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Does natural gas and its unconventional production method benefit US commerce?

Prepared for

Professor Scott E. Atkinson

Economics 5900

Fall 2017

Prepared by

Dhruvin Patel

dhruvin@uga.edu

12.04.2017

Economics of Fracking for Gas 1

Abstract This research paper shines light on the economic benefits of modern hydraulic fracturing of unconventional hydrocarbon resources for the extraction of oil and natural gas in the United States. Data compilation shows “fracking boom” resulted from an efficient supply of natural gas and a simultaneous demand for the gas. The paper analyzes the gas market to show that increase in the supply of natural gas results in increase in the growth of US economy.

Economics of Fracking for Gas 2 Does natural gas and its production method benefit the US economy?

Introduction

Natural gas burns cleaner than oil and coal due to its low carbon content. As a result, governments world-wide support its use as a substitute of coal in power generation. Countries have seen natural gas as a valuable energy source to meet their environmental targets. Technological advances have increased efficiency in the extraction of both oil and gas using hydraulic fracturing. The abundance of supply of gas together with the demand for cheap gas has created a fracking boom in the nation during the Great Depression. However, there are many environmental and health repercussions of extracting and using natural gas for our energy needs. My research involves understanding whether there are substantial economic benefits of using natural gas. The paper uses research done by others in the field of fracking and its impact on employment. Then we look at another study that shows that the supply of natural gas impacts US economy. Further research from reputed media sites shows that US will be a leading producer and exporter of natural gas in the coming years. Using literature review as a reference, I will analyze how growing supply and demand will benefit US commerce as a whole and how government should help with the supply of gas to boost economic growth.

Conventional method of extracting hydrocarbons use vertical drilling to access shale with large pores from which oil and gas to flow out easily. However, oil and gas trapped in the smaller pores of shale is inaccessible with vertical wells. The new technology of hydraulic fracking fractures the shale layer horizontally underground with pressure from a mixture of water, sand and chemicals to break the shale rocks underground. Technology now allows fracking directionally from a site up to 5 miles (8 km) away from the target area. (Petroleum)

This horizontal drilling technique allows wells to tap into shale rocks inaccessible from vertical

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drilling techniques. The efficiency in the production of gas and oil increased the number of fracking wells from 23000 to 300000 between 2000 and 2016. During that time frame, oil output from fracking wells dramatically increased 102,000 barrels per day to 4.3 million barrels a day. (Eagan 201) On average, each well increased its production by 223.19% between 2000 to 2016.

With the help of the literature, I will help understand the drastic growth in natural gas supply.

Literature Review

The study uses research done by Peter Manilor and Ralph Mastromonaco in 2017 to support the benefits of hydraulic fracking on employment. The results from Manilor (2017) show positive effects of new fracking technology goes beyond the mining sector. He finds that counties with shale development had 11% higher income, but the so called “boom” counties (referred to as well growth of top 25% among counties with non-zero change in the number of wells) incomes increase even higher to 29%. The findings of income growth went beyond mining, as incomes were found to increasing at 5% in retail and hotel businesses, 8% in construction and 11% in transportation. This suggests that hydraulic fracturing boom had the incomes trickle into other sectors of local economies studied in the research. The study compares a national database of oil and natural gas production with county level employment and income to find the relation between the two. Manilor also finds that counties with at least one well drilled before 2011 experienced 10.8% rise in income, whereas boom counties experienced 28.6% rise in income. This shows that using fracking for production of natural gas indeed has a greater effect on income than conventional methods of extraction. Moreover, the “boom” counties experienced a 38% rise in job growth from 3005 to 2011. To counter the evidence of resource curse in the fracking of shale, Manilor argues that low income counties with shale development are prominent because counties, with high education, ban fracking fearing environmental

