The downsides of living in an oil producing region

Apr 30, 2018|Merlin Uwalaka

Oil spills, pipeline leakages, and gas explosions have rendered the water noxious, surrounding land barren and the air toxic in South-South Nigeria. Ecological damage of this nature is a byproduct of oil & gas production, and Nigeria is home to some of the highest-polluting companies in the world.

But understanding the economic logic of externalities can help us address Nigeria's biggest environmental tragedy.  


Pollution as an Economic Issue

The Nigerian government continues to ignore environmental issues in its pursuit of economic growth. While some level of pollution is expected in the process of resource extraction, extreme levels of pollution are signals of undervalued ecosystems where the non-direct uses of resources are ignored – as explained previously

But we shall focus more on the externalities of pollution. 

First of all, economic activity imposes two costs on society: a private cost and an external cost. External costs (externalities) are harmful effects realised by third parties who aren't directly involved in the transaction or production.

For example, oil production in the Niger Delta causes water pollution which affects fishing and imposes a cost on the fishermen in the area even though they are not a party to the oil production process. This is important as while private costs are factored into the economics of an activity (i.e. an oil company will only extract oil if the price of oil is higher than the cost of extraction), external costs are not included in the cost of extraction.

As a result, companies will produce even when the price is lower than the combined private and external cost (social cost). In the oil scenario, this means that oil companies are over-producing oil – rather than accounting for the private and external costs of extraction, they only consider their private costs. 

The externalities of oil production can be direct, e.g. health effects on local communities, and they can be indirect, e.g. opportunity costs of lost activities from pollution. Earlier, I mentioned the environmental degradation of the Niger Delta. But in the absence of pollution, this region would have many uses: fishing, crop production, logging, and hunting, etc. So, pollution has an indirect economic effect by eliminating potential jobs in the region. This story of the Niger Delta as endemic pollution has come at the expense of local communities that have poor infrastructure, limited economic opportunities, and severe health challenges. 

However, we can estimate the size of these externalities, and once we do so, we can include them in the economics of an activity. Think about the cost of hospital bills, damage to property because of soot, etc. These can all be quantified and explains why firms have been asked to pay damages for oil spills. So how do we estimate these externalities?   


Valuing the effects of pollution

The estimated cost of pollution in the Niger Delta area is $758 million. Of this, Niger Delta states spend $187 million a year on remedial work, meaning that local communities bear an unaccounted cost of $571 million in environmental degradation and opportunity costs. This should not be the case. The $571 million externality could be included in the production costs of guilty companies, either through taxes or fees.

Economists have a number of tools for estimating how much this tax should be. One method is to ask people how much they are willing to pay (WTP) to avoid pollution damage, effectively putting a price on pollution. But WTP has many problems, especially as it tends to be much lower for poor people.

Alternatively, you could ask people what they are willing to accept (WTA) to tolerate the damage, implicitly giving them the property rights of pollution. An evaluation of willingness to accept in a Kwara community suggested that residents were willing to accept a one-time payment of ₦785,000 in compensation for an oil spill. This amount would then be charged as a tax or fee to polluting companies. Of course, these are just estimates. We do not have to go with people's WTA if we think they are too high or too low, but the approach gives us a way of putting a market price on pollution

Another method is to estimate the monetary value of the alternative uses if the natural resources being exploited or damaged. What is the economic value of the activities that the Niger Delta loses to pollution? We would consider the benefits from increased earnings, improved health, human development, etc. and account for these as a cost of oil production in the region. Once again, estimates here would help us estimate the size of the tax to be imposed. 

Even as the global economy looks beyond oil and gas, Nigeria's identity remains wedded to oil. There is a persistent belief that oil production is the most profitable economic endeavour. But as we have seen, this is only true when we ignore the externalities involved, especially in a country like Nigeria where enforcement of production and environmental standards is wanting. Once we account for the externalities of oil production, we would realise that the industry has been a significant burden to its host communities, and has cost us all far more than we would have imagined. 


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