What Is Meant by Externalities? How Have Oil Companies in Trinidad and Tobago Employed Solutions to Externalities as Part of Their Corporate Social Responsibilities (csr)?

What is meant by externalities? How have oil companies in Trinidad and Tobago employed solutions to externalities as part of their corporate social responsibilities (CSR)?

Externalities exist when a third party bears costs or receives benefits arising from an economic transaction in which he or she is not a direct participant. This occurs when producers or consumers provide benefits to third parties or impose costs on third parties for which the market system does not enable them to receive full payment in return.

A harmful externality occurs, for example, when a factory generates pollution. Individuals who live and work in the neighbourhood bear costs arising from the factory’s production, including adverse health effects and clean-up costs.

A beneficial externality occurs, for example when Mr Francois paints his house and enhances his neighbours’ views and the values of their properties.

Externalities arise with any interdependency of household utility or firm production functions that is not reflected in market prices. Such externalities result in inefficiency and are nonpecuniary externalities. However, when all affected parties have directly operated through the market price system, they are identified as pecuniary externalities, and pose no inefficiency.

When nonpecuniary externatlities are present, resources are likely to be misallocated by producers or consumers whether the externality is beneficial or harmful to its recipients. This misallocation or resources occurs because the price system fails to provide the correct signals to firms making output and resource allocation decisions.

However, there are solutions to externalities.

• Firstly, the solution to misallocation of resources is clear. An external cost, for example, should be reduced up to the point where marginal spillover costs saved by any further reduction just equal the marginal lost profits from the externality generating activity. Similarly an action that external benefits should be expanded to the point where the marginal benefits to society from such an expansion just equal the societal marginal costs.

• Coasion Bargaining for reciprocal externalities

A reciprocal externality is a spillover that results from competing incompatible uses of resources. The Coase Theorem states that reciprocal externality generators and recipients will choose efficient activity levels whatever the initial liability assignment, through bargaining.

• Prohibition

One simple approach to solving externalities is basically to prohibit the action that generates the external effects. However, upon reflection, this may seem impractical. Therefore, an optimal solution does not require that externalities be completely eliminated, but rather that the right amount of them be eliminated.

An example of this may be seen with the BP Energy Company of Trinidad and Tobago. Significant contribution has been made by BPTT to BP Global’s goal of reducing 2003 Green House Gas emissions by 53% Although targets for Green House Gases are not yet legally regulated in Trinidad & Tobago, bpTT has shown commitment reduce flared gas emissions. Through the introduction of performance management systems and flare trading agreements owned by operations offshore, BPTT successfully reduced flared gas emissions to 5.4 mmsfcd (million cubic feet per day), 33% below target.

• Regulatory Directive

As outright prohibition is often suboptimal, another possibility that has been suggested is to let the government decide just how much of the externality may be produced.

For example, BHP Billiton Trinidad and Tobago and its partners, stress on excellence in the areas of health, safety, and environmental affairs. The Greater Angostura Field project has been designed, constructed, installed, commissioned and operated in compliance with the BHP Billiton Global HSE Management Standards.

• Taxes and Subsidies

Another potential solution to externality problems is to provide subsidies to those whose activities generate significant external benefits and to tax those whose activities create external costs.

• Sale of pollution rights

An increasingly popular approach to the problem of pollution is the sale of pollution rights. Licenses could be sold that give the license holder a right to pollute up to some specific limit during a particular period of time.

• Merger

When the entities generating and absorbing the externalities are firms, merger is a very attractive way of internalizing externalities. After the merger it is in the best interest of the