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repercussions. Moreover, the study doesn’t find any evidence of incomes increasing in the tradable manufacturing sector suggesting that there was no increase in the input cost for manufacturing firms. Therefore, fracking doesn’t cause resource curse where the resource extracting industry damages long-run economic prospects by putting local manufacturers at competitive disadvantage Manilor’s study took some bias into consideration and made necessary adjustments in his model. Due to the geographical location of shale rock, drilling is often conducted in concentrated regions. This may lead to an overestimation of growth in a well county adjacent to another well county. The drilling in the adjacent county will show in the growth results of particular well county. To remove this endogeneity, a count was created for number of neighbor shale wells for each county and year. Then, this “neighbor shale well” number is added to the regression to adjust for its impact on the employment and income. Now that we have looked into research about economic impacts of fracking, I will show how natural gas supply helps US economy. Vipin Arora and Josef Lieskovsky work use VAR model and related sensitivity analysis to conclude that natural gas supply changes are the primary means through which natural gas market impacts domestic economic activity. However, natural gas demand for heating homes and generating electricity does not have a substantial economic impact. Arora finds such conclusions by conducting supply and demand shocks to the model. The study uses annual data to remove seasonal effect on variables. The demand for gas is analyzed by two different variables. One variable encompasses demand for use in the production of goods and service, and the other variable represents the demand for heating and power. The supply variable represents the marketed gas instead of total gas produced, because some of it may be used for extraction processes. Using these variables, it is found that demand shocks show effects on productivity that

Economics of Fracking for Gas 5 are statistically insignificant. On the other hand, a positive supply shock supports a lower natural

gas price which leads to a rise in investment by firms that use natural gas as an input. Arora finds that supply shocks cause a more influence on industrial production after 2008 than before. Arora concludes that shale gas revolution has brought a significant relationship between natural gas supply and US economic activity.

Data

Fracking has helped American economy with increased incomes, more jobs and an abundance of natural gas. The abundance of shale gas has reduced the price of natural gas to around $2 per million BTU from $15 per million BTU in 2005. (Team 2016) The increase in the supply of natural gas has allowed for a cheaper input for U.S. production firms. U.S. steel can use natural gas in some stages of steel production by cutting use of expensive coking coal by 10%. (Team 2016) Not only does cheaper gas allow for the production of cheaper steel, but it reduced input costs for heating homes. Gas bills have dropped $13 billion per year from 2007 to 2013 as a result of increased fracking, a $200 per year saving for gas consuming households. (Brooking 2015) Overall, natural gas market have gone through a supply shock that has increased consumer and producer surplus in our economy. Fracking industry has blunted the impact of financial crisis on Americans. Between 2005 and 2012, fracking has employed 725,000 jobs reducing unemployment by 0.5%. (Reuters 2015) Fracking industry’s technological advancement has allowed firms to cut their cost of development. Improving production efficiency has resulted in a 40 percent reduction in the cost of production for U.S. drill operators in just 2 years. (Energy in Depth 2016) We also observe the fracking preference of natural gas producers in the graph below.

Economics of Fracking for Gas 6

Economics of Fracking for Gas 6 According to Energy Information Administration, fracking now accounts for 67

According to Energy Information Administration, fracking now accounts for 67 percent of marketed gas output, up from less than 7 percent in 2000. The efficiency that comes with fracking for natural gas production reduces cost and number of wells drilled, which results in higher incomes and more jobs respectively. Each $1 million invested in its production results in wage increases of $243000 and 2.49 jobs. (Feyrer, 4) With such substantial gains, I found that fracking industry added value to the U.S. GDP by $284 billion, and it is estimated to grow to $533 billion by 2025. (The American Petroleum Institute, 2017) This growth will only be supported under the current prices and uninterrupted supply due to possible regulations. However, the glut in natural gas supply has resulted in a historic low price for itself. Natural gas at its low price have benefits for consumers, but no so much for the government revenues and company profits. Pennsylvania's fifth-largest shale gas producer reported net income of $5.6 million, during the first quarter 2016, down from $173.4 million, a year ago. (Shonti, 2016) Texas state, the leading producer of oil and natural gas, saw a decline in tax revenue of 40% from $583 million in August 2014 to $352 million in January 2015. (Krohn, 2015) Lower corporate profits tend to show a decline in investments and growth. Although production levels keep rising over this period, it is vital for a price increase for the firms and government to have a positive balance sheet.

