The Value of Nature?

Kenneth Boulding is reputed to have said that “Economists know the price of everything and the value of nothing”. There is no place where this statement would be more appropriate than in environmental issues. Economics is at the stage where it treats relative market prices as proxies for value. Our aim in this short post is not to challenge whether there ought to be a better measure of value but simply to point out that this metric poses tremendous challenges in environmental economics since so many of the environmental services do not get captured by the market. We have acted for a long time as if these huge environmental costs do not exist simply because we have chosen not to recognize them.

Well, this has changed a bit. Such major externalities lead to inefficient allocation of the resources and so many environmentalists and non environmentalists have been asking that we find ways to value these non-market activities that are usually on the cost side. As a result we have developed many mechanisms such as Contingent Valuation methodology and created property rights ; permit to pollute, that will force corporations to take these external costs into account.

The problem worldwide could be huge. A recent estimate by a study co-sponsored by the United Nations Environmental Programme, UNEP, has shown that if the worlds’ 3000 largest corporations were to account for the environmental damage that ensues from their activities then at least 1/3 of their profits would have to be wiped out. That would amount to over $2.2 trillion. In some cases the value of these negative externalities will more than compensate for all the profits. In a study by the New Economics Foundation it was estimated that the combined profits of Shell and BP for the year 2006 ; $40 billion; would cover just 57% of the damage bill; $70 billion.



How would we value the marginal ton of carbon that might act as a tipping point to the delicate climate balance? Is it possible that the whole exercise of valuing natural services is a vulgar one?

The Price of Energy

The following article contains factual data about energy prices. Read it and note that low prices do not coincide with clean sources. If you believe that our major environmental challenge is related to carbon emissions then should we ; in this case; let the market rule?
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The price of energy has a very strong influence on the energy choices governments and individuals make. I sometimes hear people ask "Why are we still building coal-fired power plants?" or "Why don't we replace more petroleum with biomass?" One reason is that biomass is generally more difficult to use from a logistical point of view. Another is that there just isn't enough biomass to meet present energy demands. But a major factor comes down to price.

The price and convenience of energy sources are ultimately the keys to customer acceptance. Homes can be heated with wood, heating oil, natural gas, or electricity. Automobiles can be fueled with gasoline, ethanol, natural gas, diesel, electricity, and a wide variety of more unconventional fuels. If consumers have a choice and the supply is convenient, they will tend toward the cheapest energy source they can get.

Below I have compiled a list of current prices for some of the more common energy options on an energy equivalent basis - the British Thermal Unit (BTU). A BTU is simply the amount of heat energy it takes to raise the temperature of one pound of water by 1 degree Fahrenheit. Everything has been converted into U.S. dollars per million BTU (MMBTU). The sources for the data are listed below.

I have included the cost of electricity, although it is important to note that the efficiency of electric motors is higher than for internal combustion engines. For comparison, I have also included the cost of the federal ethanol tax credit (Volumetric Ethanol Excise Tax Credit), which is $0.45 per gallon of ethanol for 2010.

Energy Prices per Million BTU

* Coal - Powder River Basin1 - $0.56
* Coal - Northern Appalachia1 - $2.08
* Natural gas2 - $5.69
* Ethanol tax credit3 - $5.92
* Propane4 - $13.28
* Petroleum5 - $13.43
* #2 Heating oil4 - $14.74
* Jet fuel4 - $15.48
* Diesel4 - $15.59
* Gasoline4 - $17.81
* Wood pellets6 - $18.57
* Corn ethanol7 - $23.46
* Electricity8 - $26.31
* Cellulosic ethanol from corn cobs9 - $30.92

Observations

The list above illustrates why wood pellets for home heating are flowing out of Canada and the U.S. and into Europe. Wood pellets are much more expensive and generally less convenient to use than natural gas in North America. It isn't difficult then to see why wood pellets have a difficult market in North America. For people with access to natural gas, the lower price and convenience of natural gas is compelling. In Europe, natural gas supplies aren't as secure, so they have more incentive to consider wood pellets as an option.

The cost of the ethanol subsidy is interesting. Taxpayers presently pay more for the subsidy than natural gas costs. However, if you consider that the subsidy is on a per gallon basis - and a large fraction of that gallon of ethanol is fossil fuel-derived, the subsidy for the renewable component is higher.

For instance, consider an energy output of 1.5 BTUs of ethanol (and by-products) per BTU of fossil fuel input (this is approximately where today's corn ethanol plants operate). In this case the renewable component per gallon is only 1/3rd of a gallon; the rest of the subsidy is essentially subsidizing the fossil fuel inputs. (An energy return of 1.5 indicates that it took 1 BTU of fossil fuel to produce 1.5 BTUs of ethanol; hence the renewable component of the ethanol in that case is 1/3rd). That means that the subsidy on simply the renewable component is actually three times as high - $17.76/MMBTU. Also bear in mind that this is only the subsidy; the consumer then has to pay $23.46/MMBTU for the ethanol itself.

Of course there are many other considerations, and government subsidies can tilt the playing field toward or away from different options. But if you ever wonder why those long railroad cars filled with coal are headed east from Wyoming, or why we tend to heat homes in North America with natural gas or heating oil, now you know.

Sources for Data

1. U.S. Energy Information Administration (EIA), Coal News and Markets Report for the Week Ending 1/15/2010. (Link).

2. EIA, Natural Gas Futures Prices for 1/15/2010. (Link).

3. U.S. Department of Energy, Volumetric Ethanol Excise Tax Credit (VEETC). (Link).

4. EIA, Spot Prices for 1/15/2010. (Link).

5. EIA, World Crude Oil Prices, U.S. average price for 1/15/2010. (Link).

6. WoodPelletPrice.com, typical premium wood pellet prices for 1/15/2010. (Link).

7. CME Group, Chicago Board of Trade Ethanol Futures for February 2010 Contract. (Link).

8. EIA, Wholesale Day Ahead Prices at Selected Hubs for New England 12/31/09. (Link).

9. POET, POET Announces Cost Reductions in Cellulosic Ethanol. (Link).

Conversion factors

Petroleum - 138,000 BTU/gal

Gasoline - 115,000 BTU/gal

Diesel - 131,000 BTU/gal

Ethanol - 76,000 BTU/gal

Heating oil 138,000 BTU/gal

Jet fuel - 135,000 BTU/gal

Propane - 91,500 BTU/gal

Northern Appalachia Coal - 13,000 BTU/lb

Powder River Basin Coal - 8,800 BTU/lb

Wood pellets - 7,000 BTU/lb

Electricity - 3,412 BTU/kWh