In a piece I wrote shortly after the Trump administration took office, I argued that there were so many checks and balances in our regulatory and political system that the rollbacks planned for environmental regulation would be seriously impeded. In hindsight, I see that I failed to consider how an unwavering commitment to deregulation would dismantle many of the necessary and efficient energy regulations put in place by the Obama administration.
Still, some obstacles have blocked these rollbacks, one of which is a US District Court for the Northern District of California ruling from last Wednesday. The court rejected the Trump administration’s repeal of the bulk of a rule that was established by the Obama administration, which reduces methane emissions from oil and gas development on federal lands.
The court stated that the current administration's ruling was arbitrary and capricious (the term “arbitrary” is used 32 times in the 57-page report, while “capricious” is mentioned 29 times) and that it failed to follow the science, was riddled with procedural errors, and had many other issues. Among the issues raised in the court’s order are economic considerations, several of which I will attempt to unpack here.
On the Definition of Waste
As the district court order explains in recommending the rescission, the Bureau of Land Management (BLM) argued that the 2016 rule “exceeded BLM’s statutory authority to regulate the prevention of ‘waste.’ Critically, BLM adopted a new regulatory definition of ‘waste of oil or gas’ so that it would only apply ‘where compliance costs are not greater than the monetary value of the resources they are expected to conserve.’” Ultimately, the court did not elaborate on the economic logic here, instead dismissing this idea on procedural grounds.
From an economics perspective, the new definition is, on its face, illogical. Wasted oil and gas is just that—wasted oil and gas—and, under the Mineral Leasing Act, companies have a legal obligation to maximize returns to the government of the public’s assets in the ground. From a private decisionmaking perspective, the definition makes sense in that companies will capture oil and gas only when it is economically beneficial to do so (i.e., when the cost of capture is less than the value of the captured gas).
One of the biggest considerations in private cost calculation is whether takeaway capacity exists for natural gas associated with oil. Since the price of oil far outstrips the price of natural gas on a volumetric basis, the associated natural gas generally is flared unless a gas pipeline can capture it. These areas developed so quickly, with profit incentives so strongly tied to getting oil to market, that gas pipeline systems were developed much more slowly than oil takeaway capacity—or not developed at all. And incentives to build gas pipelines are misaligned, as the oil companies do the wasting, while the pipeline companies consider their relative returns from building oil versus natural gas pipeline capacity.
However, the private-cost argument generally falls apart when social—rather than private—costs are considered. The social value of reducing pollution from carbon dioxide, methane, volatile organic compounds, and toxic chemicals also needs to be included in the calculation if the formulation used by BLM is implemented. A formulation that includes the social costs would likely greatly extend the definition of waste.
Examining the Social Cost of Carbon
The US District Court for the Northern District of California makes two economic arguments about the social cost of carbon (SCC). The first argument states that “focusing solely on domestic effects has been soundly rejected by economists as improper and unsupported by science.” While examining global benefits has been the standard approach, a legitimate debate continues among economists about the appropriate SCC for use in regulatory impact analyses (RIAs) of domestic regulations.
On one hand, standard cost-benefit analysis practice includes all benefits and costs of a regulation, which would support weighing global benefits of methane emissions reductions against the costs of reducing methane emissions, which are incurred domestically. Particularly in the case of carbon dioxide and other greenhouse gases, the global effects vastly dominate domestic effects, and so should not be ignored in US decisionmaking.
However, Circular A-4, the RIA guidance document from the US Office of Management and Budget (OMB), states that domestic benefits should be compared to domestic costs in the main analysis, while comparisons of global benefits can be compared to domestic costs in a sensitivity analysis. This language was added to OMB’s prior guidance during the Bush II administration (2003) and generally guides RIA practice. For instance, tighter US rules on ozone generate health benefits in Canada and Mexico, as the pollutant is unconfined by borders, but these international impacts are not considered in US RIAs for this or other conventional air pollutants.
As I argue with Justine Huetteman and Arthur G. Fraas in our analysis of this repeal attempt and the US Environmental Protection Agency’s rule for reducing methane from new oil and gas sources, transparency and deference to cost-benefit principles and to the OMB guidance demand that RIAs include both domestic and global estimates of the SCC, but without preference for one or the other. By applying the global SCC (about $42/ton), benefits vastly exceed costs, whereas using the current domestic SCC (about $6/ton) tends to produce the opposite result.
By considering both global and domestic benefits, this approach puts the decision squarely where it belongs—in the hands of the BLM administrator and ultimately the White House—while simultaneously educating the public about the consequences of climate change. Even better would be to include some quantification of the uncertainties in the estimates of these economic damages, as considerable variability remains.
The second argument made by the court quotes a paper by William Nordhaus: “regional damage estimates are both incomplete and poorly understood,” and “[a] key message here is that there is little agreement on the distribution of the SCC by region.” This issue is arguable. In the DICE model developed by Nordhaus, damages are estimated globally. But damage estimation is fundamentally a bottom-up exercise, wherein damages are added up across affected sectors or endpoints by region. As far as I can tell, the difference between the estimate of the domestic SCC of about $6/ton is not more controversial (apart from it being a domestic estimate) than the global SCC estimate of about $42/ton.
Our Cost-Benefit Analysis
The court says that “BLM reversed course and now claims that the Waste Prevention Rule ‘added regulatory burdens that unnecessarily encumber energy production, constrain economic growth, and prevent job creation.’” BLM also added a new analysis focusing on the burdens to marginal wells; as described below, this shift in the analysis is notable because the definition of “marginal wells” depends on the context. While the court dismisses the claims on largely procedural grounds, economic considerations have salience here, as well.
First is the legitimacy (or not) of even considering the potential effects of encumbering energy production, constraining growth, and preventing job creation in an RIA. The primary purpose of an RIA is to estimate the costs and benefits of, in this case, rescinding a rule—which include the cost savings to the oil and gas sector, the value of the oil and gas “wasted,” and pollution damages incurred. Presumably, “encumbering energy production” is covered by this part of the RIA, although it is not clear if production would be much affected; in any event, “encumbering energy production” was not estimated in the Trump administration’s RIA. However, a supplementary portion of the RIA permits economic growth and job impacts to be considered. Here again, the current administration’s RIA does not estimate such impacts.
Second, the price of oil is set in a world market, so even very stringent regulations to oil produced on federal lands would be unlikely to raise oil prices and thereby “constrain economic growth.” Oil sector profits would take a hit, but this effect is not claimed by BLM.
Finally, the new focus on the impacts on marginal wells is used by BLM as an argument to rescind the regulation on all wells. In economics, the term “marginal wells” refers to wells for which small changes in compliance costs would lead to behavioral change, be that well shutdown or other regulatory avoidance behavior. In the industry, however, “marginal wells” refers to low-producing wells from “small,” barely profitable operators that would take the brunt of a regulatory tightening. (I use quotes around the word “small” because in the oil and gas sector, “small” can be greater than $1 billion capitalization.) Both the US Environmental Protection Agency and BLM, even under the Obama administration, struggled with the burden of their regulations on these “small” businesses. The options, then, are to exempt these small businesses from the regulation, or create weaker regulations for this group, or simply justify the economic hit as necessary for the common good. However, using the burden on marginal wells as an excuse to rescind regulations for the entire sector is not an appropriate option.
Ultimately, the court’s order to reinstate the Obama BLM’s methane rule has some errors of commission and omission regarding its economic reasoning. Even so, these errors should not detract from the court’s legal reasoning or the identification of procedural failures that have led to the court's ruling.