s OECD report for details), no carbon pricing policy in place today comes close to that type of stringency.  Put another way, despite all the good things about BC’s carbon tax (and it got some laudatory words in the OECD report yesterday), it’s barely stringent enough to fit into the IEA’s 450ppm path and it’s not likely to be stringent enough to see BC’s emissions decrease between now and 2020 (see Table 17).

Your second order concern should likely be political feasibility, and in particular you should ask whether more stringent regulations are more feasible than a stringent price-based policy.  If that’s true, then your regulation will lead to more expensive emissions reductions, but the total benefits to society of a stringent regulation could easily outweigh a weak carbon price.   It’s possible, but by no means guaranteed, that more cost-effective policies will be more politically feasible. If your condition for GHG policy is that you must impose the same price on all sectors of the economy because you want to be cost-effective, that rules out higher prices on some sectors where deep emissions reductions are possible, or lower prices in more politically sensitive areas to ensure you get a policy in place at all. Policies are also most cost-effective when the costs are transparent, but when you see the NRDC campaigning against Keystone XL by telling Americans that their gas prices might go up, you know just how politically palatable a transparent price at the pump will be.  If you want a policy that will actually reduce emissions, it has to be implemented and kept in place by people who face elections every 4 years or less. You might not like it, but that’s a reality.

So, can we all talk a little more about stringency and political feasibility and a little less about prices vs. regulations?