NRC Report on Hidden Costs of Energy Production and Use is Admirable, but Limited

by James Goodwin

November 04, 2009

Last month the National Research Council (NRC) released Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use. Properly understood, the NRC report is an admirable attempt to bring the consequences of energy use into sharp focus by putting those consequences into terms that are readily understandable by the general public. The NRC recognizes that the report is limited because it was unable to quantify and monetize all the impacts of energy production and use, thereby significantly understating their full costs. But the problem is worse: Even where the NRC did attempt to quantify and monetize the costs associated with energy, the methods that it used systematically understate the costs of those impacts.

According to the NRC report, the “cost” of energy production and use was at least $120 billion in 2005. The report reached this result by identifying and quantifying many of the impacts of energy production and use before converting those impacts into monetary terms. The NRC cautioned that “this aggregate total substantially underestimates the damages” because many impacts could not be quantified and/or monetized due to challenges like insufficient data. (See pages 4 and 16 of the report.)

To its credit, NRC acknowledges that its individual estimates of costs of impacts “can have large uncertainties” (for example, see page 4 of the report), but the report does not explain what contributes to these uncertainties, or that these uncertainties tend to result in underestimates of the costs of impacts.

To compile its report, the NRC was forced to monetize—or put a price on—impacts like premature deaths and ecological damage. But things like lives saved or environmental protection involve values that transcend simple dollar amounts -- they are priceless. Nevertheless, the NRC employed a number of controversial techniques in order to put a monetary value on these impacts. But, they also have significant practical problems as well: These techniques suffer from methodological shortcomings that inevitably underestimate the very values that they purport to measure.

For example, the report assigns a value of $6.0 million to each premature death caused by energy production and use. (For example, see page 62 of the report.) The NRC derived this number by looking at “wage premium” premium studies. (See page 38 of the report.) Wage premiums are the amount of additional compensation that workers are paid in exchange for accepting the risks that accompany a dangerous job. In theory, a wage premium indicates how much a worker is willing to pay for a safer work environment, because if the worker moves to a safer job, she has to give up the wage premium. Wage premiums assume that workers have full knowledge about workplace risks and are, in fact, able to successfully negotiate with their employer for the appropriate increase in wages. Because these conditions do not exist in real life, however, wage premiums systematically underestimate what a worker would be willing to pay for safer employment. Thus, these wage premium studies fail as a proxy measurement for the value of a life, because what they purport to measure is too small to be accurate.

Notably, U.S. regulatory agencies such as the EPA have used wage premium studies in order to derive the value of life, which they use for their cost-benefit analyses. (These agencies are required by Executive Order to perform cost-benefit analyses on all of the regulations they promulgate, which they must submit to the White House Office of Information and Regulatory Affairs for approval.)

The NRC report also relies on “willingness-to-pay” techniques for monetizing the impacts of energy production and use. (See page 38 of the Report.) Again, this technique suffers from methodological problems that cause it to systematically underestimate the costs of these impacts. In particular, willingness-to-pay is a function of a person’s wealth, which means that a person’s wealth will limit how much money she or he can pay to be safer. By comparison, the use of a willingness-to-sell technique would undoubtedly place a higher value on the costs of energy production and use, since this technique would be bounded by a person’s wealth. The wage premium studies discussed above are but one specific example of the methodological problems associated with the willingness-to-pay technique. There, analysts are looking at how much workers are “willing to pay” for safer work. This technique is used for estimating the value of other costs as well, however. For example, researchers use willingness-to-pay studies to derive values for things like environmental protection, by conducting surveys in which they ask participants how much they would be willing to pay to ensure that the environment is not harmed. Again, the values given by the participants in these studies would be much higher if the willingness-to-sell technique was used instead—that is, if participants were asked how much money they would have to be given in order to allow someone to harm the environment. Nevertheless, the NRC report relies on the willingness-to-pay technique without acknowledging its methodological flaws.

(For more information about the methodological problems of the techniques used in cost-benefit analysis, see CPR’s Perspective on Cost-Benefit Analysis.)

Despite its limitations, the NRC report makes a useful contribution to the national policy discussion on America’s energy production and use. In particular, it states in powerful terms that our choices about how much and what kinds of energy we produce and use have real consequences. At the same time though, it is important to keep this powerful statement in perspective by recognizing its limitations. It is impossible to put a dollar amount on many of the values affected by our energy choices, and even if we could that price would be substantially greater than $120 billion. Accordingly, the limitations of this report must be kept squarely in mind if we are to have a productive discussion about our energy future.

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