Winners and Losers in the Shale Gas Boom

Just recently, New York State officially banned the use of hydraulic fracturing. The official statement stated that prohibition “is the only reasonable alternative.” Other cities and counties have also embarked upon the same path. The main concerns are the potential risks of fracking, including methane leaks to groundwater and even a possible association with earthquakes. However, some people argue that there are some environmental benefits of fracking. For instance, natural gas is a less carbon intensive source of energy (compared to coal and oil), so it is helping to reduce greenhouse emissions.

Even though there is no consensus on the overall environmental effect of these processes, a recent study shows their economic impact by estimating the net benefits of the natural gas industry between 2007 and 2013. The paper points out that, in this period, shale gas extraction resulted in an increase in US natural gas production of more than 25 percent. This significant growth led to a sharp fall in prices—prices were cut almost in half when comparing the average of the past decade to that if the supply had not increased so abruptly. These supply and price changes had relevant distributional impacts. While estimating the benefits, the authors also note that environmental consequences must be taken into account for a comprehensive social welfare analysis in the US.

Consumers have seen the most benefits from shale gas extraction. Residential and industrial users’ natural gas and electricity bills have decreased. Among the states benefitting the most are those with intensive electric power consumption and a larger industrial sector, such as Texas and Oklahoma, and also those with colder weather, such as Illinois and Wisconsin. All industrial sectors benefit, as they are consumers of natural gas, at least indirectly through electric energy. Most industries transfer the lower cost of gas to final consumers.

Besides the boost in associated industries (i.e. pipeline construction, which is considered in the analysis of the producer surplus), the natural gas industry is on the losing end of low prices. Among those especially impacted are producers that drilled wells prior to 2007, when the prices were much higher. Such investments made sense at the time, but now they do not. But, while all consumers of natural gas benefit, not all producers are harmed.

For example, for producers from states with large shale reserves, such as Arkansas or Pennsylvania, the increase in supply is high enough to more than compensate for the decrease in prices. Among them, the owners of scarce equipment and specialized labor accrued economic rents in the new wells. On the other hand, for wells operating before this boom, owners of the mineral rights and oil and gas companies benefited the most.

The overall welfare change includes the transfers from natural gas producers to consumers—an increase in consumers’ benefits because of the greater supply, and a decrease in producers’ benefits due to low costs, as well as the international sale of natural gas, which benefits the producers who sell it overseas. The study estimates that the net benefit of the increase in natural gas production amounts to $48 billion per year. That figure is equivalent to the GDP of Ghana or Slovenia in 2013. Depending on the assumptions (particularly on the elasticity of demand and supply), those benefits can vary between $37 and $56 billion per year during the period studied. That is half of the size of the economy of Hawaii and the entire economy of North Dakota in 2013.

Among the environmental costs, the authors recognize potential negative effects, both globally and locally. The former includes leaks of methane, a powerful greenhouse gas, as well as its use as a fuel, which contributes to global warming. Among the local impacts, the paper includes water contamination due to the fracking process and an increased incidence of seismicity. The authors do not investigate these topics, however, instead indicating that more research is needed in these areas.

As with any other mechanism used to obtain energy, fracking has costs and benefits. This study shows that there is apparently a large economic benefit to increasing natural gas production through methods such as fracking. This is only one side of the coin, however. More evidence is needed to calculate the costs of the externalities and environmental damage associated with the drilling industry. The article describes the large economic benefits of this technology and raises some unknown but real costs. According to a cost-benefit analysis, in order to institute a moratorium on fracking, those external costs must be high enough to overwhelm the economic benefits.

 

Article Source: Hausman, C. and Kellog, R. “Welfare and Distributional Implications of Shale Gas” NBER Working Paper No. 21115. April 2015

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