Key Strategies for Valuing Natural Resource Damages

Key Strategies for Valuing Natural Resource Damages

When environmental disasters strike, experts can look to several approaches and considerations in assessing economic damages.

November 13, 2017

Shortly before 10 p.m. on April 20, 2010, a large explosion ripped through the Deepwater Horizon rig off the coast of Louisiana.[1] The explosion killed 11 workers aboard the rig and initiated one of the most damaging and well-known environmental disasters in U.S. history. Ultimately, roughly 4.9 million barrels of crude oil were spilled into the Gulf of Mexico. In addition to $18.7 billion in fines owed, criminal and civil settlements have cost BP $61.6 billion as of July 2016.[2

In unfortunate instances like these, before parties can come to such settlements, they must first agree on a reasonable method of assigning value to natural resource damage. Providing such an accurate estimate of economic damages for the purposes of a dispute involving natural resource degradation can be a challenging task for an expert witness. Damages to natural resources are often difficult to quantify due to their status as publicly available assets, the variety of benefits they provide to the economy, the difficulty of measuring those benefits, and the scope with which environmental degradation can occur. For example, the BP oil spill impacted communities across the Gulf Coast, affected many industries in the regional economy, and affected public natural assets such as fisheries that belong to no one plaintiff or group of plaintiffs.[3]  

When similar events occur, experts generally use several common approaches to evaluate natural resource damages, and there are certain considerations they should keep in mind when constructing analyses.

Damages Framework

Whether in the scope of violations of established statues, or in civil tort cases, the aim of any assessment of compensatory damage awards is to put an injured party in a position as near as possible equivalent to their position prior to the action in question.[4However, in the case of environmental damages, the injured parties can be numerous and difficult to define. Environmental damage that is exclusively limited to private property can be addressed with a civil tort action and may be dealt with under more established damage calculation frameworks.[5] Many environmental damages cases, however, involve a party injuring a public land or natural resource. In such cases, the application of damages takes on a different framework.

Although there are a number of state and local statutes that can and do come into play in an environmental damage or degradation case, at the federal level, these actions generally fall under the jurisdiction of the Department of the Interior, the Department of Agriculture, the Environmental Protection Agency, or a combination of the three.[6] Through various statues and regulations, these agencies have the authority to compel guilty parties to pay to clean up sources of pollution and environmental degradation or to divert agency funds to that effort in cases where liability for the pollution cannot be established. Regardless of venue or case specifics, it is always important for experts to consider some key points before building analyses.

Preliminary Considerations for Assessment of Damages

There are three states of being that are important when considering the assessment of natural resource damages: the preinjury or baseline state, the damaged state (generally the current state for purposes of valuation), and the remediated state.[7] The differences between these states leads to two major damages categories: 1) direct costs of remediating the damage to the natural resource and 2) economic damages incurred by the affected parties.

Typically direct costs of remediation are straightforward to calculate. Previously incurred and projected future cash flows needed for remediation activities can be grown at a market rate or discounted back to present value. This portion of damages represents the money owed by the liable party for direct cleanup or repair of the site in question. However, remediation efforts may not be able to fully repair the harm caused by the action. In these cases, provisions for the present value of permanent damages can be added onto the calculation to compensate for changes in the environment that cannot be remediated.

Significant additional economic damages can be less straightforward for experts to assign value. Although there are several approaches for developing these estimates, it is important to begin by establishing a link between the activity or pollution in question and an observable change in the environment. It should noted that the market does not necessarily need to be aware of said link for economic damages to be incurred. For example, residents may be reluctant to eat locally caught fish due to an unpleasant taste caused by pollutants in the water. Damages may be assessed regardless of whether the residents know the pollutant is causing the foul taste. However, establishing that there is in fact a causal link between the action in question and the damage incurred is an important first step to any damages model.

Another significant consideration in calculating damages to affected parties when dealing with a public resource is the extent to which public perception affects economic value. Negative public perception of the quality of a natural asset can persist for long periods of time after the damage is remediated. For example, if a polluter poisons a fishery with mercury, making the fish inedible, fishermen may not return to the area for many years, even if the area is successfully remediated in a short time. The defendant in this action may argue that economic damages should be less because the asset is safe for use.[8] However, the plaintiff could argue that regardless of the accuracy of the public’s perception, the economic damages are incurred by the public through impaired use and are therefore attributable to the action of the polluter. This issue can come into play especially in terms of determining reasonable timetables with which to project economic damages.

Once the preliminary considerations mentioned above have been assessed, experts can move on to shaping their analyses using indirect and direct valuation methods. Both frameworks have advantages and disadvantages that can make them better suited to a particular case. It is up to the expert to decide which method, or combination of methods, presents the most accurate estimate of monetary damages.

Indirect Valuation

There are several types of indirect valuation, which use proxies to convert the impact of environmental damage to economic values. These models work by observing a change in measureable markets and attempting to link this change to effects caused by the alleged polluter. Indirect approaches operate on the basic theory that a natural asset has a value equal to the sum of individual values for all relevant parties. Therefore, the economic value of the damage can be modeled by the change in value from the preinjury state to the value in the current state across all affected parties.[9]

One example of how this is done is through what is called a Hedonic Model. A Hedonic Model is similar to standard supply and demand models, except it deals with commodities with characteristics that are closely associated.[10] Often, the housing market in an affected area can be used as a proxy for economic damages because the factors of the natural assets surrounding the property generally cannot be unbundled from the property itself. Although not every buyer and seller will be equally affected by the environmental degradation, if the market size is sufficient, the overall change in housing prices for an area can help to estimate economic damages for the area.

