In this series, I'll game-out strategies of different anti-fracking groups. Should the environmental movement compromise on watered-down regulations, or instead take a radical stand against the fracking industry's very existence?
<< Back to part 3
<< Back to part 3
By Jon Riley
Tick, tock, tick tock. Governor Cuomo has until tomorrow to decide whether or not to renew New York state's ban on hydraulic fracking. He can either renew the short-term moratorium to give the state government more time to review health and safety concerns and craft appropriate regulations, or he can allow it to expire and open up New York to fracking development. Yet a mere 24 hours away from the deadline, it is not at all clear which direction the Governor is leaning on this issue. His Administration is being pressured hard by both environmental groups and lobbyists from the natural gas companies. The most recent poll from the Sienna College Research Institute shows New Yorkers are equally split on the issue. [1]
Tick, tock, tick tock. Governor Cuomo has until tomorrow to decide whether or not to renew New York state's ban on hydraulic fracking. He can either renew the short-term moratorium to give the state government more time to review health and safety concerns and craft appropriate regulations, or he can allow it to expire and open up New York to fracking development. Yet a mere 24 hours away from the deadline, it is not at all clear which direction the Governor is leaning on this issue. His Administration is being pressured hard by both environmental groups and lobbyists from the natural gas companies. The most recent poll from the Sienna College Research Institute shows New Yorkers are equally split on the issue. [1]
This confrontation is not unique to New York. It is one we continue to see as the great fracking empire conquers more and more communities. The State Senate of North Carolina just voted to lift their fracking moratorium a few days ago, [2] joining New Jersey, which allowed theirs to expire this January, exposing residents to toxic water pollution. [3] But in other states, momentum has been building for statewide moratoriums, including most recently in Maryland where a moratorium bill was introduced just last week. [4] In this post, we will construct a generalized model for negotiations over fracking rules in states that have secured a moratorium.
In the previous installments of this series, we looked at what would happen if the Environmental Activists demanded that fracking be banned for good. We showed the campaign to ban fracking gives Activists maximum leverage, because the threat of a ban alone can be enough to outweigh the cost of comprehensive regulations. But in many states the probability that fracking would be banned entirely is too low to give anti-fracktivists any meaningful leverage. In these states, the most successful environmental groups have been able to win short-term moratoriums until fracking is proven safe (*cough* *cough.*)
Obviously a temporary moratorium doesn't give anti-fracktivists quite as much leverage: the Industry Lobbyists could refuse compromise and just wait for the moratorium to expire. But that's not the end of the story. Before the expiration date, the state government could still renew the moratorium. The two players in our game, the Environmental Activists and Gas Industry Lobbyists, don't know with certainty whether it will be renewed or allowed to expire. So if there's no agreement, we roll the dice: there's a certain probability the moratorium will be renewed and a certain probability that it will not. Following this logic, it's hypothetically possible that it could be renewed every year, indefinitely. That is, until some presently unknownable event interrupts the course of history, making the fracking debate irrelevant. Like, for example, if decades from now a dirt-cheap method of generating solar power were invented. Or if a zombie hoard rose up to eradicate humanity. By the way, in this apocalypse scenario the environmentalists would win anyway, because, as expert Professor Oliver Stuenkel of the Getulio Vargas Foundation points out, "zombies’ carbon footprint is low – they usually walk (rather than drive) and consume only organic food." [5] By which of course Professor Stuenkel means locally-grown, preservative-free brain.
In the end, I decided not to include the zombie scenario in my model. The point is that baring some unpredictable change in our trajectory that we can't account for, we could imagine the fracking debate going on basically "forever," at least within any germane time horizon. So for the sake of argument, we extend the game into infinity. Every time the moratorium comes up for a vote, we roll the dice to see if it will be renewed, or if instead it will expire and the game will finally end. Because we roll the dice each time, it is less likely to be renewed three times than it is to be renewed twice, which is less likely than for it to be renewed once, etc. If you go far enough into the future, this probability approaches the limit zero, but never actually drops all the way down to zero. So the Gas CEOs have no guarantee that the moratorium won't go on and on and on, until after they've already retired from the company, died, and years later burst out of their graves in search of nutrient-rich, organic brain meat.
