Fracking: The Economic and Budgetary Effects of Producing Oil and Natural Gas From Shale

December 9th, 2014
in econ_news, syndication

from the Congressional Budget Office

Recent advances in combining two drilling techniques, hydraulic fracturing and horizontal drilling, have allowed access to large deposits of shale resources—that is, crude oil and natural gas trapped in shale and certain other dense rock formations. As a result, the cost of that "tight oil" and "shale gas" has become competitive with the cost of oil and gas extracted from other sources. Virtually nonexistent a decade ago, the development of shale resources has boomed in the United States, producing about 3.5 million barrels of tight oil per day and about 9.5 trillion cubic feet (Tcf) of shale gas per year.

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Those amounts equal about 30 percent of U.S. production of liquid fuels (which include crude oil, biofuels, and natural gas liquids) and 40 percent of U.S. production of natural gas. Shale development has also affected the federal budget, chiefly by increasing tax revenues.

The production of tight oil and shale gas will continue to grow over the next 10 years—by about 30 percent and about 60 percent, respectively, according to a recent projection by the Energy Information Administration (EIA). Another EIA estimate shows that the amount of tight oil and shale gas in the United States that could be extracted with today’s technology would satisfy domestic oil consumption at current rates for approximately 8 years and domestic gas consumption for 25.

How Will Shale Development Affect Energy Markets?

Total domestic production of oil and natural gas will continue to be higher than it would have been without shale development, reducing the prices of those energy supplies. The lower prices, in turn, will increase domestic consumption of oil and gas, domestic consumption of energy overall, and net exports of gas, while decreasing the production of oil and gas from conventional resources, net imports of oil, and the use of competing fuels.

Shale gas has affected energy prices in the United States more strongly than tight oil has, and it will continue to do so. Indeed, CBO estimates that if shale gas did not exist, the price of natural gas would be about 70 percent higher than currently projected by 2040—whereas if tight oil did not exist, the price of oil would be only about 5 percent higher. One reason for the difference is that shale gas is more plentiful than tight oil, relative to the size of their domestic markets. Another is that the North American market for natural gas is relatively insulated from conditions elsewhere by high transportation costs, so the effects of higher or lower domestic production on market prices are concentrated within the continent; oil, by contrast, is heavily traded in a worldwide market that diffuses the effects of domestic production on prices. (Oil prices are thus influenced by events that occur elsewhere in the world. For example, the recent sharp drop in crude oil prices—as of the end of November 2014, they had dropped about one-third from their recent peak in June—was caused not by any sudden or dramatic increase in the supply of tight oil during that period but by other factors, such as a rapid increase in Libyan production and a slowdown of consumption in Europe and Asia.)

EIA’s projections of the development of shale resources are the most detailed currently available, and CBO considers them an appropriate basis for estimating the potential economic and budgetary effects of shale development. Nonetheless, like all projections of the future, they are subject to significant uncertainty. Many factors contribute to the uncertainty; for example, the abundance of shale resources, the fraction of those resources that will be recoverable with evolving technology, and the costs of recovering that fraction are not known for certain. Projections of more or less shale development would lead to larger or smaller estimates of the economic and budgetary effects.

How Will Shale Development Affect Economic Output?

The technological innovations behind hydraulic fracturing and horizontal drilling make existing labor and capital—whether they are employed in shale development, in industries using natural gas or oil, or in industries using products derived from natural gas or oil—more productive than they otherwise would be. That heightened productivity has increased gross domestic product (GDP) and will continue to do so.

Shale development also boosts GDP in other ways. The increase in GDP just described represents increased income, which allows people and firms to save and invest more in productive capital, and the higher productivity just described increases wages, raising the amount of labor available. Both the increased capital and the increased labor raise GDP. In addition, in the near term, shale development causes labor and capital to be used that would otherwise be idle, again raising GDP. In the longer term, however, whether shale resources are available or not, the labor and capital available in the economy will be used at roughly their maximum sustainable rates, so the additional labor and capital used to produce shale resources or energy-intensive goods will mostly be drawn away from the production of other goods and services. As a result, there will be no net change in GDP through that last route, although GDP will continue to be increased by shale development in the other ways just described.

On net, CBO estimates that real (inflation-adjusted) GDP will be about two-thirds of 1 percent higher in 2020 and about 1 percent higher in 2040 than it would have been without the development of shale resources. The actual effect on GDP could be higher or lower than that estimate, depending on the uncertain factors noted above—the abundance of shale resources, the fraction of those resources that will be recoverable, and the cost of developing that fraction—as well as on other considerations.

How Will Shale Development Affect the Federal Budget?

The increase in GDP resulting from shale development has increased federal tax revenues, and it will continue to do so. That increase will be slightly larger than the GDP increase in percentage terms, CBO expects. Specifically, CBO estimates that federal tax revenues will be about three-quarters of 1 percent (or about $35 billion) higher in 2020 and about 1 percent higher in 2040 than they would have been without shale development.

Shale production also contributes to federal receipts through payments that the developers of federally owned resources make to the government—but that contribution has been modest and will continue to be, because most shale resources are not on federal land. Working from EIA’s projections of the future production of tight oil and shale gas, and also from its own forecasts of oil and natural gas prices, CBO estimates that federal royalties from shale (minus the amounts that the federal government transfers to the states) will be about $300 million annually by 2020.

What Policy Options Would Affect Shale Development?

There are a number of ways that the Congress could affect shale development and thus affect the oil and gas markets, economic output, and the federal budget. This report considers options that would change export policies—easing the current ban on exports of crude oil, repealing it, or changing the government’s criteria for judging applications to export liquefied natural gas (LNG)—and concludes that the options would probably increase domestic production but have little effect on prices. That increase in production would probably make GDP and federal revenues slightly higher than they would be under current export policies.

Policy choices related to environmental regulation, such as whether the federal government should regulate further the environmental effects of shale development or leave such decisions to the states, are outlined in Appendix A. The Congress could also affect shale development through policies not considered here, such as those related to the infrastructure used to transport and process domestic shale gas and tight oil.

[read the entire report by clicking on image below]

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