We’ve been evaluating pipeline projects all wrong

We should ask whether the social returns on investment are sufficiently large to outweigh the costs of resources used

Etienne de Malglaive/REA/Redux

Etienne de Malglaive/REA/Redux

Last week, I wrote a piece critiquing the use of economic impact analysis as a means of evaluating the social benefits of new infrastructure or other major projects. My main critiques of this method centered on two areas: first, that the method does not differentiate with respect to what the spending produces in the end and, second, that the method does not generally account for the fact that at least some of the spending comes at the expense of other activities which would otherwise have occurred. In other words, the method does not account for the value of what is built or for the opportunity cost of the resources used in producing it.

While it’s easy to criticize, some readers rightly asked what the alternative would be—what should we do instead? There’s a relatively simple answer to this: benefit-cost analysis. If we want to ask what the net benefits of a project are, the logical approach would be to assess the benefits and costs accruing to relevant stakeholders, and to then determine the net benefits (or net costs) of the investment. In effect, we should be doing the same calculation from a societal perspective as firms would undertake for their investments—we should ask whether the social returns on investment are sufficiently large to outweigh the costs of resources used.

There are three main challenges with respect to this method, each of which are present within our current discussions over pipelines. First, determining standing, or whose benefits and costs should factor into the analysis. Second, converting non-market benefits and costs into a comparable metric often presents a challenge. Finally, determining how we should weigh benefits and costs over time both in the near and long term is very controversial.

The question of standing with respect to benefit-cost analysis is controversial in many ways since you are effectively asking who counts and who doesn’t. Perhaps the best illustration is with respect to greenhouse gas emissions and pipelines. New pipelines, and the associated resource development, will produce greenhouse gas emissions, some of which will likely be incremental to what would have otherwise occurred. To determine how best to include the costs of these incremental emissions in your benefit-cost analysis, you’d need to assess the likely impacts associated with emissions (i.e. the climate sensitivity) and the damages associated with induced changes in climate. While these are very challenging to estimate in-and-of themselves, even supposing you could do so accurately, you’d then need to determine the share of those damages which you consider to impact the relevant population. In other words, do we assess the damages to Canadians associated with incremental GHG emissions, or do we assess global damages? The two figures will vary by multiple orders of magnitude.

The same issues apply on the benefits side. Improved pipeline infrastructure will allow Canadian oil resources to be more efficiently shipped to higher value markets, increasing their value. But, some of the rights to these resources are owned by non-Canadians. Should we consider additional profits accruing to non-Canadian shareholders as part of the social benefits of a pipeline project, or should we consider only the share of incremental profits as well as the increased taxes and royalties which will be captured by Canadian shareholders and governments? If you spend much time around the pipeline file, you’ll notice that many who say we should count the global costs of climate change don’t feel quite the same way about the appropriate reach of standing with respect to counting increased profits from resource extraction and vice versa.

Once you’ve determined standing, then the next step of the analysis is the quantification of costs and benefits to those with standing. For benefits such as the expected increases in resource values or financial costs like those from potential cleanup costs for oil spills, this is relatively straightforward, since they are already measured in dollar terms. Where this gets difficult, and where a great deal of economics research has been focused for decades, is when we try to measure environmental and other non-market costs in comparable ways. Of course, nothing in economics says we would need to do this in dollar terms—we could do the whole analysis in acres of old growth forest equivalents or polar bear equivalents where the increased revenues in financial terms would be converted to natural capital equivalents, but that’s not the direction in which most of the research has gone. Economists tend to use either stated (i.e. surveys) or revealed (i.e. looking at behavior) preferences of individuals to estimate values for intangible benefits and costs in dollar terms.

Expressing the value of non-market amenities and costs in dollar terms is not popular, but we will end up doing so implicitly in most project evaluations, so let’s make it explicit. Consider the example of an oil spill—either the non-market costs (over-and-above clean-up costs) are zero (which seems indefensible), infinite (also indefensible in my view), or somewhere in between. Reasonable people can argue about how we should measure those costs, and it’s important to recognize that this is a discussion which goes far beyond traditional economics, and into ethics, sociology, and other disciplines. The fact that it’s difficult or controversial to assign a number between zero and infinity doesn’t mean that we should use zero or infinity.  If you want to calculate net benefits, you need costs and benefits to be in the same units or the math doesn’t work.