If the Environmental Activists offer the Gas Industry Lobbyists a compromise during the first year of the moratorium, the Gas Industry Lobbyists will only accept it if their expected profit under the proposed regulations is greater than their expected profit if they walk away from the negotiations and just wait until the moratorium expires at some point. On the one hand, as long as there's some probability of the moratorium expiring, it's more and more unlikely to be renewed each subsequent year. On the other hand, the Industry loses potential interest payments each year fracking profits are delayed. So, in order to quantify the Activists' leverage to demand strong regulations, we will calculate the Industry's expected profit from rejecting compromise every year by representing their payoff from this theoretically unending strategy as a infinite geometric series. Then using a neat calculus trick, we'll reduce this infinite series to a simple and interpretable formula that shows the highest cost regulations that the Environmentalists can propose that the Industry Lobbyists would accept in order to keep the moratorium from being renewed. We'll see mathematically why the Environmentalists' leverage to demand more and more costly regulations goes up exponentially as (the Industry's perception of) the probability of a renewal bill passing the state legislature increases.
The conclusion is that while a short-term moratorium might not be as big of a stick for environmental advocates as a indefinite ban, it is actually more of a threat to the Gas Industry than you might think. Because if you can get the state government to stop fracking for one year, then you probably have a pretty good shot at getting them to ban it for a second year. And if that's the road that these big oil bullies want to go down, then guess what, we can play that game forever.
The conclusion is that while a short-term moratorium might not be as big of a stick for environmental advocates as a indefinite ban, it is actually more of a threat to the Gas Industry than you might think. Because if you can get the state government to stop fracking for one year, then you probably have a pretty good shot at getting them to ban it for a second year. And if that's the road that these big oil bullies want to go down, then guess what, we can play that game forever.
Outline of the Game Tree.
Imagine the following typical scenario. Assume a state government passed a short-term fracking moratorium to give themselves time to study whether fracking is safe and determine what regulations to establish. In different states these moratoriums have been for different time lengths, so in our generic example we'll say it's a one-year moratorium for simplicity. As the expiration date approaches, the Environmental Activists can offer a compromise allowing the moratorium to expire if in exchange the Industry accepts regulations. If both sides agree, the bill would be sure to pass: politicians would see it as a win-win. But after a year, if no deal is reached then the moratorium comes up for reauthorization, and it's anybody's guess whether it will be renewed. If it expires, the Industry wins: they can frack with no regulations. If it's renewed, then the negotiations go back to square one. Every year it's extended, the game starts over and fracking profits are further delayed, which is costly for the Gas Industry.
We'll find the Industry's expected payoff from adopting a strategy of rejecting compromise every time. For our purposes, it is sufficient to model the negotiations as the Environmental Activists declaring an ultimatum, which the Industry Lobbyists can either accept or reject. In the real world, both sides can make multiple counter-offers. But our simpler model will reveal the point at which the Industry is better off walking away from a deal, what game theorists call their "Best Alternative to a Negotiated Agreement (BATNA)." This will set the upper limit on the cost of the regulations the Activists could offer that the Industry would be willing to accept. [6]
Here's the game tree:
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Time, Profit, & Regulatory Cost.
We'll say t represents the number of times the fracking moratorium is renewed. So if the moratorium expires after the first year, then the game ends in time t = 0 . If, on the other hand, the moratorium expires after being renewed for, say, five additional years, then the game ends in time t = 5 .
Recall that V represents the profit that the Gas Industry could make from fracking without regulations, and that C represents the cost that a proposed set of regulations would impose on the Industry as a percentage of V, where 0 < C < 1 . In this game, we'll specify that Ct is the regulatory cost of the compromise offered after the moratorium has been renewed t times.
The Interest Rate: the Cost of Delay.
