Regulation of Natural Resources
Lecture 15

Natural Resources - Definition and Overview

1. Natural resources - two types

• Exhaustible Resources
  • Consuming each unit of a resource today prevents the future consumption of the resource
  • Examples
    • Petroleum
    • Natural gas
    • Coal
  • Could include minerals and metals; however, some minerals and metals can be recycled
• Renewable Resources
  • The natural resource grows overtime
    • Fishing stocks
    • Forests

2. Common property and open access resources

• Private property - an owner controls a property and can exclude outsiders.
• Common property- the property is held by a group of individuals and excludes those not in the group.
  • Group can exclude outsiders
• Open access property is the absence of ownership
  • Cannot exclude public use of property
  • Also known as the Tragedy of the Commons.
  • People have less incentive to develop, improve, or maintain land, if others cannot be excluded from consuming it.
• Examples
  • Over fishing in public waters
    • Fishermen catch too many fish, causing fish populations to decrease to such a level that hurts future fish catching.
  • Dumping wastes onto public lands or waters.

3. Mathusian - applies to natural resources

• Mathus was a priest
• If human population grows too quickly relative to the food supply,
  • Not enough food to feed the population
  • Part of the population dies
• Mathus assumed that population grew geometrically and the food supply grows arithmetically
  • Did not include technology
• Food shortages, disasters, and wars keep the population in check.
  • Why economics is called the dismal science.
• Mathusian ideas are still here
  • World is running out of natural resources, like petroleum
  • Population Time Bomb
  • Global Warming
  • Pollution.

Exhaustible Resources

1. Hotelling's prices - resources prices continuously increase over time as the resource is depleted

• Refer to graph below
• Time period 0 (blue supply and demand functions)
  • Market price is P* and Q*
  • Society consumes some of the resource, causing less resources to be used the following year
• Time period 1 (green supply function)
  • Supply decreases as less resources are available
    • Market price increases
    • Market quantity decreases
• Time period 2 (red supply function)
  • Supply decreases again as more resources are depleted
    • Market price increases
    • Market quantity decreases
• Price continually increases until all the resource is consumed.
• Benefits
  • Hotelling's price places a value on the resource that is in the ground
    • Called "in situ" values
  • Society conserves more of the resource as the price increases
  • Firms accrue economic rents
    • Also called user costs,
    • Market price exceeds marginal costs (or P* > MC) over the life of the resource.
  • Government can tax this economic rent; substantial source of tax revenue
• Empirical evidence is mixed concerning Hotelling's prices.

Market - Hotelling's Price
Price
Quantity

• Hotelling's price ignores two factors
  1. Technological improvements cause resource (marginal) extraction costs to fall over time
     • A competitive industry passes the lower costs to the consumers as a lower price (Fishelson 1983; Solow 1974).
  2. Hotelling prices depend on the petroleum reserves being known and fixed.
     • Resource companies do not know the location of all reserves and deposits.
     • When resource prices are high, petroleum companies have a strong incentive to explore and drill for new reserves and deposits (Farzin 2001; Fishelson 1983; Morrison 1987)

2. Hubbert’s Life Cycle Hypothesis.

• Applied to the petroleum industry
• When the petroleum industry was young and expanding its infrastructure
  • Petroleum companies discovered and developed new large petroleum reserves
  • Market price decreases over time.
• Discoveries become rarer and smaller, and petroleum depletion caused (marginal) extraction costs to increase
  • Supplies of petroleum decreased, causing market prices to increase
• Petroleum prices and petroleum production should be parabola shaped.
  • The graph below is the U.S. petroleum production
• Technological advances could extend the time paths
  • Hubbert underestimated the U.S. oil production peak by 10 years.
• Hubbert's Hypothesis applies to other exhaustible resources

