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When Expenses Outweigh Benefits

April 24, 2009

When Expenses Outweigh Benefits

By INVESTOR’S BUSINESS DAILY | 24 April 2009

Regulation: Should the Environmental Protection Agency place limits on carbon dioxide emissions, the costs to the oil industry, its customers and consumers in general will be stiff. Fighting global warming is not cheap.


IBD Exclusive Series: The High Costs Of Carbon Caps


For now, we’ll forget that there’s no reason to go to war against a mythical enemy that has been created through vain imaginings and focus on the expenses humanity will incur in the battle to keep man from heating his planet. Because either through EPA regulation or by legislative initiative, there’s a better than even chance carbon emissions will one day be regulated in America, and those rules won’t come without costs.

But before the rules are carved into the cornerstone of the Washington Monument, it’s policymakers’ duty to take a sober look at the price and determine if demon carbon is worth the prohibition crusade.

U.S. petroleum refineries discharge hundreds of million of tons of CO2 into the sky each year. Oil companies don’t spew carbon into the air out of malice toward the environment or through a misanthropic negligence. They do it to make products, in particular motor fuels, the world demands and the global economy needs if it is to continue growing.

The oil industry employs a complex finishing process for crude and will not be able to simply flip a switch that will reduce its carbon dioxide discharges. It will have to make expensive changes in its operations if it is to keep providing the market with energy. The power it uses to run its refineries and light its buildings will cost more. To comply with regulations, oil companies will likely have to sink resources into new equipment that is not as cost-effective as what they are running now.

At the production level, costs will increase as the industry will no longer have the same economies of scale that keep prices down. With demand being lowered by regulation, the volume that oil companies will be able to spread their costs over will shrink, making each unit more expensive to produce.

Karen Campbell, a macroeconomic policy analyst at the Heritage Foundation, says that to operate within the government-imposed limits oil companies will have to cut their production by “about 2.2% below where it would be in the baseline scenario.” In terms of costs to the industry, “Producers of refined petroleum would see their price index (costs) grow 81% more than the baseline.”

Congressional Democrats and agitators on the left would have the public believe that the additional expenses incurred by the oil industry will come out of the pockets of the obscenely (in their minds) wealthy Big Oil executives. Some of it will. If the companies become less profitable, workers at all levels will lose income.

But consumers, some of whom support CO2 caps, will take a hit, as prices are expected to increase by 28% over the next 20 years. Oil industry workers will be affected, as well, with as many as 14,000 in both the oil and coal industries losing their jobs, Campbell reckons.

Meanwhile, investors, some of whom also support CO2 caps, will find that their investments in the oil industry will lose strength.

“The increase in prices and decline in operations is not only bad for consumers and employees, but also bad for all the owners of these stocks — pension funds, mutual funds, 401(k)s, etc. — who would get an average 3.25 percentage points lower return on their equity — about 11%,” said Campbell.

“The power of compounding makes this loss in return, year over year, significant. A $1 million investment would grow at a slower rate over the 20 years resulting in about $20 million less wealth accumulated for the saver or fund that invested in the petroleum industry.”

It’s hard to see how this trade-off could ever be of any real benefit. In exchange for a decrease in anthropogenic emissions of carbon dioxide, American jobs must be sacrificed; investors will have to expect — and receive — lower returns; capital in an essential sector that needs investment to find and produce new sources will be depressed; and consumers will have no choice but to use a greater share of their incomes for energy.

Washington, as is too often the case, has it wrong on CO2 emissions. It is treating speculation as if it were a genuine emergency. The political leadership needs to stop, take a deep breath and rethink the trendy position on carbon.

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