The Activists' leverage is that delaying fracking is costly to the Gas Industry. Now, there will be the same amount of natural gas under the ground whether the Industry extracts it now or has to wait a few years. But a dollar earned today is worth more than a dollar earned in the future. Companies use money earned now to make other investments, which pay interest. If the moratorium is renewed, then the Industry can't start earning interest on their money for another year.
Let's say r represents the annual interest rate. This means if the Industry were allowed to frack now ( t = 0 ), and there were no regulations ( C = 0 ), then the Industry would make $ V. If the moratorium is renewed once ( t = 1 ), then their profit drops to $ V ( 1 - r ). If it's renewed twice, this becomes $ V ( 1 - r )2. In general, if no regulations are agreed upon, then the Industry's profit when the moratorium finally expires is $ V ( 1 - r )t .
Probability of the Moratorium Being Renewed.
If the Industry believed the anti-fracking coalition was gaining momentum, they'd be willing accept a high degree of regulation to reach a compromise quickly. But if they believed they could use their lobbying power to stop the state government from renewing the moratorium, then they would have little incentive to compromise on costly environmental rules.
Recall that in earlier posts we said p represents (what the Industry perceives to be) the probability that a fracking ban will pass. Now that we're talking about a temporary moratorium rather than an all-out ban, we'll say that p is the probability that the state government will renew the moratorium each time it comes up for a vote. This implies that ( 1 - p ) is the probability that the moratorium will expire. Here's an example: can you figure out the probability that the moratorium will expire after being in place for three years?
Before the moratorium can expire the third time it is up for reauthorization, it must be renewed for a first time and then a second time. So the probability that the moratorium will be renewed twice in a row and then allowed to expire is the probability ( p ) that it will be renewed the first year, times the probability ( p ) that it would then be reauthorized a second time, times the probability ( 1 - p ) that it will expire the third year, which equals p2 ( 1 - p ).
In general, the probability of the moratorium expiring after being renewed t times is pt ( 1 - p ) .
Present Expected Value: Profit Adjusted for Political Risk and Time Delay
We want to find the Industry's expected payoff if they rejected compromise every time. With this strategy, the only way the game could end is if the moratorium expires. Let's consider the Industry's payoffs if the moratorium expired after one year, two years, etc., along side the probability of each of these unique outcomes occurring.
The Industry's expected payoff from a strategy of rejecting every compromise, every time is the sum of their payoffs from each of these outcomes, weighted by the probability of each outcome occurring. We multiply the Gas Industry Profit if the moratorium is never renewed ( V ) by the probability that it will expire after one year (1 - p ). Then do the same for t = 2, and add these two products together. Repeat this procedure, adding up the expected present value of fracking if the moratorium expires each subsequent year times the probability that it will expire that year for every value of t as t goes to infinity. Let's call this infinite sum S. Plugging in these values from the chart above gives us:
S = V ( 1 - p ) + V ( 1 - r ) ( 1 - p ) p + V ( 1 - r )2 ( 1 - p ) p2 + ...
Rearrange terms:
S = V ( 1 - p ) + V ( 1 - p ) ( 1 - r ) p + V ( 1 - p ) ( 1 - r )2 p2 + ...
The Industry's expected payoff from rejecting every compromise is the expected present value of the fracking operation, after taking into account the probability of the moratorium being renewed each year and the cost of delay, and is represented by the sum of this infinite series S. But how can we calculate the sum of something that approaches infinity? We're going to use a cool calculus trick to find the finite sum of this infinite series. [7] You can either take my word that the math works and skip down, or if you want you can check out the proof below.
It can be demonstrated (proof below) that the sum of the infinite geometric series,
S = V ( 1 - p ) + V ( 1 - p ) ( 1 - r ) p + V ( 1 - p ) ( 1 - r )2 p2 + ...
simplifies to
S = V ( 1 - p )
1 - ( 1 - r ) p
Here's the proof:
First, note that the common ratio between each term in this series is ( 1 - r ) p . That is, if you take the first term V ( 1 - r ) ( 1 - p ) and multiply it by the "common ratio" of ( 1 - r ) p, then you get the second term V ( 1 - r )2 ( 1 - p ) p. If you multiply that again by the common ratio ( 1 - r ) p, then you get the third term V ( 1 - r )3 ( 1 - p ) p2. And so on. We call this common ratio the "discount factor." The discount factor is the percentage of the fracking operation's expected present value that the Industry believes will remain if, in any given year, they reject compromise one more time.
