David R. Henderson  

Freakonomics on Shale Gas

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Steve Sexton over at Freakonomics has an excellent piece on shale gas. It lays out some basic economics beautifully.

Before I continue, a disclosure: I have invested in a fracking operation in Colorado. I wish I hadn't, but that's another story.

Some key paragraphs:

A suite of technologies has brought vast supplies of previously unrecoverable shale gas within reach of humans, dramatically expanding natural gas reserves in the U.S. and around the world. Horizontal drilling and hydraulic fracturing have produced a fuel that can at once promote a cooler planet and an expanded economy, essentially eliminating the tradeoff between climate change mitigation and the pursuit of other public projects and, perhaps, economic growth. But unlike the iPhone, the productivity gain embodied in shale gas technologies doesn't attract a cult following and its benefits get obscured.

Among some of the most ardent advocates of climate policy, the growth of shale gas extraction is lamented because, in addition to being 30-50% cleaner than coal (even accounting for escaped methane), it is also (gasp) cheaper than coal. And cheaper than wind. And cheaper than solar.

And that means shale gas not only postpones a day when renewables are competitive with fossil fuels, but also increases carbon emissions concomitant with the economic growth spurred by cheap energy. That's why Mother Jones's Kevin Drum recently wrote that the story of shale gas "gets a lot grimmer as you dig deeper."

According to the International Energy Agency, the carbon emissions from expanded production are sufficient to wipe away nearly all the carbon emissions savings from substituting shale gas for coal. But consultancies estimate shale gas alone drives incremental GDP growth through 2020 and annually contributes between $100 billion and $230 billion to the U.S. economy by 2035. So at no cost to our global warming efforts, the average American household enjoys $2,000 higher annual income by 2035 with robust shale gas production. That is decidedly a good thing, right? Like the iPhone 5?

Not to some environmentalists who mistakenly conflate the high prices that induce energy conservation with high costs that reflect input requirements to produce energy. Low energy costs are good because they free resources for other production, including the production of environmental protection. Even if shale gas were only cheaper than coal, its widespread use would be a boon. But because it's also cleaner, it becomes a win-win.

If a $100-200 billion larger economy were deemed unimportant, then policy could drive a wedge between the cost of shale gas production and the price paid by consumers. The difference would constitute a tax yielding revenues to the state with which to either reduce other taxes or undertake additional public projects, like clean energy investments. In other words, government could appropriate for its own uses the resources freed by the substitution of shale gas for coal. Carbon emissions would be lower, energy prices, and, therefore, the private economy would be at worst unchanged, and government would have new wealth with which to carry out policy.


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COMMENTS (16 to date)
Sieben writes:

The environmentalists are going to be really mad if we figure out how to mine methane hydrates.

Mike W writes:

I have invested in a fracking operation in Colorado. I wish I hadn't, but that's another story.

Would love to know why an ardent libertarian "wish I hadn't". Because it is not a good investment....or something else? I hope it's not something else.

Mark Brophy writes:

Real libertarians invest in gold and silver and are glad they did. Why invest in something risky like fracking when you can count on the government to print money and increase the value of precious and industrial metals?

kebko writes:

Ironically, regulatory (and logistical) obstacles to exporting gas keep the price low, and create inefficiencies. If it could trade on the world market, marginal US gas would be used for $12 purposes instead of $3 purposes, and the world would be even better off.

Vangel writes:

Sorry but I have been looking at 10-Ks and listening in to conference calls for years. I have yet to see a primary shale producer that is self financing and cash flow positive. Yes, some good wells in the core areas are very profitable but the average well in the typical formation destroys capital investment. Unless I see some sound financial numbers regarding operations I will remain a skeptic. Sadly, most of what we are given is little more than promotional hype to fool the unsophisticated investors looking for a big score that will allow them to recover the previous losses from the housing and tech booms.

David R. Henderson writes:

@Mike W,
Would love to know why an ardent libertarian "wish I hadn't". Because it is not a good investment....or something else? I hope it's not something else.
Because it wasn't a good investment. Hayek's "local knowledge" strikes again. The general partner did not have it.

Glen Smith writes:

A bad investment is as good a reason for being mad about a given investment but how does not liking an investment you made for another reason have anything to do with being a libertarian?

