Environmental Consequences of Hydrocarbon Infrastructure Policy
What this paper finds — and why it matters
Covert and Kellogg study policies that aim to “keep carbon in the ground” by blocking fossil fuel infrastructure investment, with the Dakota Access Pipeline (DAPL) as their empirical application. DAPL moves more than 500,000 barrels per day of oil from the Bakken Shale of North Dakota to the U.S. Gulf Coast and was completed in June 2017 amid substantial opposition. The central research question is whether blocking pipeline construction actually keeps oil in the ground or merely shifts transport to alternative modes — specifically crude-by-rail — and what the net environmental and economic consequences are.
The paper develops a two-period model of crude oil production and transportation mode choice. In the model, oil shippers decide in period 1 whether to commit to pipeline capacity under ship-or-pay contracts, then in period 2 allocate flows between the committed pipeline and the more flexible but costlier railroad alternative. Pipeline construction is an irreversible sunk cost with zero ongoing marginal cost; rail involves no sunk cost but substantial ongoing marginal costs including quadratic adjustment costs that capture capital investment in rail cars and loading/unloading facilities. Equilibrium pipeline capacity is determined by a shippers’ indifference condition: expected per-barrel returns from pipeline access equal the FERC-regulated tariff.
The empirical model is estimated using monthly Bakken oil production and transportation data, price differentials across three coastal destinations (Gulf, East, West), and drilling productivity data. Crude-by-rail marginal costs are estimated via 2SLS, yielding static marginal cost intercepts of $9.49/bbl to the East Coast, $12.64/bbl to the Gulf Coast, and $8.69/bbl to the West Coast, plus a dynamic adjustment cost of $1.28/bbl per mbbl/d of flow change. The upstream supply model follows Anderson, Kellogg, and Salant (2018), with old-well production following exponential decline (estimated decay parameter β = 0.955) and new-well drilling responding to current and lagged prices with a total long-run elasticity of 1.32. Shippers’ beliefs about future oil prices are calibrated to an AR(1) process fit to historical price volatility (persistence φ₁ = 0.9925, volatility σ_G = 0.098). Model validation confirms a predicted expected return to pipeline commitment of $6.17/bbl against DAPL’s actual tariff of $5.50–$6.25/bbl.
The main counterfactual asks what would have happened had DAPL’s construction been enjoined. In expectation, blocking DAPL reduces pipeline flows by 306 mbbl/d. Expected crude-by-rail flows increase by 248 mbbl/d, offsetting 81% of the pipeline reduction. Bakken oil production falls by only 58 mbbl/d, a 4% reduction. The modal shift from pipeline to rail worsens local environmental outcomes: per-barrel local pollution damages from rail transport substantially exceed those from pipelines, dominated by locomotive NOx emissions in populated areas. Foreclosing DAPL increases net local pollution damages by $444,000 per day (the decrease in pipeline-related harm of $144,000/day is more than offset by the increase from rail of $588,000/day). The total cost of blocking DAPL is $45/tonne of CO2 abated — $28/tonne from lost producer surplus and $17/tonne from increased local pollution damages — a figure comparable to the contemporaneous U.S. government social cost of carbon estimate of $42/tonne.
An upstream production tax achieving the same CO2 reduction costs only $1.01–$2.68/tonne CO2 abated, an order of magnitude less, because it does not induce the distortionary modal shift to rail. Two caveats apply: if 57% of Bakken production reductions leak to other basins, the cost of blocking DAPL rises from $45/tonne to $104/tonne; and if reductions represent production delays rather than permanent reductions, effective abatement is further diminished. The analysis is scoped to Bakken crude oil and land transportation alternatives. The finding that blocking infrastructure increases local pollution is atypical of CO2 abatement policies, which usually generate local pollution co-benefits.
Q: What is the core economic mechanism by which blocking a pipeline can keep oil in the ground? A: When a pipeline is foreclosed, crude oil can still move by railroad, but rail transport involves substantial ongoing marginal costs. These costs create a wedge between upstream (Bakken) and downstream (Gulf Coast) prices that depresses upstream supply. Only when downstream prices are high enough to cover both rail marginal cost and this wedge will rail fully substitute for the pipeline; at lower prices, some production is uneconomical and stays in the ground. In the model, this price-depressing wedge is the mechanism that reduces production — but it operates only partially, since rail can substitute for much of the pipeline’s flow.