The next step is to multiply both sides of this equation by the discount factor:
S ( 1 - r ) p = ( 1 - r ) p * [ V ( 1 - p ) + V ( 1 - p ) ( 1 - r ) p + V ( 1 - p ) ( 1 - r )2 p2 + ... ]
Multiplying this out gives us:
S ( 1 - r ) p = V ( 1 - r ) ( 1 - p ) p + V ( 1 - p ) ( 1 - r )2 p2 + V ( 1 - p ) ( 1 - r )3 p3 +...
Notice that this series S ( 1 - r ) p is nearly identical to the first series S, except that every term has been shifted up one spot, and so the first term V ( 1 - r ) ( 1 - p ) is missing. The next step is to subtract S ( 1 - r ) p from both sides of equation S , which gives us gives us:
S - S ( 1 - r ) p = V ( 1 - p ) + V ( 1 - p ) ( 1 - r ) p + V ( 1 - p ) ( 1 - r )2 p2 + ...
- V ( 1 - p ) ( 1 - r ) p - V ( 1 - p ) ( 1 - r )2 p2 + ...
On the right hand side of the equation, everything cancels out except for the first term:
S - S ( 1 - r ) p = V ( 1 - p )
Rearranging terms and solving for S, we get:
S [ 1 - ( 1 - r ) p ] = V ( 1 - p )
S = V ( 1 - p )
1 - ( 1 - r ) p
S is the Industry's expected payoff from adopting a strategy of rejecting compromise no matter how long the game is played. S is the value of the fracking operation if the ban expires in year t = 0 , times the probability of it expiring in that year, divided by 1 minus the discount factor. Recall that the discount factor is the percentage of the expected value of the fracking operation left remaining if the Industry decides it will reject a compromise for one more year. So that means that 1 minus the discount factor equals the percent of the expected present value that is lost every additional time the Industry refuses to compromise.
To make sense of this expression, let's insert our interpretation of each set of variables:
S = V ( 1 - p )
1 - ( 1 - r ) p
Industry's Expected Payoff from Rejecting Compromise =
(Fracking profits if moratorium expires) x (Probability of expiring each year)
Percentage of expected value lost each year of delay
Now that we know the Industry's expected payoff from walking away from negotiations, we can figure out how much regulation they'd accept willingly. The Industry will only accept a compromise offer if V ( 1 - C ) , the profit they would make from fracking under the regulations, is greater than S , their expected payoff if they just fought to kill the moratorium instead. So the Industry will accept a compromise if and only if:
V ( 1 - C ) > V (1 - p)
1 - ( 1 - r ) p
We want to find the strongest regulations the Environmental Activists could offer in the first year that the Industry Lobbyists would accept, so the next step is to solve this equation for C. You can either take my word for it or check out the proof below, but it can be demonstrated that if you solve the above equation for C , you get:
C < rp
1 - ( 1 - r ) p
Here's the proof:
Start with the condition above:
V ( 1 - C ) > V (1 - p)
1 - ( 1 - r ) p
Dividing both sides by V , this simplifies to:
1 - C > 1 - p
1 - ( 1 - r ) p
Solving for C, we get:
C < 1 - 1 - p
1 - ( 1 - r ) p
C < 1 - 1 - p
1 - ( 1 - r ) p
C < 1 - ( 1 - r ) p - 1 - p
1 - ( 1 - r ) p 1 - ( 1 - r ) p
C < 1 - p + rp - 1 + p
1 - ( 1 - r ) p
C < rp
1 - ( 1 - r ) p
In English, this result translates to:
Cost to the Industry of Proposed Regulations <
(Probability of expiring each year ) x ( interest rate )
Percentage of expected value lost each year of delay
Example with Real World Numbers
Let's plug-in some real world stats to the formula for the sake of concreteness. Alas, I don't have much insider knowledge about the closed door negotiations going on in the states we've mentioned. So the following real-world statistics were simply found by a quick Google search. But the top negotiators from the environmental lobby would have more wisdom regarding which figures would be most relevant. But if you'll play along with me here, the premise is that we're imagining this environmental advocate could use this formula in a similar manner.
