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Weighing the Benefits & Costs of Offshore Drilling

Offshore drilling remains a risk well worth taking, even in the wake of the oil spill disaster.

Ronald Bailey
May 4, 2010

Two weeks ago BP’s Deepwater Horizon oil drilling rig in the Gulf of Mexico exploded, killing 11 workers. The exploratory well began gushing oil at an estimated rate of 5,000 barrels per day when the blowout prevention system failed. The growing oil slick menaces the marshes and beaches of Louisiana, Mississippi, Alabama, and Florida. Should the slick come ashore, previous research suggests the deleterious effects on fisheries and wildlife would be substantial and long-lasting.

As someone who has enjoyed the sugar white sands of Alabama’s beaches, it is a terrible shame that they are at risk of being despoiled by oily muck. But as someone who also enjoys the conveniences of modern civilization including the on-demand mobility offered by airplanes and automobiles that enable me to visit those beaches, I understand trade-offs.

Opponents of offshore drilling have jumped on the spill as evidence that offshore drilling is inherently dangerous, and not worth the risk. They see the blowout as evidence that the recently lifted moratorium on offshore drilling in parts of the outer continental shelf should be reinstated. Miyoko Sakashita of the Center for Biological Diversity decried “the absurdity of the claims by the oil industry and politicians beholden to that industry that offshore oil and gas development is safe." As a consequence, the center is urging the Obama administration “to reinstitute a moratorium on new offshore oil leasing, exploration, and development on all our coasts.” The Natural Resources Defense Council is also calling for a “time-out” on any further offshore oil drilling until an independent investigation of the BP spill is completed. On April 30, the Obama administration heeded the call for a time-out and halted plans to expand offshore drilling until an investigation into the causes of the BP blowout are complete.

But in deciding whether or not to continue offshore exploration for oil and gas, a calm quantitative approach makes more sense than a rush to ban drilling after seeing some pictures of oily birds. It would be useful to figure out if the costs, economic and ecological, outweigh the benefits of producing offshore oil and gas. Luckily, a recent study by Georgetown University economist Robert Hahn and Milken Institute economist Peter Passell offers some insight to this question. Published in the December 2009 issue of Energy Economics, their study “The economics of allowing more U.S. oil drilling,” finds that the benefits of producing offshore oil greatly outweigh the costs.

In their analysis, Hahn and Passell look at three types of benefits: producer revenues, lower prices to consumers, and less fluctuation in oil prices. These benefits are considered in a scenario in which oil is priced at $50 per barrel, and in another in which it goes for $100 per barrel. (The current price is around $85 per barrel.) At $50 per barrel they estimate that 10 billion barrels of oil would be recoverable from the off-limits outer continental shelf, and at $100 this rises to 11.5 billion barrels.

On the cost side of the ledger they calculate that it would cost $17 per barrel to produce offshore oil at $50 per barrel and $20 per barrel at $100 per barrel. They incorporate a Minerals Management Service estimate of $700 million as the cost of the environmental damage [PDF] caused by producing 10 billion barrels of oil offshore. They include an estimate of damage caused by greenhouse gases produced by burning the oil as fuel, and the direct costs of local air pollution, and traffic congestion and accidents. So what did they find?

At $50 per barrel, the benefits of offshore oil production in the formerly off limits areas of the outer continental shelf would garner $492 billion in revenues, $42 billion in lower oil prices, and reduce the cost of oil price disruptions by $42 billion, yielding total benefits of $578 billion. The direct drilling costs would come to $166 billion, environmental costs $1 billion, greenhouse gas damages $1 billion, local air pollution $28 billion, traffic congestion $28 billion, and traffic accidents $32 billion, for a total cost amounting to $255 billion. So at $50 per barrel the benefits of producing 10 billion barrels of offshore oil would be $323 billion greater than its costs.

At $100 per barrel, outer continental shelf oil production of 11.5 billion barrels of oil would reap $1.15 trillion in revenues, lower oil prices by $99 billion, and reduce the costs price disruptions by $51 billion, resulting in total benefits of $1.3 trillion. Drilling costs would be $238 billion, environmental costs and greenhouse gas damages would total $2 billion, the costs of local air pollution, traffic congestion, and traffic accidents would be $22 billion, $33 billion, and $38 billion respectively. So the total costs of producing 11.5 billion barrels of offshore oil would be $332 billion. Hahn and Passell calculate that at $100 per barrel, the net benefits of producing offshore oil would come to $967 billion, or a trillion dollars. They note that even if the total costs were doubled in both scenarios, “the qualitative conclusion that resource development passes any plausible benefit–cost test still holds.”

But perhaps the environmental costs used by Hahn and Passell are too low. Could they be wrong about the cost of greenhouse emissions? Hahn and Passell note that even at the highest social cost of carbon at $321 per ton suggested by British economist Nicholas Stern, the total benefits of producing offshore oil are still positive. In that case, the net benefits drop from $325 billion to $120 billion at $50 per barrel, and from $975 billion to $725 billion at $100 per barrel.

As for other environmental impacts, analysts at the Environmental Protection Agency (EPA) have devised a Basic Oil Spill Cost Estimation Model to try to figure out the costs of various types of spills. For example, the EPA model projects that the socioeconomic costs of spills over a million gallons is about $60 per gallon and the environmental costs are $30 per gallon. So if the BP blowout continues as-is for a total of 50 days, it will spew 10 million gallons into the Gulf, resulting in $900 million in costs. Applying the model’s highest socioeconomic sensitivity adjustment factor of 2 raises those costs to $1.2 billion, and applying the EPA formula including the highest vulnerability (wildlife) and habitat sensitivity factor (wetlands) raises those costs to nearly $1 billion, for a total of $2.2 billion.

This figure is basically the same as the total clean up costs of the biggest oil spill in U.S. history: In 1989, the Exxon Valdez oil tanker leaked 250,000 barrels of crude oil (about 10 million gallons) after being run aground on a reef in Alaska’s Prince William Sound. The BP blowout will eclipse the Exxon Valdez spill if it continues flowing for another 33 days. The ultimate clean up costs for the Exxon Valdez accident amounted to about $2.2 billion, with additional legal costs and damage payments of $2.3 billion. Some analysts are estimating that the costs for clean up and payment for economic losses from the BP spill might reach as high as $12.5 billion. As it should be, BP’s corporate leadership has declared that the company will be responsible for paying for the costs of the spill.

In his book, Normal Accidents: Living with High Risk Technologies (1984), Yale University sociologist Charles Perrow noted that when a technology fails, it often does so because “the problem is just something that never occurred to the designers.” Assuming no malfeasance, whatever went wrong with the Deepwater Horizon drill rig will likely uncover just such a problem and future designers will fix it. Progress is a trial and error process, and increasing safety results from learning how to make better trade-offs over time between risks. Despite this current disaster, offshore oil drilling remains a risk well worth taking.

Ronald Bailey is Reason's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is available from Prometheus Books. This column first appeared at Reason.com.


Ronald Bailey is Science Correspondent


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