28 February 2013

Smiling Happy People And Coal Rights

Colorado is second only to Hawaii on the Smiling Happy People index.  Grungy grumpy people, in contrast, are the order of the day in West Virginia, which was at the bottom of that list.

Within this distinction is a teachable moment. 

The dramatically different levels of well being between people in West Virginia and the people of Colorado has a great deal to do with the way that the state supreme courts of these respective states resolved a single important but obscure issue of property law about a century ago, give or take.

At that time, both Colorado and West Virgina were thinly inhabited states with beautiful mountains and foothills and adjacent valleys or flat lands that millions of years ago were coastal wetlands.  There are vast swaths of both states that have underneath their beautiful land huge seams of coal.

In most of the territory of both of these states, private land owners took their original title to their land without the reservation to the United States government of mineral rights found in the later Homestead Acts in the American West.

It was common (and continues to be common) for owners of this land to at some point within a few generations to sever these mineral rights from the surface rights.  At the time, there had been enough Beverley Hillbillies style fortunes made that moderately sophisticated landowners knew that their land might have coal or oil or gas underneath it which could have a lot of value if it was there.  But, it was impossible to place a good value on those rights because hydrocarbon geology wasn't very advanced.  Since no one wanted to have sold what turned out to be an extremely valuable mineral right for a pittance to a buyer who wasn't willing to pay extra for mineral rights because his main goal was to use the surface rights immediately to farm or log or hunt on or build a house upon, not to pay money to gamble on the odds that land would turn out to have valuable minerals under it.

Everywhere, an owner of mineral rights had a right to come onto the property for the purpose of determining if there are valuable minerals on the property and to mine them.  The hard question which was resolved in different ways as a matter of common law by the courts of different states was what obligation a mineral rights owner owed to the surface rights owner while exploiting the mineral rights and extracting valuable minerals when they turned out to be present.

West Virginia's supreme court concluded that since the mineral rights are what the law calls a "dominant estate" and the surface rights owner is what is called the "serviant estate" that the mineral right owner had the right to completely destroy the surface estate, for example, by strip mining for coal.

The Colorado Supreme Court took a more balanced position.  It held that the mineral rights owner who is mining for coal has an obligation to disturb no more of the surface estate than is absolutely necessary, even if that means that the mineral rights owner has to make underground mine tunnels with supports that hold up the surface, and is denied the ability to strip mine the land which is a profoundly less expensive way to extract coal but destroys completely the surface of the land.  Historically, the predisposition probably had to do with a stereotypical image of what exploiting mineral rights involved based upon tunnel mining for goal and silver, rather than strip mining coal, because the initial influx of European-Americans to the Colorado territory that was formative in the state's self-image and culture was largely driven by a gold rush.

As a result of West Virginia's decision (also basically followed by Wyoming), coal mining has been a thriving, indeed, a dominant industry in that state every since, but much of the natural beauty in the state's mountains has been destroyed and it is beyond foolish to build any significant factory or office building or hotel or what have you without first engaging in the often expensive and cumbersome and slow process of assembling and purchasing all of the mineral rights to the property that they are building upon from many fractionating owners of this difficult to market asset (pre-production), so that their work can't be destroyed to facilitate strip mining at some future date.  West Virginia has a tourism industry, but it consists mostly of penniless young hikers on the Appalachian Trail, hunters from fairly nearby, and honeymooners going to cheesy, tacky bed and breakfasts and little inns.

In Colorado, in contrast, mining companies have declined to exploit huge amounts of high quality known coal reserves that would be too expensive to tunnel mine profitably, but would be very profitable if it was strip mined.  But, land development of surface rights has been much more secure and our state's natural beauty has mostly remained unspoiled.  Outdoor activities like fishing and hunting and whitewater rafting, skiing and ski resorts are now major drivers of Colorado's economy not only in the tourism sector but because the help Colorado businesses attract employees who want to play in our wilds to work at quality jobs in Colorado.

So what happens?  In 2013, West Virgina has the lowest level of Well Being in the entire United States, and the well being of the citizens of Colorado is second only to that of those in Hawaii.  This is true notwithstanding the fact that earlier on, West Virginia was largely spared the economic devastation caused by the Civil War because they didn't have a slave based economy and sided with the winning Union instead of the losing Confederacy.  Even all of those other states devastated by the the Civil War have a century and a half later and not burdened by decisions about coal mining rights that are irrelevant because they don't have much coal, have recovered to a position better than West Virginia is in now. 

Judicial pandering to business interests in order to make the local economy more prosperous, which seemed like a good idea at the time and for many decades thereafter, as an overall key strategic decision in the process of the state's economic development turned out to be a catastrophically bad idea.  A more balanced legal position the weighted the interests of all involved, in contrast, paid off in the long run in terms of economic development.  Fair rules are better for economic development in the long run than "business friendly" rules.

The legislature could have intervened, but by the time it became clear that this issue was an important one, expectations and interests were entrenched, mineral interest exploiters had big sacks of money and strong incentives to exercise political influence to prevent that from happening, and people who had a different vision for the state's economic future didn't.

This case also illustrates how a judicial ruling on a single obscure matter that no one was focused upon when the judges who decided it were put in office, on what was basically a question of first impression in both states upon which there were little precedent to guide the courts on an obscure common law property issue, can have a profound, centuries long impact on the course of a state's entire economic development.  I'm certain that none of the judges involved really realized just how profound an impact this one case would have for both of their states and even very informed observers at the time would never have picked that case out of the entire docket for the year as one of the real blockbuster decisions of the year.  From a lawyer's perspective, it is an ambiguous issues upon which courts need to provide rules of the road, but it is largely independent of most of the issues that a lawyer deals with on a day to day basis.  But, it turns out that this one decisions has immense economic relevance intrinsically (in the tens or even hundreds of billions of dollars), even though it is a technical question with little relevance as precedent to anything else important, and the stakes in any particular dispute between a given surface right owner and mineral right owner is slight.

From the perspective of an economist, the ruling is so important because exceptions to Coase's law which says that under most conditions private parties will work out side deals that circumvent inefficient legal rules is largely neutralized in this situation.  As set forth at Wikipedia, it provides that "if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. In practice, obstacles to bargaining or poorly defined property rights can prevent Coasian bargaining."

By the time that these decisions had been rendered, the surface rights and mineral rights in so much potential coal mining land had already been severed and fractionated on the basis of property rights that were ill defined at the time and have an intrinsicaly indeterminate economic value due to the coal prospecting geology technologies there were available at the time,  to such a degree that the transaction costs of working around in initial inefficient set of entitlements were too great to make it feasible to easily unwind relative to the value of the minerals before anyone has undertaken the expensive process of determining whether or not they are present, of any particular set of mineral rights.  Once the transaction costs are low relative to the value of the mineral rights because their existence under a parcel of land is determined, the die is cast and the outcome of the negotiations between the parties will be a foregone conclusion. The harm to the state's overall economy by making surface rights investments perilous and discouraging environmental preservation has already been done.

Transaction costs and uncertainty are the friction the prevent Coase's law from perfectly remedying every inefficient allocation of rights perfectly, and the higher they are relative to the known value of the rights at the time, the less effectively Coase's law does its work. 

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