First we need to choose which annual interest rate to use to represent the cost of delay. If the Gas Industry started making money this year instead of next year, they could reinvest the profits starting a year earlier, which would pay interest rate r per year. Think of the interest rate as the rate of return they could make from their next best investment. The best thing for the Oil & Gas Industry to invest in is more oil & gas. ExxonMobile had a return on capital investment of 24% per year last year, [8] which means that for every dollar invested in drilling, they made 24 cents in profit after covering their costs. So as an example, let's use this ROCE as the annual interest rate faced by the Oil & Gas Industry. If fracking is delayed, they cannot reinvest the profits, so they lose 24% of the present value of the fracking operation.
Let's plug in 0.24 for r :
C < 0.24 p
1 - ( 1 - 0.24 ) p
This simplifies to:
C < 0.24 p
1 - 0.76 p
We can graph this equation. The probability of the moratorium being renewed is on the x-axis and the maximum cost of the regulations that the Industry would accept is on the y-axis:
The lesson from this graph is that as the probability of renewal increases, the Environmental Activists' leverage to demand stricter regulations increases exponentially.
Now let's pick a proposed set of environmental regulations and see where it falls on this graph. In a recent report, the International Energy Agency recommends detailed fracking rules, and estimates their potential cost to the Gas Industry. Suppose the state's Environmental Activists offered a compromise bill that would make the IEA's proposals the law of the land. The environmentalists would use an equation like the one above to answer the question, do we have enough political power to launch a grassroots mobilzation campaign that could have enough of a shot at convincing the state government to delay fracking that the Industry would be forced to come to the table and accept the IEA proposals? How large would p have to be for the Industry to accept these regulations?
Let's do some lightening-fast, back-of-the-envelope calculations to find a reasonable estimate for C , the regulatory cost of the IEA's recommendations as a percentage of their total profit. The IEA report finds a sufficiently stringent regulatory regime would only increase costs by 7%. [9] The average cost per well is $6 million. [10] Then these regulations would increase the cost of fracking by (7%) x ($6 million) = $420,000. The Gas Industry's profit margins are around 19% of total revenue. [11] That means that after paying down the $6 million of costs, they're left with $1.4 million in pure profit ( V ). This implies that the regulatory cost C is ( $420,000 ) / ( $1.4 million ) = 0.3 . So the regulations cost 30% of V, which means C = 0.3 . Now find C = 0.3 on the graph above. The corresponding p coordinate is 0.64. So the Industry would only compromise on the IEA-endorsed regulations if they believed the probability of the moratorium being renewed each time it came up for renewal was greater than 64%.
Simplifying Assumptions.
I must note that the game structure presented here makes several simplifying assumptions. I'll highlight the two most significant.
First, we held p constant. We assumed the probability of the moratorium being renewed in 2013 is the same as the probability that, having already been renewed in 2013, it will again be renewed the next time. If this turned out not to be the case, it could in fact change the game's outcome. For example, if the Gas Industry expected the New York GOP to win a veto-proof super majority in the state legislature in the mid-term elections, then the probability of renewal will be substantially higher after the mid-terms than today. But we already know the Industry will get what it wants if the Republicans win, but that's a different game. The point of our model is to map out each side's structural bargaining leverage once these power relations have already been established by holding constant the inevitable swings in policy that follow each election.
Second, we've represented the choices of presumably rational state officials to ban or allow fracking as an external probabilistic event, rather than including them in the game as players themselves, pursuing their best strategies. That would also certainly be fun to model (don't worry, I won't.) Essentially, we're assuming legislators act in response to their perception that each interest group or affected voting block has the power to help or hurt their political career. So since these special interests ultimately dictate a legislator's incentives, the game can be reduced to a battle between competing interest groups.
