Academic journal article Brookings Papers on Economic Activity

Welfare and Distributional Implications of Shale Gas

Academic journal article Brookings Papers on Economic Activity

Welfare and Distributional Implications of Shale Gas

Article excerpt

ABSTRACT Technological innovations in horizontal drilling and hydraulic fracturing have enabled tremendous amounts of natural gas to be extracted profitably from underground shale formations that were long thought to be uneconomical. In this paper, we provide the first estimates of broad-scale welfare and distributional implications of this supply boom. We provide new estimates of supply and demand elasticities, which we use to estimate the drop in natural gas prices that is attributable to the supply expansion. We find large, positive welfare impacts for four broad sectors of gas consumption (residential, commercial, industrial, and electric power) and a negative impact for producers, with variation across regions. We then examine the evidence for a gas-led "manufacturing renaissance" and for pass-through to prices of products such as retail natural gas, retail electricity, and commodity chemicals. We conclude with a discussion of environmental externalities from unconventional natural gas, including limitations of the current regulatory environment. Overall, we find that between 2007 and 2013 the shale gas revolution led to an increase in welfare for natural gas consumers and producers of $48 billion per year, but more data are needed on the extent and valuation of the environmental impacts of shale gas production.

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Following a decade of essentially no growth, natural gas production in the United States grew by more than 25 percent from 2007 to 2013. This supply boom, amounting to an increase of 5.5 trillion cubic feet a year, was driven by technological innovations in extraction. In particular, advances in horizontal drilling and hydraulic fracturing, or "fracking," have enabled natural gas to be extracted profitably from underground shale formations that were long thought to be non-economic. Figure 1 shows this increase in total natural gas production as well as the change in production from unconventional shale gas reservoirs. The increase in shale extraction began in the late 2000s, accelerated in 2010, and amounted to more than one trillion cubic feet a month by late 2013. As a result of this sustained growth in extraction, natural gas prices have fallen substantially in the United States. Figure 1 plots the real (1) U.S. price of natural gas since 1997. (2) While prices averaged $6.81 per thousand cubic feet (mcf) (in 2013 dollars) from 2000 to 2010, prices since 2011 have averaged $3.65 per mcf.

In this paper, we estimate the broad implications of this boom in unconventional natural gas for U.S. welfare. We examine the effects on natural gas purchasers and producers, paying particular attention to how benefits and costs are allocated across sectors and across space. We also discuss the potential environmental impacts associated with fracking and how regulations might mitigate these externalities.

We begin in section I by providing background on natural gas markets, including the related literature on fracking. We then provide new estimates of supply and demand elasticities. In section II, we use our estimated supply and demand functions to calculate the portion of the drop in natural gas prices that is attributable to the supply expansion, as opposed to contemporaneous changes in the U.S. economy such as the recession and recovery. For the period 2007-13, we estimate that the boom in U.S. natural gas production reduced gas prices by $3.45 per mcf.

We evaluate the impact of the supply shift and corresponding price change for consumers and producers in section III. There we show that consumer surplus increased by about $74 billion a year from 2007 to 2013 because of the price fall. In contrast, producer surplus fell: wells, once they are drilled and producing, have very low marginal operating costs and are rarely idled. Thus, from 2007 to 2013, revenue accruing to producers of existing wells declined by $30 billion a year owing to the price decrease. This loss was only partially offset by the gains associated with new wells, which totaled $4 billion a year over this period. …

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