A firm is planning to build a 1300 mile pipeline in the US that will transport foreign oil toward US ports. The pipeline (referred to here as KXL) would not be used by US producers, but US workers and products would be used to build and maintain it. It is estimated that about 4000 US workers would work for two years to build KXL and be paid an average of $80000 per year. The firm would spend an additional $200M (M for million) on other US local value added (LVA) for construction and would spend $30M per year on LVA for maintenance during the expected 40 year lifetime of the pipeline. The construction would occur at a time when the US economy is functioning normally with under 5% unemployment and little excess capacity in the construction industry.
a. Taking the annual interest rate to be 6%, use the formulas in the N5 notes to estimate the annualized net generated income for the US coming from the construction and maintenance of KXL. Show all your work and explain why you arrange the numbers the way you do. On average, about 10000 metric tons of oil spill per year from the 150,000 miles of oil pipeline in the US. The average cost of cleanup for the heavy grade oil that would pass through KXL has been estimated to be $120000 per ton of spilled oil.
b. Estimate the average expected annual cleanup cost from the KXL if oil spills from it at the rate that is average for other US pipelines. Show all your work and explain your steps.
c. Estimate the average annualized net benet from the KXL project for the US using the information above. Show your work and explain your steps. If you could have more complete data on the expected benefits and costs of the project, what other information would be most relevant ? How could you use this information to improve your initial estimate of average annualized net benefit from the project?
N5 Formulas
Cost Benefit Summary
Net benefit to community = net user benefit + net generated income + net value of other externalities cost.
Net user benefit = locals’ benefit from use (lost use)
= net local user surplus (usually area under demand curve).
Local value added (LVA) = value of what locals supply as input for the project
Net Generated Income
= (net new spending on LVA) · (multiplier) · (profit rate) ≈ (net new spending on LVA) · (0.2) in normal times.
NET new spending on LVA = spending on LVA with project − (what would have spent on LVA without project).
Compare annual benefits, costs. Convert one-time capital cost into annual cost of debt repayment or opportunity cost (≈ interest rate times total cost for long-lived project).