Some of these same issues also arise when it comes to valuing a “job”—a salary paid to someone is not a gift, but a payment for services, and a worker employed on this project may or may not have been employed elsewhere in its absence. So, how would a cost-benefit analysis value a job? Supposing that the salaries are paid by Canadians to Canadians, you’d be close to zero-sum as long as the labour market is at or close to full employment. It would be reasonable to assume, in that case, that the workers employed building a pipeline would be otherwise employed building something else in the absence of the pipeline project, and so the impact on their well-being is limited. Similarly, from the employer’s perspective, they pay the wages, but also receive the value of the labour, and in a tight labour market those two should be close to equal at the margin.

The analysis gets more complicated in a slack labour market in which the opportunity costs of labour will generally be lower, and there may be social benefits over-and-above the product of labour from having higher employment. These should be factored-in to a complete analysis.

The final issue is one where, again, we have to look beyond economics and be content that there likely is no right answer: how do we value costs and benefits over time and across generations? This is certainly relevant to the issue of valuing environmental damages from climate change, where the U.S. government for example publishes a range of potential social costs of carbon emissions for different assumptions on how we value future costs and benefits. It’s easy to say that we should not discount future benefits or costs relative to current ones, but that would lead to some bizarre conclusions. Reasonable people should be able to agree that some time-value of money is acceptable (if you don’t, can I borrow some money and pay you back in 50 years, without interest?), but we should welcome disagreement, discussion, and research on exactly what the time value should be or at least the range we should use for evaluation of projects.

In my piece last week, I said that we were doing project evaluation wrong. How do we do it right? We should deploy a technique analogous to what the project proponents are doing—we should look at the resources which we, as a society, would supply to that project were it granted a permit and what our returns on that investment would be, adjusting for risks. It’s entirely reasonable to suggest that a project could have private returns which far exceed its social returns (which may even be negative). Preventing projects with negative social returns from being built is why we have the regulatory process in the first place, so let’s demand that the process assess these returns carefully and using the best techniques we have available. Taking spending, cycling it through multiplier a model and yielding an economic impact is not that technique, and we can and must do better. Let’s stop using it.


We’ve been evaluating pipeline projects all wrong

  1. There are a couple of things routinely left out of the energy discussion. One is about competing cultures/societies. Whether the green crowd likes it or not, the Anglosphere and it’s foundation of economic, political, and religious liberty remains the pinnacle of civilization. We can choose to commit economic and cultural suicide at the altar of Gaia, but what comes after us? What happens to a world where China or Russia or Islam is at the top of the food chain? There are no, and will never be, Islamic Churchill’s or Locke’s or Smith’s or Jefferson’s. Ditto Russia and China. But if we choose to ignore that energy is the lifeblood of the liberty we enjoy and commit ourselves to reducing our energy use by a third or a half, as the greens and the left are wont to do, then what? If we condemn hundreds of millions of Westerners to unemployment and starvation, while Russia and China and the Muslim world look on, then what? Do we honestly believe that China will join us in a massive reduction in energy usage, knowing that it will lead to mass death and, likely, revolution? Russia? Much of the Muslim world would just as soon we did anyways. I have yet to see an honest appraisal from the left of what many of us know- reducing our energy footprint in Canada by 20% will create massive unemployment and human misery. Enough so that the Great Depression will look like picnic, yet even our so-called political leadership fails to put it into blunt terms.
    The other is the left’s routine overstatements of the problems of carbon fuels, and their gross overstatement of the benefits of “renewables”. You would have to create a system of windfarms stretching almost continuously from Grande Prairie to Winnipeg in order to replace half of Alberta’s coal plants. If you did, half the people in Western Canada would be creating power from gas and diesel fired generators in order to escape the ruinous costs of windpower.
    Sorry. Produce the oil and build the pipelines. Maybe the promoters of Keystone just need to take a page from the Cliven Bundy playbook. Ya really think you could convince the Border Patrol to shoot a bunch of welders, truck drivers, and excavator operators?

  2. Um no, we aren’t the pinnacle of civilization. Never were. A statement like that is not only arrogant….and racist….it shows a complete lack of education on your part.

    Whites are a minority in the world….and getting smaller as a group in NA all the time. I assume you find this scary…..so you are reverting to bragging and boasting….and this kind of nonsense…….. just to save an oil well.

    Btw….China invented oil wells.

