There’s a Slippery Slope ‘Twixt Externality and Immorality
By: Chandu Visweswariah
In economics, an externality occurs when an activity by one party causes a cost or benefit to another party, without compensation or payment. Thus, externalities are unintended or “spillover” costs or benefits experienced by third parties when goods or services are produced or consumed. In other words, the price of those goods or services don’t reflect their true cost or benefit, taking all impacts into account.
What’s a good example of a positive externality? If your neighbor maintains a beautiful garden, it is a positive externality that may increase your property value, a benefit you didn’t pay for. The word ‘externality,’ however, is usually used to mean a bad hidden cost.
What’s a good example of a negative externality? If you live next door to an incinerator plant or bus depot, your family may be harmed by higher particulate pollution, for which you are not compensated. More broadly, fossil fuels add greenhouse gases (GHGs) to the atmosphere when they are burned, a harm that is not built into the price of the fuel. Thus, society pays for this externality, not the producer or consumer of the fuel. In this case, the externality manifests itself as higher costs for health care, mortality costs, disaster response, investment in climate resilience, and so on, paid by all of society.
In economic theory, externalities are considered to represent market inefficiencies that require corrective actions to align private and social interests. The theory is that if all goods and services are priced correctly, including externalities, then the market will achieve peak efficiency, send the ‘right’ signals to investors and optimize the ‘right’ benchmarks. This is called ‘pricing in’ the externality. For example, if we had a carbon tax, it would ‘price in’ carbon emissions into the cost of goods and services, and the market would ‘self-compensate’ in the most efficient way, including creating added demand for low-carbon products.
All subsidies are inherently externalities. Governments provide these subsidies to encourage things that they think are good for society at large. Examples include low-cost or free public education, vaccine injury compensation programs and tax deductions for charitable donations. One of the largest subsidies worldwide is for the fossil fuel industry, totaling $7 trillion per year according to the International Monetary Fund. This staggering amount ($13.3 million in the one minute it took you to read this paragraph, every minute of every day!) consists of low-cost leases of public lands and waters for drilling, rights of way for pipelines and absorption of the cost of externalities (direct and indirect costs of dealing with emissions and pollution). Most economists agree that the best way to solve the climate crisis would be to end these subsidies and price the externalities into the market.
In this blog, I will drill down on externalities related to methane leakage at oil and gas wells. By way of background, all oil and gas wells leak unburned methane. Methane is a powerful greenhouse gas. A ton of unburned methane causes as much climate damage as 85 tons of carbon dioxide when measured over a period of 20 years.
Under the Biden administration, new regulations were enacted to impose strict limits on methane leakage from active oil and gas wells, expected to achieve 80% methane reduction. This is an example of “pricing in” an externality – i.e., fossil fuel companies and their customers bear the cost of reducing methane emissions, instead of society at large. The Trump administration, in one of its first actions, delayed the methane leakage fee passed through the Inflation Reduction Act (IRA) by 10 years. The next 10 years are absolutely critical in fighting climate change and staving off a cascade of climate tipping points, so society will pay a heavy price. These harms once again constitute a clear externality that is not priced into the cost of oil and gas.
Oil and gas drillers had already started scrambling to comply with the Biden administration leakage limits, and multiple CEOs even said they welcome the new regulations (more on this a bit later). Then they were let off the hook by President Trump’s executive order. What this means is that we are hurtling towards climate disaster 85 times faster for every ton of methane leakage – we’d be much better off fixing the leak or even burning the methane (so-called ‘flaring’).
Let’s talk for a moment about inactive or abandoned oil and gas wells. There are 29 million abandoned oil and gas wells worldwide, with 3.5 million in the United States (1 abandoned well per 100 citizens)! These are called “zombie” or “orphan” wells. No surprise here, they leak methane, contaminate water and pose environmental risks. Satellite studies have shown that about 10% of these abandoned wells are super-emitters. In fact, a series of satellite studies in the last decade have shown large, previously unidentified methane leaks. A significant amount of decarbonization can be achieved with relatively small investments necessary to cap these super-emitters.
Abandoned oil and gas wells represent another externality. Fossil fuel companies extract crude oil and gas until wells run dry, and then simply move on leaving behind a mess. The cost of capping and cleaning up those wells falls to society – in other words, all of us pay for it. Even worse, uncapped wells continuously spew unburned methane into the atmosphere.
What about the ‘immorality’ part of the title of this piece? Fossil fuel companies now have legal permission to treat unlimited methane leakage as an externality, i.e., they can wiggle out of paying for either fixing the leaks or the damage thereof. But there’s a huge difference between externality and immorality. One is an economic construct used to greedily maximize shareholder value by lobbying for weaker environmental regulations. The other is a question of decency and ethics.
It is immoral to make money off a well and then abandon it to leak methane and other harmful chemicals (that would be like trashing a rental apartment or hotel room and just leaving with no consequences). It is immoral and unethical to leak huge amounts of methane from active oil and gas wells (that would be like poisoning children by using leaded gasoline to save a few pennies). Now that we have a clear-eyed understanding of the harms of leaking methane, fossil fuel companies must treat this as a moral obligation, irrespective of the policies of the current administration.
Consider that the fossil fuel industry made a $4 trillion profit in 2022 (benefiting from the Ukraine war) and $2.7 trillion in profit in 2023. The industry pays an effective income tax rate around 0% (yes, you read that right, zero). Remember the $7 trillion annual subsidy number (including externalities)? If public money were not supporting the fossil fuel industry, they would either be bankrupt by now or the price of oil and gas would be at least 3x what it is now if it were priced fairly. In the latter case, we’d be securely on our way to a renewable energy future. It is immoral for an industry to make such outsize profits and at the same time cause huge harm to humanity.
Therefore, I am calling on all fossil fuel CEOs to take the following simple pledge.
- I understand the urgent nature of the climate crisis. I therefore pledge to use my company’s resources to voluntarily comply with the Biden administration’s methane leakage rules now.
- I understand the urgent nature of the climate crisis. I therefore pledge to cap my company’s share of abandoned oil and gas wells with urgency, while prioritizing super-emitters.
Fossil fuel CEOs have expressed that they actually prefer that methane leakage be regulated, because that provides protection from lawsuits (“This lawsuit is frivolous; even though we understood the harms, it is not our fault because we complied with all Federal regulations”). McKinsey estimates that an 80 to 90 percent reduction in methane leakage can be achieved by 2030 at an annual cost, worldwide, of $40 billion. The industry’s global profits have averaged over $1 trillion per year for many decades. Thus, a drastic reduction in methane leakage would reduce profits by at most 4% over the next five years. Dear CEOs, take the pledge, or go down in history as the Sacklers of the climate crisis.
