from Energy, Security, and Climate and Energy Security and Climate Change Program

Would Keystone XL Lead to Infrastructure "Lock In"?

September 26, 2011

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One of the most interesting debates about the Keystone XL pipeline revolves around what’s often called “lock in”, the claim that, having developed expensive infrastructure and “opened the spigot”, industry will not pull back, even in the face of later efforts to address climate change.

 

This is unpersuasive as far as the pipeline itself is concerned. The seven billion dollar pipeline will move that much worth of crude every hundred days. More importantly, if you amortize the cost of the pipeline over thirty years, you’re looking at a sunk cost of about a dollar a barrel. This is not the sort of thing that will make or break producers’ economics.

 

There is a substantially stronger argument to be made, though, when it comes to the investments in oil sands production infrastructure that Keystone XL would presumably facilitate. Industry tends to believe that investment in oil sands production is sensible if oil prices can be expected to stay above about fifty dollars a barrel or so over the long haul. Once money is sunk into fixed capital, though, the marginal cost of producing a barrel is lower, probably around twenty five or thirty dollars. (I don’t include taxes or royalties in this, since I’m interested in identifying the threshold where production would remain barely viable, and taxes and royalties would be small in that situation.) Demand-side policy that moderates the price of oil, then, would need to pack a real wallop to actually shut in existing production. Even if large demand reductions sent the price of oil down to, say, forty dollars in 2020, new investments in oil sands production following quickly on the approval of Keystone XL would probably continue to pump out oil.

 

Is this a problem? It depends on your perspective. If you think that, all else being equal, low oil prices and more North American production are a good thing, then this is good news. The same holds if you approach climate change from a traditional economic perspective: given a particular cap on greenhouse gas emissions, or a preset level of carbon tax, economic welfare would probably be improved by this potential oil sands production.

 

The picture gets more complicated, though, once you bring politics in. Economic theory assumes that emissions cuts should come from wherever they’re cheapest. Pick an emissions cap: if the peculiarities of sunk costs in the oil sands mean that oil sands production is unlikely to be scaled back, more reductions will be found elsewhere in the economy, all at lower net cost. In reality, though, the burden that can be placed on any one sector without inspiring severe and potentially debilitating political resistance is limited. The more you make oil production economically resistant to climate policy, the more other sectors are likely to become politically opposed. The net result may well be weaker climate policy in the aggregate. It’s worth noting, though, that if you think that the optimal climate policy is some set carbon tax, this argument doesn’t really work, since less abatement in one sector doesn’t then imply greater costs in others.

 

The problematic political dynamic might be compounded by production side politics. Once you’ve built production infrastructure, every extra dollar on the price of a barrel of oil is another dollar in your pocket. (Well, not quite, since that dollar is split among investors, workers, suppliers, and governments, but the basic point remains.) Industry opposition to serious climate policy is probably only going to intensify if it sees more money to be made from inaction.

 

This all strikes me as respectable logic. But, set against a broader backdrop, I’m not sure how much it matters. The forces for and against serious climate policy are large and powerful; I’m not sure how much these oil sands dynamics would change things at the margin. Moreover, one still must account for the real economic benefits of greater production – the only difference here is that there’s a plausible argument to be made for anticipating greater climate downsides (which have economic consequences themselves) against which they must be balanced. It’s also worth remembering that policymakers have limited capacity and political capital: if they block Keystone XL, they may find themselves making offsetting concessions somewhere else.

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