The BP Gulf Coast Oil Spill, Option Value, and the Of shore Drilling Debate
In the wake of recent unrest in the Middle East, rising gasoline prices have politicians from both parties scrambling to ramp up domestic oil production. Perhaps ironically, this scramble coincides with the one year anniversary of the BP Gulf Coast Oil Spill, the single largest of shore oil spill in history.
This regulatory report examines the economics of increased domestic oil drilling, in light of large uncertainties associated with this activity. Many of the most important factors for making smart choices about oil drilling are uncertain: future oil prices cannot be perfectly forecasted; science has a limited understanding of the scope and consequence of environmental damages from oil exploration, production, and accidents; and the rates of technological innovation for both production improvements and cleanup technologies are dii cult to predict.
The primary finding of this report is that, unless uncertainty is incorporated into the economic models used to determine whether oil drilling is appropriate, the United States will allow too much drilling, too soon, and with too much risk. h is reality should be rel ected in how the Department of the Interior structures the sale of leases to extract of shore oil—but presently, it is not.
A major l aw with the rhetoric currently dominating both sides of the political debate over domestic oil drilling is the focus on gasoline prices. In fact, expanding domestic drilling will have practically no ef ect on, and so should not be motivated by, gasoline prices. Economic analysis of oil markets shows that expanding domestic oil production is “not likely [to] have a signii cant impact on prices that consumers pay at the gasoline pump now or in the future.” Because the United States is engaged in global oil markets, even relatively large domestic changes in production will be swallowed by the larger global supply and demand, leading to only negligible changes in price.
If increasing domestic oil production is economically justifier, it will not be as an ef ective or ei cient response to rising gasoline prices. Rather, the choice would only be justified because the benei ts of drilling (namely, revenue from the operation) outweigh the costs (like the production costs and the risks of environmental damage from accidents). Consequently, to make that choice, the full extent of both the benefits and costs of drilling must be examined.
Link al Paper