Economic and environmental impacts of fracked shale gas

Catherine Hausman, Ryan Kellogg 15 May 2015

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The fracking revolution has happened incredibly quickly, with natural gas output in the US increasing by 25% in just six years. Research is accumulating on its impact on the economy (e.g. CBO 2014, Mason et al. 2014) and the environment (e.g. Jackson et al. 2014, Moore et al. 2014, Small et al. 2014). Some uncertainties are being resolved which will help policymakers better understand the implications of this rapid change in domestic fossil fuel production, but a number of big-picture questions remain unanswered.

In recent research (Hausman and Kellogg 2015) we offer evidence on several new pieces of the fracking puzzle. We focus on shale gas, rather than shale oil, and we direct the reader to other recent work on unconventional oil (e.g. Kilian 2014).

How much have domestic natural gas prices fallen?

The first step is to understand just how big a technological advance has been made in the extraction of natural gas. From 2007 to 2013, for instance, production grew by 25% and Henry Hub prices (the pricing point for natural gas futures contracts) fell by over 50%. Concurrent with these changes, of course, were a recession and a recovery, so we therefore have to separate out the impact of changes in demand for natural gas. To do this, we provide new estimates of natural gas supply and demand curves, allowing us to calculate just how much of the price decline was due to the expansion in supply. We find that the supply boom lowered prices by almost 50%.

Figure 1. The natural gas supply boom is associated with a price fall 1

Figure 2. Holding demand constant, the supply boom caused prices to fall almost 50% 2

Who wins and who loses?

Between the price fall and the expansion of quantity consumed, we estimate that in 2013 fracking made buyers of natural gas $74 billion better off. Some of these gains accrued directly to households in the form of lower utility bills, while other gains went to commercial and industrial users. Even more gains were seen in the electric power sector as a direct result of lower input prices.

However, we estimate that producers have, on net, lost because of fracking (a $26 billion loss in 2013) – for them, the price decline has outweighed the quantity expansion. Moreover, while states such as Pennsylvania with large amounts of shale gas have benefited, states with primarily conventional reserves have on net lost because of the price decline.

Overall, we calculate that the private gains to consumers and producers from shale gas, not including environmental impacts, totalled $48 billion in 2013. This is about one-third of 1% of GDP, around $150 per capita.

Will this reverse the decline in American manufacturing?

One reason the price fall has been so dramatic is that the North American natural gas market is not fully integrated with overseas markets. Natural gas must be transformed into liquefied natural gas before transport overseas. This is expensive and there are policy barriers on top of the transportation costs.

Figure 3. Domestic and international prices3

As a result, some policymakers have hoped that the decline in US manufacturing would be reversed, spurred on by low domestic energy prices that are not mirrored in international markets. Using data on manufacturing sector activity and inputs, we find increases in establishment counts, employment, employee compensation, and capital expenditure for natural-gas-intensive industries. We see especially strong impacts for fertiliser manufacturing, the most gas-intensive industry we analyse. This result is not surprising – while input prices have been depressed, output prices for fertiliser itself have remained high. Fertiliser is easily traded internationally, and prices are set on the world market. Similar dynamics are at play in other chemicals manufacturing, such as high-density polyethylene, a common type of plastic.

Figure 4. For fertiliser and chemicals, inputs prices are falling but output prices are not4

Overall, we find that manufacturing employment appears to have risen because of fracking, although the total employment effect depends, of course, on how these changes impact non-manufacturing employment.

How big are the environmental impacts?

The gains to households and industries must, of course, be weighed against environmental impacts. The scientific literature on fracking’s environmental effects is accumulating, but much remains uncertain.

Take, for instance, the impact of fracking natural gas on climate change, where three mechanisms are at play:

  • First, with greater natural gas consumption comes higher CO2 emissions produced during combustion;
  • Second, and counteracting some of the first effect, is the displacement effect on coal – when natural gas power plants substitute for coal-fired plants, CO2 emissions decrease;
  • A third effect, which is harmful for climate change, is the leakage of methane, a powerful greenhouse gas, from the natural gas supply chain.

While measuring the first impact – greater natural gas combustion – is easy, a precise understanding of the second two impacts remains elusive. The coal displacement effect depends on how coal markets around the world re-adjust, and more research is needed on this area. Also, the methane leakage rate is much debated by scientists. Overall, past researchers (McJeon et al. 2014, Newell and Raimi 2014) have concluded that fracking could either increase or decrease total greenhouse gas emissions. We show that plausible bounds on the greenhouse gas costs from shale gas for 2013 are $3 billion to $28 billion.5 At the most extreme, if methane leaks are quite high and if no coal is displaced, the climate change impacts could erase about half of the welfare gains from fracking.