The next step is to multiply both sides of this equation by the discount factor:
S ( 1 - r ) p = ( 1 - r ) p * [ V ( 1 - p ) + V ( 1 - p ) ( 1 - r ) p + V ( 1 - p ) ( 1 - r )2 p2 + ... ]
Multiplying this out gives us:
S ( 1 - r ) p = V ( 1 - r ) ( 1 - p ) p + V ( 1 - p ) ( 1 - r )2 p2 + V ( 1 - p ) ( 1 - r )3 p3 +...
Notice that this series S ( 1 - r ) p is nearly identical to the first series S, except that every term has been shifted up one spot, and so the first term V ( 1 - r ) ( 1 - p ) is missing. The next step is to subtract S ( 1 - r ) p from both sides of equation S , which gives us gives us:
S - S ( 1 - r ) p = V ( 1 - p ) + V ( 1 - p ) ( 1 - r ) p + V ( 1 - p ) ( 1 - r )2 p2 + ...
- V ( 1 - p ) ( 1 - r ) p - V ( 1 - p ) ( 1 - r )2 p2 + ...
On the right hand side of the equation, everything cancels out except for the first term:
S - S ( 1 - r ) p = V ( 1 - p )
Rearranging terms and solving for S, we get:
S [ 1 - ( 1 - r ) p ] = V ( 1 - p )
S = V ( 1 - p )
1 - ( 1 - r ) p
S is the Industry's expected payoff from adopting a strategy of rejecting compromise no matter how long the game is played. S is the value of the fracking operation if the ban expires in year t = 0 , times the probability of it expiring in that year, divided by 1 minus the discount factor. Recall that the discount factor is the percentage of the expected value of the fracking operation left remaining if the Industry decides it will reject a compromise for one more year. So that means that 1 minus the discount factor equals the percent of the expected present value that is lost every additional time the Industry refuses to compromise.
To make sense of this expression, let's insert our interpretation of each set of variables:
S = V ( 1 - p )
1 - ( 1 - r ) p
Industry's Expected Payoff from Rejecting Compromise =
(Fracking profits if moratorium expires) x (Probability of expiring each year)
Percentage of expected value lost each year of delay
Now that we know the Industry's expected payoff from walking away from negotiations, we can figure out how much regulation they'd accept willingly. The Industry will only accept a compromise offer if V ( 1 - C ) , the profit they would make from fracking under the regulations, is greater than S , their expected payoff if they just fought to kill the moratorium instead. So the Industry will accept a compromise if and only if:
V ( 1 - C ) > V (1 - p)
1 - ( 1 - r ) p
We want to find the strongest regulations the Environmental Activists could offer in the first year that the Industry Lobbyists would accept, so the next step is to solve this equation for C. You can either take my word for it or check out the proof below, but it can be demonstrated that if you solve the above equation for C , you get:
C < rp
1 - ( 1 - r ) p
Here's the proof:
Start with the condition above:
V ( 1 - C ) > V (1 - p)
1 - ( 1 - r ) p
Dividing both sides by V , this simplifies to:
1 - C > 1 - p
1 - ( 1 - r ) p
Solving for C, we get:
C < 1 - 1 - p
1 - ( 1 - r ) p
C < 1 - 1 - p
1 - ( 1 - r ) p
C < 1 - ( 1 - r ) p - 1 - p
1 - ( 1 - r ) p 1 - ( 1 - r ) p
C < 1 - p + rp - 1 + p
1 - ( 1 - r ) p
C < rp
1 - ( 1 - r ) p
In English, this result translates to:
Cost to the Industry of Proposed Regulations <
(Probability of expiring each year ) x ( interest rate )
Percentage of expected value lost each year of delay
Example with Real World Numbers
Let's plug-in some real world stats to the formula for the sake of concreteness. Alas, I don't have much insider knowledge about the closed door negotiations going on in the states we've mentioned. So the following real-world statistics were simply found by a quick Google search. But the top negotiators from the environmental lobby would have more wisdom regarding which figures would be most relevant. But if you'll play along with me here, the premise is that we're imagining this environmental advocate could use this formula in a similar manner.