Jon Mc. writes:

Do you have any recommendations on where to find information on the accelerated deductions of intangible drilling costs allowed by the IRS and its effects on the proliferation of the new technology? I feel like this is an under reported aspect of the Nat Gas story.

Yancey Ward writes:

Mike W,

The fracking revolution has made natural gas so cheap in the US that the investors are having a hard time recovering their costs. A number of gas producers are on the verge of bankruptcy, or are in deep financial stress.

Yancey Ward writes:

I have long had a theory about climate change alarmism and energy production that is only confirmed by today's battle over cheap natural gas. Ten years ago, the climate alarmism community was pushing hard for a switch to be made from coal to natural gas, and I theorize that the reason was the environmentalists expected natural gas to always be more expensive and limited than coal- in other words, it was a way to put a physical cap on energy production.

With gas appearing to be cheaper than coal at present moments and quite abundant (not sure whether or not this trend will actually hold long term), you see the natural counter-reaction to this event- gas is bad, fracking is evil, etc. I also predict that should solar or wind ever become cheaper and abundant than natural gas or coal due to some great breakthrough in technology, you will also see an environmental counterattack against those sources of power. They will suddenly become planet threatening sources of energy. The target, in other words, was never carbon dioxide and warming, but, rather, was increasing energy production itself.

Mike W writes:

@Glen Smith

A bad investment is as good a reason for being mad about a given investment but how does not liking an investment you made for another reason have anything to do with being a libertarian?

Before DRH responded that his reason for "wish[ing] I hadn't" was that it was a bad investment I imagined that he might have had second thoughts due to environmental concerns about the fracking process. If that had been the case my question would have been, "How does the Libertarian philosophy address how the rest of us are to be protected when he chooses to provide capital to an activity that causes environmental pollution (possibly because it cannot earn a sufficient return or cannot raise sufficient capital to mitigate the pollution it causes)?"

James Hamilton has a relate post today at Econbrowser.

I found this (quoting Christopher Knittel) to be funny;

Large-scale adoption of natural gas vehicles requires coordination between vehicle manufacturers, consumers, and refueling stations-- either existing gasoline stations or replacements. This creates a chicken-and- egg problem, or a network externality issue.

That problem existed for the first (gasoline powered) autos too, but markets solved it.

ColoComment writes:

PRS: that chicken/egg problem also existed for the container shipping industry. Container boxes, ships built to hold them, rail cars reconfigured to move them, trucking trailers to carry them farther, bigger cranes to load/unload them, harbors deep enough to float the ships, ports redesigned to move them efficiently, longshoremen's unions convinced that containers were the future, etc., etc., etc. It is a story of an industry that reinvented itself. All by itself.

A marvelous book abut the development of the container shipping industry is The Box, by Marc Levinson.

Mark Bahner writes:
in addition to being 30-50% cleaner than coal (even accounting for escaped methane),

Natural gas is actually many orders of magnitude cleaner than coal for the pollutant that's most important to human health: particulate.

Carbon dioxide and methane are by no reasonable use of the word, "dirty." Particulate is dirty.

Brandon Berg writes:

Why does natural gas produce less carbon dioxide than coal? Aren't all heat engines more or less equivalent? At first I thought that it was just about heating. Obviously there's a lot of waste involved in the coal => heat => electricity => heat conversion as opposed to just burning gas for heat directly. But Drum's post claims that a coal-fired generator produces more carbon dioxide than a gas-fired generator, and I'm not sure what to make of that. Shouldn't burning hydrocarbons to power a generator work pretty much the same regardless of the type of hydrocarbon?

Yancey Ward writes:

Brandon,

The simplest illustration I could give you is that methane(CH4) produces 1 CO2 and 2 H2O molecules on complete combustion. Ethane (C2H6) produces 2 CO2 and 3 H2O molecules. Propane (C3H8) produces 3 CO2 and 4 H2O molecules, and so on. In the limit, coal simply has a far higher ratio of carbon to hydrogen, and can largely be thought of as pure carbon for illustration purposes.

Now, add to this the fact that the oxidation of a H-C-H fragment by O=O and the formation of one C=O bond and 2 H-O bonds is a slightly more enthalpy releasing process than the oxidation of one C-C-C fragment by 1.5(O=O) and the production of 3 C=O fragments, and you get the net result that methane produces more energy for a given amount of CO2 production than does coal.

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