On local environmental impacts, there is even more uncertainty. We direct the reader to a substantial literature cataloguing the potential impacts, including water contamination, earthquakes, road congestion, air pollution, and habitat fragmentation (useful summaries are provided in Jackson et al. 2014, Mason et al. 2014, Moore et al. 2014, and Small et al. 2014). With good estimates of the marginal cost of damages to water and air, these impacts could be properly valued and weighed against the private gains from fracking.6 The limitation, however, is that comprehensive data across time and space are not available on these impacts. Some of the data, for instance, are industry-reported. Data on other processes lack a baseline against which current conditions can be compared. Other data are snapshots of single sites at a point in time. Aggregation and extrapolation to other sites and other time periods is complicated by the fact that many of the impacts (e.g. water contamination and methane leaks) are likely to be very heterogeneous.

What next?

We find a noticeable impact of the shale gas boom on the US economy. We estimate that benefits to producers and consumers totalled $48 billion in 2013, or around one-third of 1% of GDP. Under some assumptions, the climate change impacts have been large, but they do not erase the private gains. More research on this area is still needed. Better data on the impacts to water, air, and seismic activity are also urgently needed. This lack of data means that environmental impacts cannot yet be properly valued, and policymakers are hampered in their ability to target the areas of greatest concern. Moreover, regulatory options are unlikely to be cost-effective when the monitoring of damages is incomplete.

References

Congressional Budget Office (CBO) (2014), “The Economic and Budgetary Effects of Producing Oil and Natural Gas from Shale”.

Hausman, C, and R Kellogg (2015), “Welfare and Distributional Implications of Shale Gas”, NBER Working Paper 21115 and Brookings Panel on Economic Activity, Spring.

Jackson, R B, A Vengosh, J W Carey, R J Davies, T H Darrah, F O'Sullivan, and G Petron (2014), “The Environmental Costs and Benefits of Fracking", Annual Review of Environment and Resources 39: 327-362.

Kilian, L (2014), “The Impact of the Shale Oil Revolution on U.S. Oil and Gasoline Prices", Working Paper.

Mason, C F, L A Muehlenbachs, and S M Olmstead (2014), “The Economics of Shale Gas Development”, Annual Review of Resource Economics, forthcoming.

McJeon, H, J Edmonds, N Bauer, L Clarke, B Fisher, B P Flannery, J Hilaire, V Krey, G Marangoni, R Mi, K Riahi, H Rogner, and M Tavoni (2014), “Limited Impact on Decadal-Scale Climate Change from Increased Use of Natural Gas”, Nature 514: 482-485.

Moore, C W, B Zielinska, G Petron, and R B Jackson (2014), “Air Impacts of Increased Natural Gas Acquisition, Processing, and Use: A Critical Review”, Environmental Science and Technology 48: 8349-8359.

Newell, R G, and D Raimi (2014), “Implications of Shale Gas Development for Climate Change”, Environmental Science and Technology 48: 8360-8368.

Small, M J, P C Stern, E Bomberg, S M Christopherson, B D Goldstein, A L Israel, R B Jackson, A Krupnick, M S Mauter, J Nash, D Warner North, S M Olmstead, A Prakash, B Rabe, N Richardson, S Tierney, T Webler, G Wong-Parodi, and B Zielinska (2014), “Risks and Risk Governance in Unconventional Shale Gas”, Environmental Science and Technology 48: 8289-8297.

Footnotes

1 Source: EIA data.

2 Equilibrium prices are not at the intersection of domestic supply and demand, since they also account for imports and exports. See Hausman and Kellogg (2015) for details.

3 The Henry Hub price is a monthly average of the daily NYMEX spot price. The UK price is a monthly average of the daily National Balancing Point price, and it has been converted from GB pence per therm to dollars per mcf (a thousand cubic feet). Source: EIA for the Henry Hub price; Bloomberg for the UK NBP spot price; World Bank for the Japanese liquid natural gas price.

4 Source: Bloomberg.

5 These bounds are at a social cost of carbon of $40 per tonne.

6 As with the climate change impacts, there are some local benefits from fracking when coal is displaced – natural gas-fired power plants emit less than coal-fired plants.

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Topics:  Energy

Tags:  climate change, manufacturing, fracking

Assistant Professor at the Ford School of Public Policy, University of Michigan

Associate Professor of Economics, University of Michigan

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