More Boon Than Bane: How the U.S. Reaped the Rewards and Avoided the Costs of the Shale Boom.

Author:Murtazashvili, Ilia
 
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The United States has vast quantities of shale gas, but for decades it was not economically profitable. The economics of shale gas changed in the late 1990s, when drillers working the Barnett Shale in Texas figured out how profitably to extract natural gas from shale. They did so by combining horizontal drilling with hydraulic fracturing, each of which were already standard industry practices. The challenge was that regular water could not be injected at high enough velocities to fracture the shale. One of the keys to the shale revolution was discovering the right chemical mix to make the water slick enough to work in the fracturing process. The combination of these standard techniques and the right chemical mix to treat the water used in the process had consequences similar to a new technology of extraction (Fitzgerald 2013). One of the results of this new process--often called "fracking"--was a dramatic increase in U.S. natural gas production. (1)

The boom was in part a result of the leadership of gas and oil companies. Much credit has been heaped on George Mitchell, whom The Economist called the "Father of Fracking" ("Father" 2013). Mitchell, alert to the opportunities presented by fracking shale gas, invested millions on a part of the Barnett Shale known as the Wildcatter's Graveyard (Zuckerman 2013). His investment eventually paid off as drillers working for his company, Mitchell Energy, unlocked the secret to economically profitable shale gas extraction. (2) The process exemplifies the importance of Kirznerian entrepreneurial vision as well as Schumpeterian creative and destructive forces of technology-driven economic change: the shale boom was a boon for consumers, but for coal producers it was something of a bane as fracked gas cut into coal companies' producer surplus.

Fracking shale gas sharply increased American natural gas production (Bartik et al. 2016). By one estimate, U.S. oil and gas production increased 69 percent from 2005 to 2014, with nearly two-thirds concentrated on farmland, much of which was a direct result of the shale boom (Hitaj, Weber, and Erickson 2018). However, the shale revolution has been accompanied by substantial debate about its consequences as well as divergent political responses to these new opportunities. For example, despite sharing a shale play--a large accumulation of natural gas in a shale basin--Pennsylvania has seen a massive increase in shale production beginning around 2007-8, whereas New York has yet to see any production because the state adopted a moratorium in 2009 that remains in place today.

The first section of our paper takes up these debates about the consequences of the shale revolution. We review the economics literature on the shale boom, including studies of the effects on prices, employment in the mining and nonmining sectors, and economic externalities, including the consequences for public health and the environment.

Our reading of the literature is that the shale boom produced substantial benefits, among which are lower energy prices, billions in royalty payments to mineral-rights owners, higher employment in the mining sector, and, according to several accounts, positive employment effects in the nonmining sectors. We also address the existing literature on the external costs of shale gas production. Although these costs are significant, and it may be several decades before we can assess the long-run consequences of the shale boom, the benefits appear to substantially exceed the costs. Our provisional conclusion is that the "shale era"--almost twenty years of shale gas development--has been more boon than bane.

In the second section, the paper argues that it is necessary to consider fracking from a political economy perspective to understand the key features of the shale boom, including why the benefits appear to exceed the costs. Several schools of thought provide insight into the performance of political-economic systems, including institutional economics, Austrian economics, the Bloomington School of institutional analysis, and public choice (Boettke and Leeson 2015). Recent work suggests that these schools of thought, despite many differences, remain complementary (Boettke and Lopez 2002; Leeson and Subrick 2006).

The U.S. shale boom illustrates the complementarity of these political economy perspectives. Austrian economics, with its understanding of entrepreneurial leadership and vision as well as of creative destruction as a result of technological change, provides insight into the origin and consequences of tracking technology. Economic institutions, especially the robust system of private-property rights to minerals, provided powerful incentives for owners to contract with gas companies. Another defining feature of the U.S. institutional context is polycentrism, which we argue encouraged regulatory experimentation in an environment characterized by uncertainty about how to best regulate shale gas. We conclude with some considerations about the role of politics in the shale boom.

