Paying to keep oil in the ground
Source Tufts GDAE
Date 09/08/12/23:02

Paying to keep oil in the ground
Should the world pay Ecuador not to extract oil? President Rafael Correa's argument makes perfect economic sense
Kevin Gallagher

Ecuador's President Rafael Correa is often dismissed as a radical leftist. Such has been the response to his proposal that the world pay him not to extract oil from Yasuni National Park in the western Amazon. Yasuni is home to almost 850 million barrels of oil, or 20% of Ecuador's reserves.

A closer look at Correa's proposal reveals that it comes straight out of an economics textbook, and makes perfect sense.

Ecuador has a national income of $7,500 in purchasing power terms, and the top 20% of Ecuadorans have more than half that income. More than half of Ecuador lives on less than $2 per day.

From where Ecuador sits on the global poverty and inequality ladder, the benefits outweigh the costs of extracting the oil. However, take into account the value of the park to the rest of the world, and the benefit-cost ratio shrinks. Its only rational then to ask the world to help pay for what it values.

In Ecuador's case, the net benefits of the project are projected oil revenues minus the costs of extraction. A conservative estimate is that exploiting the oil would bring in $5.7bn in present value terms, or 10% of Ecuador's GDP.

Cutting down the forest to extract oil could cost the country in terms of the other uses of the land that generated income, such as tourism, as well as in losses of biodiversity and carbon dioxide. Many of these benefits, however, may accrue to those outside Ecuador.

Ecuadoran economist Carlos Larrea has a model that tries to estimate some of the broader costs and benefits.

Yasuni is considered the most biodiverse park on the planet and has been named a Unesco Biosphere site. One hectare in the park has more species of trees than all of the United States and Canada combined. In addition to all sorts of flora, one can find ocelots, giant ant-eaters, white bellied spider monkeys, manatees and more.

People from across the world show they value this resource by travelling there upwards of 20,000 per annum. However, Larrea estimates that those receipts amount to a mere $5m per year. Larrea also looked at losses to the use of other sectors due to degradation of the environment and estimated that to be small, at $56m.

The methodologies for analyses like these are in their infancy, as Frank Ackerman and Lisa Heinzerling show in their book Priceless: On Knowing the Price of Everything and the Value of Nothing. Indeed, the cost figures are gross underestimates. One thing that's missing from this calculation is what economists call the park's "option value". Many around the world derive utility from knowing there are white bellied spider monkeys out there and would be willing to pay to preserve them.

What is more, given that the park is one of the most diverse places in the world, there is a chance it could house the key to some future wonder drug and bring in even higher receipts than the oil. Finally, the park is home to the Waorini, an estimated 20,000 indigenous peoples who have a livelihood and culture that cannot be priced.

What ups the ante is climate change. The carbon dioxide emissions from extracting and burning the oil would be about 375 million tons, and emissions from deforestation would be 172 million a total of 547 millions tons. The World Bank has estimated the abatement cost for carbon dioxide at $14 to $20 per ton (similar to the range in the pending Waxman-Markey legislation in the US Congress). The cost to the world to abate these emissions will be between $1.7bn and $2.4bn for the extraction and burning, and $909m for deforestation, for a total between $2.6bn and $3.7bn.

Correa proposes that Ecuador issue bonds for the value of the carbon dioxide emissions avoided by preserving the forest. He promises to park the funds at a neutral bank and only spend them on social development and alternative-energy projects in Ecuador. If a future government of Ecuador decides to exploit the oil, they have to repay the bondholders plus interest.

Preserving Yasuni is a rare win-win situation. The rich world (that created the climate problem) can help mitigate it in a relatively low-cost manner. Ecuador obtains the funds to help grow its relatively poor economy. Far from radical populism, this is economic efficiency at its finest. Guardian News and Media Limited 2009

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