Q: How much of the blocked pipeline flow substitutes to rail versus stays in the ground? A: In expectation, blocking DAPL reduces pipeline flows by 306 mbbl/d. Expected crude-by-rail flows increase by 248 mbbl/d, offsetting 81% of the pipeline reduction. Bakken oil production falls by only 58 mbbl/d, or approximately 4%. In a specific simulated month (December 2019), 348 mbbl/d (67%) of the 520 mbbl/d of foregone pipeline flows would still move by rail.
Q: How are crude-by-rail costs estimated, and what is the role of adjustment costs? A: The authors estimate a 2SLS model of rail flows on price differentials, allowing for quadratic adjustment costs to capture investments and disinvestments in rail cars and loading facilities. Static marginal costs are $9.49/bbl (East Coast), $12.64/bbl (Gulf Coast), and $8.69/bbl (West Coast). The adjustment cost parameter γ is estimated at $1.28/bbl per mbbl/d, meaning a 10 mbbl/d monthly increase in rail flows raises marginal shipping cost by $12.76/bbl — a substantial share of total rail costs. Adjustment costs are necessary to reconcile the model with the sluggish observed response of rail flows to price differentials.
Q: What is the structure of the upstream oil supply model and what are its key parameter estimates? A: The model distinguishes “old” production from pre-existing wells, which follows exponential decline with estimated decay parameter β = 0.955, and “new” production from newly drilled wells, which is price-responsive with a total long-run elasticity of 1.32 — comparable to the 1.1–1.2 estimated by Newell and Prest (2019) across major U.S. shale plays. This structure implies that total production is highly inelastic in the short run (dominated by old wells) but responds to persistent price shocks over the long run through changes in drilling rates.
Q: How do the local pollution damages of rail compare to those of pipeline transport? A: At a social cost of carbon of $100/tonne, local air pollution damages from rail transport to the Gulf Coast are $1.66/bbl (plus $0.73/bbl in spill/accident costs), versus only $0.35/bbl local pollution (plus $0.11/bbl spills) for pipelines. Locomotive NOx emissions are the dominant factor, both because locomotives have high NOx emission factors and because these emissions often occur in densely populated areas. CO2 damages at $100/tonne SCC are roughly similar across modes ($0.79–0.83/bbl), so local pollution is the key differentiator.
Q: What is the net welfare impact of foreclosing DAPL, and how is it decomposed? A: Foreclosing DAPL reduces producer surplus by $716,000/day, increases net local pollution damages by $444,000/day (the $588,000/day increase from rail more than offsets the $144,000/day decrease from pipeline), and reduces CO2 emissions by 25.2 mtonnes/day from the 58 mbbl/d production reduction. The cost per tonne of CO2 abated is $28/tonne from lost producer surplus and $17/tonne from increased local pollution damages, totaling $45/tonne — broadly comparable to the U.S. government’s contemporaneous SCC estimate of $42/tonne. This means the policy’s abatement cost is approximately equal to the social value of each tonne abated, leaving little or no net social gain even before accounting for leakage.
Q: How does the model validate against observed data and institutional parameters? A: The model predicts an expected return to committed DAPL pipeline shipment of $6.17/bbl, which closely matches the actual DAPL tariff for committed shippers of $5.50–$6.25/bbl. The authors also validate simulated crude-by-rail flows against actual flows across destinations. The close match on the tariff is particularly meaningful because it tests the model’s equilibrium condition for pipeline capacity investment rather than a within-sample fit.
Q: How does an upstream production tax compare to blocking DAPL as a policy instrument? A: A production tax normalized to achieve the same CO2 reduction requires only $3.68/bbl if imposed after shippers have committed to DAPL (holding capacity fixed), or $3.24/bbl if announced before commitments are made (reducing pipeline capacity to 443 mbbl/d). The production tax reduces combined producer surplus and government revenue by only $96,000–$109,000/day versus $716,000/day under the DAPL ban, and reduces local pollution damages by $82,000/day rather than increasing them. The resulting cost per tonne CO2 abated is $1.01–$2.68 — an order of magnitude smaller than the $44.63/tonne for blocking DAPL.