    • Okay- Make your case that the Anglosphere isn’t the pinnacle of civilization in light of these basic facts
      1- The greatest achievements in engineering, medicine, and science are products of the English speaking world.
      2- English speaking people’s enjoy the greatest economic, religious, and political liberty of any citizens on earth.
      3- When tyrannical governments threatened the lives of scores of millions, it was the English speaking people who bore the greatest burden of sacrifice in preventing both the Nazis and the Soviets from destroying civilization.
      Make your case.

      • I don’t need to ‘make a case’…..history has done it for me.

        Until about 1500CE China had the largest GDP in the world, then they hit a couple of bad emperors and things went downhill.

        China is now back…..so the western world has had about 500 years to flourish….and we wasted much of it in wars.

        China and India had vaccines before we existed. China had a brilliant civil service with stiff exams while we were still running around in bear skins.

        And China invented paper, gunpowder and cannons, the compass and printing. Also the abacus….you are typing on the latest version of it. Hydraulics, astronomy…..all before us. We reinvented things after we discovered how from the Chinese. We weren’t the originators.

        And what you call Arabic numbers are actually Indian….Indians are brilliant at math…..while stars in the sky have Arabic names for a reason….great at science.

        All civilizations rise and fall….some disappear, some rise again. China is rising again…..it’s our turn to go downhill….and we are doing so at speed.

        PS….the anglosphere doesn’t include the Russians, French, Germans, Italians, Finns, Danes, Dutch and so on ya know

        In WWII the Soviets were our allies, and won the war, at the cost of 20 million lives.

        Nazis were white folk and religious and thought themselves to be superior to everyone else. Think about it.

        • And what, pray tell, did the Chinese do with their vaunted technological advantage over the rest of the world? Did freedom sail on the world’s oceans with the Chinese navy, as it did with the Royal Navy and later the US Navy? Where are the Chaucer’s and the Shakespeare’s of these other cultures? What have the Chinese or the Russians contributed to the world of science and medicine since, say, 1900? Their contribution to these fields matches the output of, maybe, Finland. What has the world of Islam contributed to the greater world in the last few centuries? Did you know that more works of literature have been translated into Spanish in the last year than have been translated into Arabic in the last 25? How is it that, in spite of literally cubic MILES of western money flowing into oil-rich Arab and Muslim nations over the last 75 years, they don’t even possess the wherewithal to invent or engineer new petroleum recovery techniques?
          The bottom line Emily is this: If you live in a country where you enjoy the rule of law, broad economic, religious and political freedom (i.e “civilization”) and all that goes with it, it’s because the English speaking people of the world (and the list of them is pretty short) have done the bulk of the heavy lifting that has allowed that kind of civilization to exist for the past several hundred years.

          • China has run a civilization for 5000 years, and contributed a massive amount of knowledge and technology to the rest of the world.

            Everything we have rests on the work and discoveries of others.

            PS Gosh, you don’t know about Confucius and Lao-tze or classical Chinese poetry?

            The Russians since 1900?? Gosh Sputnik, the first man in space, the first woman in space, the first space station…..

            Arabs helped us out of the Dark Ages boyo….algebra, surgery, astronomy….even coffee. We thanked them with an attack.

            Law and freedom? We’ve had that for thousands of years. Not an invention of ours I’m afraid.

            Wherever you got your education….ask for your money back.

          • “Everything we have rests on the work and discoveries of others.” No kidding.

            Your “Russians since 1900” put people in space with science stolen from the Nazis who of course stole it from the German scientists who developed rocket science.

            The West – specifically its several empires – is guilty of many crimes. But your attempt to refute the Enlightenment, Industrial Revolution, liberalism, etc, is simply farcical.

            Did it not occur to you that the Taoists found much of their traction in opposition to the “brilliant civil service” you applaud? I suspect you could profit by investigating the possibility of a refund from whichever school taught you.

          • Really? That wouldn’t be like Werhner von Braun and the other Nazis the Americans brought over and put in charge of NASA at the end of WWII eh?

            Mind you, the Chinese invented rockets and the Arabs invented missiles, so the Nazis were latecomers too.

            I don’t recall ‘refuting’ anything…..I said that other countries all did much the same thing, and before we did.

            Taoism is a spiritual belief from the 4th century BCE. The civil service has been around since 200 BCE

            So before you…um… gird your loins, thump your chest and start bellowing about your superiority I suggest you spend even 10 seconds on Google