U.S. Petroleum Production
Barrels of Petroleum

3. Backstop technology - one resource is a perfect substitute for another natural resource, but has a higher cost.

• Market price has to increase to a high level
  • High price makes the alternative resource feasible.
  • The alternative resource may have higher extraction costs or requires expensive technology.
• Example:
  • Petroleum from shale rock.
  • Firms crush and extract petroleum from shale, which is more expensive than pumping petroleum from wells.
• Backstop technology has one requirement
  o The alternative resource has to be supplied to the market in sufficient quantities at the same price
  • perfectly elastic supply
• Refer to graph below:
  • Market price and quantity are P* and Q*
  • Over time, the supply function continuously decreases as natural resource is depleted
    • Market price increases
    • Market quantity decreases
  • Once market price reaches P _B
    • Market quantity become 0
    • Market switches to the backstop technology and away from the resource

Market - Backstop Technology
Price
Quantity

Renewable Resources

Renewable resources - natural resources that could grow and replenish over time

• Examples
  • Fisheries
  • Forests
• Renewable resources have two features.
  • Resource amount is determined by the biological growth and harvest rates
  • Market structure influences how much resources are used.
    • Monopolies - higher prices and lower harvest rates
    • Competitive markets - lower prices and higher harvest rates
• If renewable resource is open-access and has competitive market, then the resource will likely be over-harvested.
  • Forests become bare
  • Fish stocks become extinct
    
• Policies
  1. Government creates property rights
     • Called individually transferable quota (ITQ)
       • Government sets the maximum harvest level
       • Government issues permits
       • Producers can sell or buy permits
     • Permit holders protect their property rights from poachers
     • Government monitors permit holders
     • Canada was successful in using ITQs for fishing and lobster stocks.
  2. Government could impose taxes or quotas
     • Quota - set a limit on amount of fish or trees harvested.
     • Producers cannot buy quotas
     • The quota applied to the whole market
       • Problem
       • Producers race to harvest much as possible
     • Taxes
       • Tax amount harvested
         • Tax decreases revenue; reducing amount harvested
       • Tax effort
         • Effort is number of man-hours; capital, etc.
         • Tax increases costs, reducing amount harvested
     • Taxes and quotas may be difficult to enforce

Resource Sustainability

Sustainability economics - ensuring future generations are no worse off than today’s generation.

• Sustainability economics is an equity issue and not an efficiency issue
• Example
  • Consuming all the world's petroleum today leaves no petroleum for future generations.
• Ensuring the welfare of future generations will not be harmed.
• Government should impose the following policies (from Daley - need reference)
  • The harvest rate of natural resources should be set lower than the growth rate, ensuring the natural resource grows over time.
  • Degradable pollution levels should be set below the assimilative capacity of the environment, ensuring pollution levels decrease over time.
    • If the pollution does not degrade, then the emission should be set close to zero.
  • For nonrenewable resources, the extraction should be divided into two streams:
    • Income stream is used for consumption
    • Investment stream is invested into renewable resource technologies that are substitutes for nonrenewable resources.
  • A society should minimize the use of natural resources and energy that are used in the economy.

References

Farzin, Y. H. July 2001. “The Impact of Oil Price on Additions to U.S. Proven Reserves.” Resource and Energy Economics 23(3):271-91.

Fishelson, Gideon. July 1983. “Hoteling Rule, Economics Responses and Oil Prices.” Energy Economics 5(3):153-6.

Hotelling, Harold. 1931. "The Economics of Exhaustible Resources." The Journal of Political Economy 39(2):137-175.

Hubbert, M. King. March 17, 1959. “Techniques of Prediction with Application to the Petroleum Industry.” Presented at American Association of Petroleum Geologists, Dallas, TX, 17 March. Available at http://www.hubbertpeak.com/hubbert/Bibliography.htm (access date: 8/24/06).

Morrison, Michael B. October 1987. “The Price of Oil, Lower and Upper Bounds.” Energy Policy 15(5):399-407.

Norgaard, Richard B. July 1990. "Economic Indicators of Resource Scarcity: A Critical Essay." Journal of Environmental Economics and Management 19:19-25.

Solow, Robert M. May 1974. “The Economics of Resources or the Resources for Economics.” American Economic Review 64(2):1-14.