Q: What is the production leakage caveat and how large is its effect? A: If blocking DAPL causes Bakken production to fall, production from other U.S. or global oil basins may increase, partially or fully offsetting the CO2 reduction. Following Prest (2022) and Prest et al. (2023), the authors note that if 57% of the Bakken production reduction leaks to other basins, the cost of blocking DAPL rises from $45/tonne to $104/tonne. Leakage would increase the cost per tonne for the upstream tax as well, but the relative advantage of the tax over the pipeline ban is unaffected by this caveat.
Q: What is the production delay caveat? A: Even absent leakage, the paper cautions that production reductions from either policy may represent production delays rather than permanent reductions — oil not extracted today may be extracted later as prices rise or technology improves. To the extent that reductions are temporary, the effective carbon abatement is smaller than the authors compute, and the cost per tonne of CO2 abated is correspondingly higher. The paper does not quantify this effect but flags it as a material caveat.
Q: What institutional features drive pipeline capacity investment and risk allocation? A: Pipelines are irreversible investments subject to ex-post holdup, so construction financing requires firm ship-or-pay commitments from shippers before construction and before future prices are known, meaning oil price risk is borne primarily by shippers rather than the pipeline owner. Pipeline tariffs are regulated by FERC on a cost-of-service basis. In the DAPL case, shippers executed binding ten-year ship-or-pay contracts in June 2014, and shippers’ beliefs about future oil prices at that date — calibrated to historical price volatility using an AR(1) process with estimated persistence φ₁ = 0.9925 and volatility σ_G = 0.098 — determine equilibrium capacity investment.
Q: How does the paper’s finding relate to the typical co-benefit structure of climate policies? A: Most CO2 abatement policies generate local pollution co-benefits (reduced NOx, SOx, particulates), so the abatement cost is partially offset by local pollution gains. Blocking DAPL reverses this: the pipeline-to-rail modal shift increases local pollution damages, making local pollution a cost rather than a co-benefit of the policy. The authors note this is atypical but not unprecedented — urban densification and post-combustion emissions controls in fossil fuel boilers also present CO2–local pollution trade-offs.
Infrastructure foreclosure policy: A “keep it in the ground” strategy that blocks construction of specialized fossil fuel transportation infrastructure (pipelines) with the aim of inhibiting production of the fuels that would have been transported, without requiring direct acquisition or buyout of mineral rights.
Ship-or-pay agreement: A firm, up-front capacity commitment in which a pipeline shipper agrees to pay for reserved pipeline capacity whether or not they ultimately use it, made before construction and before future prices are realized; the institutional mechanism by which oil price risk is transferred from pipeline owners to shippers.
Crude-by-rail adjustment costs: Quadratic costs modeled as linear in the period-to-period change in rail volumes to a given destination, capturing capital investments and disinvestments in rail cars, loading facilities, and unloading terminals needed to expand or contract crude-by-rail capacity; estimated at $1.28/bbl per mbbl/d of monthly flow change.
Production leakage: The partial or full offset of production reductions in one oil basin (Bakken) by production increases in other U.S. or global basins in response to the same price signals; at 57% leakage, the cost of blocking DAPL rises from $45/tonne to $104/tonne of CO2 abated.
Old-well vs. new-well production dynamics: The distinction between production from pre-existing wells (which follows an exponential decline path insensitive to current prices, β = 0.955) and production from newly drilled wells (which responds to current and lagged upstream prices with long-run elasticity 1.32); this structure makes total short-run supply highly inelastic while allowing substantial long-run price responsiveness through drilling adjustments.
Local pollution damages from NOx: The dominant component of environmental harm from crude-by-rail transport, arising from locomotive NOx emissions that are both large in magnitude and concentrated in densely populated areas along rail corridors; at $100/tonne SCC, monetized local pollution damages from rail exceed CO2 damages for all three coastal destinations, whereas for pipelines CO2 damages exceed local pollution costs.
Cost per tonne of CO2 abated: The authors’ metric for comparing infrastructure foreclosure to alternative policies; computed as the sum of lost producer surplus and net change in local pollution damages divided by the quantity of CO2 emissions avoided from reduced oil production and consumption; equals $45/tonne for blocking DAPL versus $1.01–$2.68/tonne for an equivalent upstream production tax.