From: Robin Moran/AA/USEPA/US

To: "Achanta, Chandana L." <Ch andana_L._Achanta@ omb.eop.gov>
Cc: William Charmley/AA/USEPA/US@EPA, rebe cca.yoon@dot.gov, james.tamm@dot.gov, Don.Pickrell@dot.gov. james.tamm@epa.gov, Michael Shelby/DC/USEPA/US@EPA

Date: 03/26/2010 01:12 PM Subjec

t: Revised Energy Security text per OMB/CEA Comments

Chandana,

Here is revised text that EPA/NHTSA developed to a ddress CEA's concern about

comment 5b.

This text will be added to Preamble Section III.H.8, and Section IV.G.4 and Joint TSD Chapter 4:

[attachment "Macro Disruption Costs for OM B.doc" deleted by Tad Wysor/AA/USEPA/US]

Robin Moran Senior Policy Advisor
Assessment and Standards Division U.S. EPA, Office of Transportation and Air Quality

2000 Traverwood Dr. Ann Arbor, MI 48105 (734) 214-4781 (734) 214-4821 (fax)DRAFT – DELIBERATIVE – PR IVILEGED AND CONFIDENTIAL

OMB Question

5b. The revised energy security benefits include two categories associated with supply disruption – one is a transfer and should probably be excl uded. While EPA and NHTSA discuss this issue, the agencies continue to include it and say th ey will examine the issue for future rulemaking. NYU School of Law argued the agencies should exclude wealth transfers from the supply disruption component. We recomme nd that the agencies evaluate this point and show what the

benefits would look like if this piece is excluded.

Response:

The agencies have added the following discussi on in Preamble Section III.H.8, and Section IV.G.4 and Joint TSD Chapter 4:

In the energy security lite rature, the macroeconomic disr uption component of the energy security premium traditionally has included both (1) increased payments for petroleum imports associated with a rapid increase in world oil pr ices, and (2) the GDP losses and adjustment costs that result from projected future oil price shocks. One commente r suggested that the increased payments associated with rapid increases in petr oleum prices (i.e., price increases in a disrupted market) represent transfers from U.S. oil consum ers to petroleum suppliers rather than real economic costs, and therefore, should not be counted as a benefit.

This approach would represent a signifi cant departure from how the macroeconomic disruption costs associated with oil price shoc ks have been quantified in the broader energy security literature, and the Agencies believe it should be analyzed in more detail before being applied in a regulatory context. In addition, the Agencies also believe that there are compelling reasons to treat higher oil im port costs during oil supply disrup tions differently than simple

wealth transfers that reflect the exercise of ma rket power by petroleum sellers or consumers. According to the OMB definition of a transfer: “Benefit and cost estimates should reflect real resource use. Transfer payments are monetary payments from one group to another that do not

affect total resources available to society...The net re duction in the total su rplus (consumer plus producer) is a real cost to soci ety, but the transfer from buyers to sellers resulting from a higher price is not a real cost since the net reduction automatically acc ounts for the transfer from buyers

to sellers.” 1 In other words, pure transfers do not lead to changes in the allocation or consumption of economic resources, whereas cha nges in the resource a llocation or use produce

real economic costs or benefits.

While price increases during oil price disruptions can result in large tr ansfers of wealth, they also result in a combination of real resour ce shortages, costly sh ort-run shifts in energy supply, behavioral and demand adjustments by ener gy users, and other response costs. Unlike pure transfers, the root cause of the disruption price increase is a real resource supply reduction due, for example, to disaster or war. Regions where supplies are disrupted (i.e., the U.S.) suffer very high costs. Businesses’ and households’ em ergency responses to su pply disruptions and

1 OMB Circular A-4, September 17, 2003. See http://www.whitehouse.gov/omb/assets/omb/circulars/a004/a-4.pdf2 DRAFT – DELIBERATIVE – PR IVILEGED AND CONFIDENTIAL

rapid price increases are likely to consume some real economic resources, in addition to causing financial losses to the U.S. economy that are ma tched by offsetting gains elsewhere in the global

economy.

While households and businesse s can reduce their petroleum c onsumption, invest in fuel switching technologies, or use futures markets to insulate themselves in advance against the potential costs of rapid increases in oil prices, when deciding how extensively to do so, they are unlikely to account for the effect of their petroleum consumption on the magnitude of costs that supply interruptions and accompanying price shocks impose on others. As a consequence, the U.S. economy as a whole will not make sufficient us e of these mechanisms to insulate itself from the real costs of rapid increases in energy prices and outlays that usually accompany oil supply interruptions. 2 Therefore, the ORNL estimate of macroeconomic disruption and adjustment costs that the Agencies use to value energy security benefits includes the increased oil import costs stemming from oil price shocks that are unanticipated and not in ternalized by advance actions of U.S. consumers of petroleum produc ts. The Agencies believe that, as the ORNL analysis argues, the uninternalized oil import costs that occur during oil supply interruptions represents a real cost associated with U.S. pe troleum consumption and im ports, and that reducing its value by lowering domestic petroleum consum ption and imports thus represents a real economic benefit from lower fuel consumption.

2 For a more complete discussion of the reas ons why the oil import cost component of the macroeconomic disruption and adjustment costs in cludes some real costs and does not represent a pure transfer, see Paul N. Leiby, Estimating th e Energy Security Benefits of Reduced U.S. Oil Imports: Final Report, ORNL-TM-2007-028, Oa k Ridge National Laboratory, March 14, 2008, pp. 21-25.