First we need to choose which annual interest rate to use to represent the cost of delay. If the Gas Industry started making money this year instead of next year, they could reinvest the profits starting a year earlier, which would pay interest rate r per year. Think of the interest rate as the rate of return they could make from their next best investment. The best thing for the Oil & Gas Industry to invest in is more oil & gas. ExxonMobile had a return on capital investment of 24% per year last year, [8] which means that for every dollar invested in drilling, they made 24 cents in profit after covering their costs. So as an example, let's use this ROCE as the annual interest rate faced by the Oil & Gas Industry. If fracking is delayed, they cannot reinvest the profits, so they lose 24% of the present value of the fracking operation.
Let's plug in 0.24 for r :
C < 0.24 p
1 - ( 1 - 0.24 ) p
This simplifies to:
C < 0.24 p
1 - 0.76 p
We can graph this equation. The probability of the moratorium being renewed is on the x-axis and the maximum cost of the regulations that the Industry would accept is on the y-axis:
The lesson from this graph is that as the probability of renewal increases, the Environmental Activists' leverage to demand stricter regulations increases exponentially.
Now let's pick a proposed set of environmental regulations and see where it falls on this graph. In a recent report, the International Energy Agency recommends detailed fracking rules, and estimates their potential cost to the Gas Industry. Suppose the state's Environmental Activists offered a compromise bill that would make the IEA's proposals the law of the land. The environmentalists would use an equation like the one above to answer the question, do we have enough political power to launch a grassroots mobilzation campaign that could have enough of a shot at convincing the state government to delay fracking that the Industry would be forced to come to the table and accept the IEA proposals? How large would p have to be for the Industry to accept these regulations?
Let's do some lightening-fast, back-of-the-envelope calculations to find a reasonable estimate for C , the regulatory cost of the IEA's recommendations as a percentage of their total profit. The IEA report finds a sufficiently stringent regulatory regime would only increase costs by 7%. [9] The average cost per well is $6 million. [10] Then these regulations would increase the cost of fracking by (7%) x ($6 million) = $420,000. The Gas Industry's profit margins are around 19% of total revenue. [11] That means that after paying down the $6 million of costs, they're left with $1.4 million in pure profit ( V ). This implies that the regulatory cost C is ( $420,000 ) / ( $1.4 million ) = 0.3 . So the regulations cost 30% of V, which means C = 0.3 . Now find C = 0.3 on the graph above. The corresponding p coordinate is 0.64. So the Industry would only compromise on the IEA-endorsed regulations if they believed the probability of the moratorium being renewed each time it came up for renewal was greater than 64%.
Simplifying Assumptions.
I must note that the game structure presented here makes several simplifying assumptions. I'll highlight the two most significant.
First, we held p constant. We assumed the probability of the moratorium being renewed in 2013 is the same as the probability that, having already been renewed in 2013, it will again be renewed the next time. If this turned out not to be the case, it could in fact change the game's outcome. For example, if the Gas Industry expected the New York GOP to win a veto-proof super majority in the state legislature in the mid-term elections, then the probability of renewal will be substantially higher after the mid-terms than today. But we already know the Industry will get what it wants if the Republicans win, but that's a different game. The point of our model is to map out each side's structural bargaining leverage once these power relations have already been established by holding constant the inevitable swings in policy that follow each election.
Second, we've represented the choices of presumably rational state officials to ban or allow fracking as an external probabilistic event, rather than including them in the game as players themselves, pursuing their best strategies. That would also certainly be fun to model (don't worry, I won't.) Essentially, we're assuming legislators act in response to their perception that each interest group or affected voting block has the power to help or hurt their political career. So since these special interests ultimately dictate a legislator's incentives, the game can be reduced to a battle between competing interest groups.