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Even with low price of natural gas, production from the Marcellus, one of the world’s largest fields, is projected to increase by 45% between 2016 and 2022, as efficiency in extracting gas keeps improving. (International Energy Agency, 2017) However, demand for natural gas seems relatively small with only 2% growth in its share for U.S. energy consumption. (The American Petroleum Institute, 2017) The extra energy must be sold in external markets to prevent further gas glut and price reduction. If the United States export gas to foreign countries

then gas producing firm can make higher profits. $5-6 per MMBtu of natural gas can sell for $10-12 per MMBtu in European market and for $15-17 per MMBtu in Asian market. (Fullenbaum, 2013) United States can use this competitive advantage for the benefit of its economy.

Analysis Using the Cobb-Douglas production function, I begin my analysis of the benefits of fracking and natural gas on the U.S. economy. Q (L, K) = A L β K α

Let’s assume that a certain level of capital (K) and Labor (L), before the fracking boom, would produce a certain quantity (Q). As we increase the capital it requires less labor to produce the same output. In the case of fracking, an increase in K is positively correlated to its power “α.” This means that an increase in the use of fracking with its new technology, output showed a rapid increase. To sustain the capital use, firms required more labor. Every additional labor added great deal or output, which reflects on the number of jobs created in the fracking industry and the amount of gas produced. Increased in output of natural gas caused its price level to drop substantially post financial crisis of 2007-08.

Economics of Fracking for Gas 8

Lower prices of natural gas increase the disposable income of consumers and firms. This culminates into cheaper input cost in the production of goods and services. In the short run, price stickiness can result in higher profits for firms and in the long run the price level falls resulting in a higher consumer surplus. Higher firm profits can result into additional hiring capital investment, higher dividends and savings. Rise in the disposable income results in lower savings and higher spending. Both these phenomenon help increase US GDP. The stagnant and abundant supply of natural gas at lower production costs allows us to fairly assume that lower gas prices permanently increase GDP potential for the US economy. For the same or lower cost price of production firms involved in fracking helped increase manufacturing efficiency to help the economy out of depression. With an increase in GDP potential, interest rates fall which sparks a rise investment and consumption of goods and services. These economic phenomena are crucial helping an economy come out of recession. In the long run, this growth leads to a drop in the price levels in the economy allowing consumption to rise in the United States. Prolonged low-price levels can be bad for the economy, as government cannot earn a high enough tax revenue over cheap goods and services. A government intervention that can increase the price levels will help reduce the budget deficit and government debt. However, an increase in the prices would possibly slow down the growth in the demand for natural gas. Arora’s research shows that changes in the demand for natural gas had negligible effect on the US productivity, therefore, we can ignore the impact on domestic demand for natural gas for an increase in its price level. To further support my analysis, world price of natural gas is way

Economics of Fracking for Gas 9

higher than its domestic price in the US. If the natural gas is allowed to be exported then it will fetch more price in international markets, and its price will also increase in the domestic market. Rise in the domestic market will keep production of natural gas rising as projected. With more supply of gas comes higher incomes, more jobs and greater growth in productivity. In addition, supplying gas to foreign markets will reduce out trade deficit. Lower trade deficits result in higher interest rates. Increase in the interest rates shift the money supply to the left, increasing price levels across the economy. At higher prices, government can earn more revenues to pay off debt or fund public programs.

Policy Recommendation

Supporting natural gas infrastructure helps with natural gas supply efficiency that drives

more production of fracking wells. There are a few policy recommendations that together will prevent the price of natural gas from falling and indirectly increase government revenues and greater investments by profit bearing firms.

(i)

A Fed monetary policy to increase reserve rates to reduce the supply of money,

(ii)

thereby increasing the price level. Freeing up export of LNG to international markets which will increase the price

(iii)

of natural gas, thereby increasing government revenues and corporate profits. Tax credit on investment related to commerce related to fracking industry can also

(iv)

boost economic growth as corporate profits will need to be used somewhere, either savings or investments. Government funded extended pipelines across United States to facilitate the supply of natural gas from fracking concentration of Marcellus, Newark East, etc.

