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Climate Change Hero

Climate Change Blog

  • 28
  • June
  • 2016

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EPA’s Cost Analysis for the New Methane Rules for the Oil and Gas Sector

On August 2, 2016, EPA’s first-ever rule to directly regulate methane emissions from the oil and gas sector will go into effect. EPA is regulating methane as a greenhouse gas (“GHG”), which it considers to be 25 times more potent than carbon dioxide (“CO2”). The way that EPA values the reduction in these emissions resulted in the agency concluding that the rule would have a net economic benefit. Specifically, EPA estimates that this rule will reduce methane emissions by the equivalent of 6.9 million metric tons of CO2 in 2020, and the equivalent of 11 million metric tons of CO2 in 2025. EPA estimates that the methane-related monetized climate benefits of these reductions will be $360 million in 2020 and $690 million in 2025, using a 3-percent discount rate.

Background

Under section 111 of the Clean Air Act (“CAA”), EPA must consider a number of factors, including cost, in determining "the best system of emission reduction . . . adequately demonstrated," or "BSER" standards, for air emission controls. The CAA does not specify how EPA should assess those costs. To determine whether the cost of a particular control is reasonable, EPA considers the capital and operating costs associated with the control, as well as the emission reductions that the control can achieve. In the context of air pollution control options, EPA's "cost effectiveness analysis" typically refers to the annualized cost of implementing an air pollution control divided by the amount of pollutant reductions realized annually. EPA has explained that its cost effectiveness analysis is not intended to be a cost-benefits analysis, but rather to provide a metric of the relative cost to reduction ratios of various control options. Historically, courts have upheld EPA's decisions about what controls are required unless the costs are exorbitant, excessive, or "greater than the industry could bear and survive." In other words, EPA did not need to find that the rule had any economic benefit in order to promulgate it.

Cost Estimates

When EPA proposed the rule in September 2015, EPA concluded that the rule would cost the industry between $170 million to $180 million in 2020 and $280 million to $330 million in 2025. When it released the final rule, EPA raised its estimates of the total industry-wide capital cost of complying significantly. EPA now estimates the total capital cost of the final rule will be $250 million in 2020 and $360 million in 2025. As detailed below, EPA also raised its estimates for the annualized engineering costs associated with the rule. Engineering costs include, for example, the additional well completion activities that operators will have to engage in for new hydraulically fractured or refractured oil wells. The capital costs represent total capital cost expenditures associated with affected facilities in 2020 and 2025, including capital cost expenditures made prior to the analysis year.

These compliance cost estimates include revenues that EPA estimates operators will receive from recovered natural gas. Specifically, EPA estimates that operators will recover about 16,000,000 mcf in 2020 and 27,000,000 mcf in 2025 of natural gas as a result of this rule. Despite the fact that natural gas has remained below $3/mcf for more than a year, EPA made these revenue calculations by assuming a wellhead natural gas price of $4/mcf. Notably, EPA calculated these costs using a seven percent discount rate, while benefits associated with reducing methane emissions were calculated using a three percent discount rate.



Calculating Benefits

 

Despite these high industry-wide costs, EPA concludes that the proposed rule has a net economic benefit. EPA’s conclusion is largely based on its use of a model called the Social Cost of Methane. EPA used this model to place a present-dollar value on projected future benefits to the climate from reducing methane emissions. Based on the model and the three percent discount rate that EPA used in the cost effectiveness analysis, EPA determined that every ton of methane emissions that this rule prevents was worth $1,100 in 2015. As previously discussed, economists have been developing a tool known as the Social Cost of Carbon (“SCC”) in an attempt to quantify the global costs associated with incremental changes in GHG emissions on a macro-level. In theory, an SCC model could capture all of the changes, both positive and negative, that each additional unit of GHGs would have on various regions of the globe and result in a single monetary value for the impact of a unit of emissions. Critics of these models argue that it is very hard to accurately determine future impacts that will occur hundreds of years in the future. In addition, the Social Cost of Methane metric has not undergone scientific review, or been subject to public notice and comment. EPA has acknowledged some of these shortcomings, but concluded that these estimates represent the best available information about the social benefits of GHG reductions.

EPA’s final rule contains an even greater estimate of the projected benefits than it had included in the proposed rule. EPA now estimates that this rule will result in “methane-related monetized climate benefits” of $360 million in 2020 and $690 million in 2025 using a three percent discount rate. EPA estimates that this rule will reduce methane emissions by 300,000 short tons in 2020 and 510,000 short tons in 2025. EPA estimates that the majority of these emissions reductions will come from repairs to gas leaks in equipment under the LDAR program, followed by reductions from oil well completions and recompletions.

By placing a value on the reduction of methane emissions attributable to this new rule, EPA was thus able to conclude that the rule has a net economic benefit despite significantly raising the estimated costs of complying with the rule.

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