The Consequences of the Shale Boom

It is useful to divide the consequences of the shale boom into fracking growth and tracking externalities. Fracking growth includes the effects of shale gas development on prices, royalty payments, and employment in the mining and nonmining sectors. Fracking externalities include the social costs of shale gas development that are not typically included in the analysis of fracking growth. Together, the extent of tracking growth and the extent of fracking externalities determine whether shale gas development is a boon or bane.

Fracking Growth

One of the effects of the shale gas revolution has been a substantial reduction in the price of energy. Catherine Hausman and Ryan Kellogg (2015) found that the U.S. shale boom reduced prices for natural gas and that the cost reductions were passed through to consumers. For the period 2007 to 2013, consumer surplus increased by about $74 billion a year because of declining prices, although producer surplus fell: once wells are drilled, they have low marginal operating costs and are rarely idled, which in this period resulted in revenue to producers declining by about $30 billion a year. These declines were partially offset by spudding--the drilling of new wells, or spuds, to extract gas--which increased producer surplus by about $4 billion a year over this period. As a consequence, the total welfare gain during this period was $48 billion annually, which is sizable given retail spending on natural gas was around $160 billion in 2013. For the economy as a whole, the change was about one-third of one percent of gross domestic product, or about $150 per capita. The study does not consider explicitly the losses of surpluses from other energy producers due to the reduced price of tracked gas and oil that would subtract from these benefits, although Hausman and Kellogg consider the environmental costs of shale gas development (which we consider later in our discussion of externalities).

The benefits of the shale boom also include royalty payments. In shale-producing counties in the United States, between one-third and two-thirds of the mineral rights are privately owned (Collins and Nkansah 2015). Gas companies must lease these mineral rights prior to tracking. A standard oil-and-gas lease specifies three terms: the length of the contract, the bonus, and royalties. Owners usually receive bonuses independent of well production, whereas the royalty depends on the latter. (3)

The available evidence suggests that these royalty payments generate large benefits to local and regional economies. According to James Feyrer, Erin Mansur, and Bruce Sacerdote (2017), each million dollars of new oil and gas extracted produced $80,000 in wage income, $132,000 in royalty payments and business incomes, and 0.85 jobs to the local economy. Within the region, these economic impacts are around three times larger. From 2005 to 2012, shale gas development in the United States resulted in 640,000 jobs, which they estimate reduced the rate of unemployment by about 0.42 percent during the Great Recession. Jason Brown, Timothy Fitzgerald, and Jeremy G. Weber (2016) found that in 2014 the six major U.S. shale plays generated a total of $39 billion in royalties. Despite these substantial benefits, the leasing process is not necessarily efficient. Katie Jo Black, Shawn McCoy, and Jeremy G. Weber (2018) found that the main source of royalty payments is a quantity effect from more leases signed with shale gas production rather than better lease deals for owners as the price of shale increases, and Ashley Vissing (2015) finds that the leasing process may be biased against women and minorities. One of the reasons for these inefficiencies is asymmetric information that benefits the landmen (4) and ultimately confers advantages on gas companies. (5) Yet even with these inefficiencies and distributional concerns, there appear to be large economic benefits for the owners of mineral rights.

The economics literature also considers the extent to which shale production has resulted in a "resource curse." Economists seek to understand how resource dependence, which is usually measured by resource production or revenues as a share of total output, affects long-run rates of economic growth, employment in the resource and nonresource sectors, and poverty rates. (6) The potentially harmful relationship between resource dependence and these outcomes is what economists mean by the "resource curse." The effect on the nonextractive sector is often called the "Dutch Disease."

A robust literature considers the extent of a resource curse in the U.S. economy. Using data from the Americans states, Elissaios Papyrakis and Reyer Gerlagh (2007) find that natural resource wealth reduces economic growth by decreasing investment, schooling, openness to immigration, and research-and-development expenditures. Ellis Goldberg, Erik Wibbels, and...

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