Economics of Fracking for Gas 10

Conclusion

The United States must help support the abundance of natural gas supply with a reliable pipeline infrastructure across its domestic markets. Supplying gas to power plants for cheaper and cleaner electricity is crucial to increase consumer surplus and long term health benefits that the Americans deserve. The infrastructure will boost more production of natural gas and its use in the domestic market bringing more and better jobs. Being the leading producer of natural gas in the coming years, United States needs to seize the opportunity to legalize export of liquefied natural gas to grow the economy, reduce trade deficit, increase government revenue and keep the social surplus at its optimum level. Now is the time for policymakers to continue to embrace natural gas and the opportunities it provides.

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References

Arora V, Lieskovsky J. Natural Gas and U.S. Economic Activity. Energy Journal [serial online]. July 2014;35(3):167. Available from: Advanced Placement Source, Ipswich, MA. Accessed December 1, 2017

Conti, David. "Profit down at EQT on low gas prices." TribLIVE.com. April 28, 2016. Accessed December 1, 2017. http://triblive.com/business/headlines/10377974-74/million-eqt-production.

Eagan, Matt. "Oil milestone: Fracking fuels half of U.S. output." CNNMoney. March 24, 2016. Accessed December 04, 2017. http://money.cnn.com/2016/03/24/investing/fracking-shale-oil- boom/index.html

Energy In Depth. July 15, 2016. Accessed December 1, 2017.

https://www.energyindepth.org/national/efficiencies-reducing-fracking-cost-shale-thrive-amid-

low-prices/.

Feyrer, James, Erin Mansur, and Bruce Sacerdote. "Local economy impact of fracking." Local economy impact of fracking | VOX, CEPR's Policy Portal. November 16, 2015. Accessed December 1, 2017. http://voxeu.org/article/local-economy-impact-fracking.

Fullenbaum, R. (2017). America’s New Energy Future: The Unconventional Oil and Gas Revolution and the US Economy. [online] Api.org. Available at:

http://www.api.org/~/media/Files/Policy/American-

Energy/Americas_New_Energy_Future_Mfg_Renaissance_Main_Report_4Sept13.pdf

[Accessed 15 Dec. 2017].

"IEA sees global gas demand rising to 2022 as US drives market transformation." International Energy Agency. July 13, 2017. Accessed December 1, 2017.

https://www.iea.org/newsroom/news/2017/july/iea-sees-global-gas-demand-rising-to-2022-as-

us-drives-market-transformation.html.

Krohn, John, and Robert McManmon. "U.S. Energy Information Administration - EIA - Independent Statistics and Analysis." Oil price decline leads to lower tax revenues in top oil- producing states - Today in Energy - U.S. Energy Information Administration (EIA). March 12, 2015. Accessed December 1, 2017. https://www.eia.gov/todayinenergy/detail.php?id=20332.

Maniloff, Peter, and Ralph Mastromonaco. 2017. "The local employment impacts of fracking: A national study." Resource & Energy Economics 49, 62-85. Business Source Complete, EBSCOhost (accessed December 4, 2017).

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"Petroleum - Oil and Natural Gas | energy4me." Energy4me Petroleum Oil and Natural Gas Comments. Accessed December 05, 2017. http://energy4me.org/all-about-energy/what-is- energy/energy-sources/petroleum/. Reuters. "U.S. fracking boom added 725,000 jobs -study." Reuters. November 06, 2015. Accessed December 1, 2017. https://www.reuters.com/article/usa-fracking-employment-study/u-

s-fracking-boom-added-725000-jobs-study-idUSL8N13159X20151106.

Team, Trefis. "U.S. Steel Looks To Natural Gas To Offset High Input Costs." Forbes. March 21, 2012. Accessed December 10, 2017.

https://www.forbes.com/sites/greatspeculations/2012/03/21/u-s-steel-looks-to-natural-gas-to-

offset-high-input-costs/#4eca42616924.

The American Petroleum Institute. "Natural Gas | America’s Abundant, Clean Energy." Natural Gas. 2017. Accessed December 1, 2017. http://energytomorrow.org/american-energy/natural- gas.