Travel cost models are also useful for natural resource valuation. In cases of contamination to areas without substantial housing markets, experts can instead look at the changes in usage rates, travel costs, or tourism revenue to estimate the economic damage to an area.[11] However, travel cost models are generally less effective at measuring nonuse damages to an area, as by their nature they tend to focus on affected parties traveling to and using public natural assets.[12]

Indirect valuations have the advantage of looking at contemporaneous data and not relying on the opinion of respondents. This can provide a more convincing argument in the eyes of some triers of fact. These methods have some drawbacks, however. In addition to making nonuse values harder to account for, indirect methods often require that the damages are perceptible or known by the market. If the degradation is unknown to the market, it is much harder to draw a compelling link between the issue in question and a change in market value. Additionally, indirect methods can more easily suffer from data quality or availability issues. Often the data used in these models has a time delay and may not be available during periods that would accurately show the effects of the damage in question. In response to these limitations, experts may also use direct valuation methods to evaluate the impact of environmental issues.

Direct Valuation

Direct valuation of environmental damages refers to the direct questioning of affected parties to assess the value of the natural resource. This type of valuation can also be referred to as contingent valuation (CV). Direct methods such as CV attempt to quantify either the willingness of a party to pay (WTP) for environmental damage to be averted or rectified, or similarly the compensation a party would be willing to accept (WTA) in lieu of the undamaged environmental resource.

CV techniques have been accepted by courts and can have several advantages over other methodologies.[13] One of the main advantages of CVs is their ability to model both nonuse values and use values of a natural resource. While use values represent the economic and intangible value a party derives from directly using or interacting with a natural resource, nonuse values represent the value derived by outside parties. For example, a migratory bird hunter in the Midwest may not directly interact with an estuary in Florida; however, a drop in bird populations due to contamination of the bird’s winter feeding grounds would certainly affect the hunter’s wellbeing in the Midwest. Questionnaires used in CV approaches naturally allow for the incorporation of these nonuse values.

The main challenge with CV models lies in designing surveys that provide an accurate representation of the affected party’s valuation of the asset. For example, attention must be paid to whether questions ask about WTP or WTA. Psychologically, respondents will have higher WTA values than WTP values. WTA money, in order to allow damage to a natural resource, can make respondents feel as though they are partly responsible for allowing the damage to continue. Therefore, care must be taken in how survey questions are asked in order to accurately determine an average value.

Of course a multitude of factors go into designing effective surveys. In most cases, a damages expert will not be responsible for creating the survey, but simply modeling the results. However, once survey results are complied, experts can then use them to find an average natural resource value for the population of affected parties. Depending on available data and case specifics, these models can be more or less granular when it comes to defining the value of the damage to certain groups.

Determining the Right Framework

Natural assets provide a unique set of challenges in their valuation. However, overlooking or diminishing their value because of these challenges results in withholding significant remedies from injured parties. There is no one-size-fits-all method for approaching natural resource cases because the case details are as varied as the environments that they represent. Ultimately it is the task of the experts to tailor their analysis to capture the effects of an action in the most accurate way possible. Experts using one or a combination of the frameworks described above can design analyses quantifying the damages to communities and public assets by the actions of polluters. 

  1. Wayne Drash and Scott Bronstein, “Rig Survivors: BP Ordered Shortcut on Day of Blast,” CNN, July 9, 2010.
  2. Nathan Bomey, “BP's Deepwater Horizon Costs Total $62B,” USA Today, July 7, 2016.
  3. Dustin Cranor, “New Oceana Report Highlights Long-Term Impacts of Deepwater Horizon Oil Disaster,” Oceana, April 4, 2016.
  4. "Actual Damages," LII / Legal Information Institute, Cornell Law School, August 6, 2007.
  5. "Environmental Property Damages," Wall Bullington & Cook, LLC, 2012.
  6. "Does EPA handle all environmental concerns?" Environmental Knowledgebase, Environmental Protection Agency.
  7. Raymond J. Kopp and V. Kerry Smith, eds., Valuing Natural Assets, Resources for the Future, 1993, Page 207.
  8. Ashley Shepherd, et al., “Risk Perceptions of Environmental Hazards and Human Reproduction: A Community-Based Survey,” ISRN Public Health, vol. 2012, September 25 2011.
  9. Raymond J. Kopp and V. Kerry Smith, eds., Valuing Natural Assets, Resources for the Future, 1993, Page 156.
  10. Raymond B. Palmquist and V. Kerry Smith, “The Use of Hedonic Property Value Techniques for Policy and Litigation,” International Yearbook of Environmental and Resource Economics, IV, August 10, 2001.
  11. Frank A. Ward, "The Travel Cost Demand Model as an Environmental Policy Assessment Tool: A Review of Literature," Western Journal of Agricultural Economics, 11.2 (1986), Pages 164-78.
  12. Raymond J. Kopp and V. Kerry Smith, eds., Valuing Natural Assets, Resources for the Future, 1993, Page 176.
  13. Alan Randall, “Passive-Use Values and Contingent Valuation – Valid for Damage Assessment,” CHOICES, Second Quarter 1993, Pages 12-15.