This is part of Fort McMoney, an interactive documentary game that lets you decide the future of the Alberta oil sands, and shape the city at its centre.
The oil sands represent a compelling opportunity for Canada, but also a daunting challenge. When people talk about the economics of oil sands, they often refer to the sector’s share of GDP or the number of people working in the sector. These statistics don’t answer the questions an economist should ask about oil sands development: Are we maximizing the value of the resource, and are we taking all relevant costs into account?
The oil sands resource is mind-bogglingly large – approximately two trillion barrels of oil in place of which up to 315 billion barrels are technically recoverable. Statistics Canada puts the present value of bitumen reserves at almost $285-billion dollars.
Development of the oil sands has been largely a free-for-all. While production currently sits at just over two million barrels a day, this is expected to more than double by 2030. But, is more production always good? Not necessarily.
Open any resource economics textbook and you’ll see a section on open-access resource problems. When there are no limits to development, the outcome is predictable – the value of the resource is eroded as people rush to develop, bidding up extraction costs. In the textbook example, many people benefit from cost inflation, in particular those with the skills or assets required for the development, like land or trades, but the owners of the resource see its value eroded below what it would otherwise be as costs increase rapidly. Sound familiar?
You’ll see plenty of studies which make you feel like increasing extraction costs are a good thing: higher extraction costs are economic impact, jobs, or benefits distributed along the value chain! These calculations ignore the fact that increased costs come at the expense of royalties, taxes, and profits. If they weren’t being spent on oil extraction, that money would be spent on other things we value, and the net impact on jobs and GDP would likely be neutral or close to it. If high extraction costs were good, we’d extract the oil sands with spoons, not with 400 ton trucks.
What would optimizing the value of this resource look like? It would start with the Alberta Energy Regulator assessing new projects with a true economic analysis, not one which simply equates spending with benefits. Allowing new projects generates direct economic activity, but may or may not increase the net benefits we derive from the oil sands. For example, if the inflationary pressures brought about by new projects increase total costs for the sector, these should be viewed as a cost of the development. If these costs get too high, development should be slowed. Just as a real-estate developer would not build too many condominiums at the same time because the combined impact would depress the market price, regulators need to take these impacts into account when approving oil sands projects.
What about other costs like climate change? Almost every economics text book will tell you that you’re generating false benefits if profits are under-pinned by costs or risks imposed on others – what economists call externalities. Even if those costs aren’t paid for by the producers, they’re paid by someone and a true economic analysis would take them into account.
Is oil sands development inherently inconsistent with mitigation of climate change? A global policy environment which allows unconstrained development of all energy resources including oil sands is not compatible with climate change mitigation, but a constraint on oil sands does not guarantee any measurable impact on global GHG emissions.
The U.S. Environmental Protection Agency has a metric called the social cost of carbon, which assesses the global damages likely to be associated with carbon emissions today. The current estimates are equivalent to approximately $6 to $30 per barrel of oil sands produced, transported, refined, and consumed. If these costs were imposed on producers and consumers, the oil industry would look radically different.
It is possible to reconcile oil sands growth and climate change mitigation. For one example, the International Energy Agency has developed a scenario which aims to keep global climate change below 2 degrees Celsius, and this scenario still sees oil sands growth through to 2035, albeit only to levels half as high as those currently forecast by industry. If industry and governments see a role for oil sands extraction in our economy for decades to come and see climate change as a problem, proper economic management of the resource would include a clear plan to reconcile the two.
The discussion of the economics of oil sands must go far beyond GDP impacts and job creation. We must look at whether the value of this resource is maximized when all costs of extraction, including the environmental costs, are taken into account. Many signs suggest we’re not on that path today.
Andrew Leach is the Enbridge Professor of Energy Policy at the Alberta School of Business at the University of Alberta. He is on Twitter @andrew_leach.