Arctic offshore leasing put on ice

The U.S. Department of the Interior announced last week that it is canceling future lease sales in federal Arctic waters off Alaska’s northern coast, a decision that places future Arctic offshore drilling on ice. This decision signals a clear shift in Arctic offshore leasing policy and marks a victory for environmentalists who have long highlighted the risks inherent in leasing in this remote and unpredictable region. But this decision also makes good economic sense: It reflects the value of delay in light of the significant economic, environmental and social uncertainties associated with offshore drilling in the Arctic.

{mosads}Interior’s decision followed an announcement by Royal Dutch Shell that it would cease exploration in the Chukchi and Beaufort Seas, citing disappointing results from a well drilled in the region. Interior canceled lease sales that were slated for 2016 and 2017 under its current five-year program (covering 2012 to 2017), which essentially sets the national agenda for offshore leasing. In addition, current leases held by Shell and other companies in Arctic waters will not be extended. Beaufort Sea leases are set to expire in 2017, and Chukchi Sea leases in 2020.

Despite grumbling from some corners, Interior’s decision makes sense when “option value,” or the informational value of delay, is acknowledged. Option value is a concept widely used in financial markets that analyzes the value of delaying irreversible decisions until more information is available. The uncertainties involved in Arctic drilling are substantial and include unpredictable and extreme weather conditions; limited offshore drilling experience as compared to other regions; pristine and sensitive wildlife habitat; and remote drilling locations distant from robust emergency response infrastructure. In addition, historically low oil prices demonstrate economic uncertainty; in fact, Shell’s own decision to abandon drilling reflects an understanding of the value of waiting for more information about oil prices, operational costs and risks.

Interior’s shift may have been influenced by a 2015 federal Court of Appeals decision, Center for Sustainable Economy v. Jewell, which addressed a challenge to Interior’s 2012-2017 leasing plan. Plaintiffs argued that incomplete and flawed economic analysis leads the government to sell fossil fuel leases too quickly and too cheaply, potentially costing the American public billions of dollars and leading to high-risk drilling (full disclosure: the Institute for Policy Integrity, with which we are affiliated, represented the plaintiffs, and Michael Livermore argued the case). Petitioners argued that Interior’s Bureau of Ocean and Energy Management (BOEM) should account for option value in order to help guide leasing away from areas with the greatest uncertainty and optimally time leases. The U.S. Court of Appeals for the District of Columbia Circuit ruled against petitioners, finding quantitative option value techniques not yet sufficiently developed to find Interior’s decision to forgo them arbitrary or capricious. However, the court’s decision explicitly acknowledged that there is “a tangible present economic benefit to delaying the decision to drill for fossil fuels to preserve the opportunity to see what new technologies develop and what new information comes to light.”

Interior’s new draft proposed program for offshore leasing, which covers 2017 to 2022, for the first time includes a robust discussion of option value. This is a welcome development: Even used qualitatively, option value can provide important insights into when, where and on what terms irreversible offshore leasing should take place. Interior’s recent decision to forgo leasing that had been authorized in the earlier plan is a further step in the direction of economically rational decision making.

But Interior’s work is not yet done. The draft program for post-2017 includes only a narrative discussion of option value, not the kind of clear, quantitative assessment that has greater power to affect decision-making. And Arctic lease sales also remain tentatively scheduled for 2020 and 2022 under the draft program. In light of the myriad uncertainties associated with Arctic drilling, greater analytic rigor and a more cautious approach to these lease sales would help ensure that Interior is making decisions that best promote the interests of the American people.

Hein is the policy director at the Institute for Policy Integrity at New York University School of Law. Livermore is an associate professor of law at the University of Virginia School of Law.