Shale Gas: Is Its Time Finally Here?

 
To get some more insights about how people view future regulations and the future of natural gas I asked a panel of 20 industry experts and academics two questions.The survey results indicate that most of the panelists believe that industry participants are the best positioned to assess the risks associated with the development of shale gas, and that they will make the appropriate choices if they are forced to bear the costs associated with any environmental damage. [60% of the participants chose c) for the first question.] In addition, most of the panelists see a plentiful supply of natural gas in the coming years and very little chance of a substantial increase in price. (65% of the respondents selected a) or b) for the second question.) Take the 2-question survey.
 

There is almost no question that natural gas will play an important role in the U.S. energy future. With the almost continual upward revision of reserves from shale gas, there is sufficient supply to replace some coal burning power plants with cleaner burning natural gas power plants, and perhaps, use natural gas as a transportation fuel, either directly or indirectly with electric vehicles. 

Professor David Spence,the UT McCombs expert on energy policy, provides his insights onthe future of shale gas in a recent energy brief.  I follow up on his findings with a few questions; if you have any further questions, please comment.

Q. We have seen how BP’s Deepwater Horizon disaster has affected the business of every offshore oil producer in the United States. Is there a comparable scenario for shale gas, one in which a single bad actor may poison the well (no pun intended) for other producers?

A. Certainly this is a politically delicate time for hydraulic fracturing, particularly in the Marcellus Shale, where there is a great deal of popular trepidation about fracking and its risks.  The movie Gasland, a documentary being broadcast on HBO right now, portrays fracking as an inherently dangerous activity.  There has already been an apparent spill near the towns of Dimock and Damascus, in Pennsylvania, one that is reputed to have affected drinking water wells.  Presumably, whatever contamination occurred there was the product of surface activities (spilled fracking fluids or produced water from the well) rather than of the fracturing process itself.  However, it is certainly theoretically possible that are poorly designed or constructed well could leak gas or fracking fluids or produced water into a drinking water aquifer through which the well passes. It only takes one mistake to provoke fear, and the average voter will not care about distinctions between contamination caused by surface spills and contamination caused by the fracturing process. Voters may think that if it can happen there, it can happen here, irrespective of the overall safety record of the industry. We saw this with nuclear power in the 1970s and 80s.

On the other hand, it seems unlikely that fracking could ever produce an enormous disaster of the Deepwater Horizon variety. Each fracturing operation affects a relatively small area, by definition. The rock is fractured in order to free up gas within a confined space, as contrasted with the blowout of BP’s Maconda well, which allowed oil to spew into the Gulf uncontained.   Nevertheless, the industry's regulatory exemptions and the desire of contractors to withhold information about the composition of fracking fluids feed fears about the risks, and play into the hands of fracking's opponents.

Q. Then why don't the companies embrace some sort of self-regulation or moderate regulation?

A. Part of the problem is that gas producers and their contractors are divided on the disclosure issue. I suspect that most gas producers, certainly the big oil and gas companies, would just as soon adopt a policy of full disclosure about the composition of fracking fluids.  It is their contractors, who consider the exact composition of their fracking fluids to be their intellectual property and part of the value they bring to the industry, who oppose disclosure. Oil and gas companies recognize, however, that this position is jeopardizing the availability of shale gas as a resource in some places. At some point in time, one suspects that oil and gas companies will exert some leverage over their contractors on this issue.

As for the industry's opposition to the remainder of the FRAC Act, presumably the industry fears prohibitions or severe restrictions on hydraulic fracturing if the process becomes regulated under the Safe Drinking Water Act.  However, as states in the Northeast begin to exert regulatory jurisdiction over hydraulic fracturing, the issue of federal regulation may become moot.  Indeed, we may eventually find oil and gas companies seeking federal regulation so as to preempt more stringent state regulation.

Q. I understand the need for regulation when there is a potential for environmental damage.  However, I generally like to find free market solutions when it is possible.  In this particular case, would it be possible to have the drillers post a bond or show that they have adequate insurance to cover potential liabilities before drilling.  If the drillers are compelled to cover all potential damages, and have the financial wherewithal to do so, is there a problem?

A. Your proposal is an approach we use in other contexts, such as hazardous waste treatment, storage and disposal facilities, and surface mining operations.  The Resource Conservation and Recovery Act requires hazardous waste facilities to post a bond (or other financial assurance) in order to secure the permission they need to operate; this is to ensure that there will be resources available for cleanup in the event of a spill.  Similarly, the Surface Mining Control and Reclamation Act requires strip mining operations to post a bond to ensure that the mining site will be reclaimed (revegetated, and contamination and other damaged remedied) upon closure of the mine.  This is a barrier to entry for undercapitalized or unprofessional firms, by design. 

Both of these financial assurance requirements, however, are supplemented by additional regulations and standards governing how the job is done – such as technical standards governing hazardous waste landfills and incinerators, and environmental standards of performance for surface mining regulations. NGOs, neighbors and others concerned about environmental and health risks might see ex post liability as an insufficient deterrent to bad behavior. They may worry that compensation will be inadequate because (i) they don’t see money damages as adequate compensation for damage to their, or their children’s, health (which they might fear from hydraulic fracturing), and/or (ii) they otherwise suspect that they will be undercompensated for property-related damages. (For example, they may worry that in the event their wells are contaminated, they will be compensated for reduction in fair market value, which may miss or underestimate their actual out-of-pocket costs or loss of use damages.)  For all of these reasons, neighbors may tend to favor the application of ex ante standards, through permit requirements, in addition to financial assurance requirements.  

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

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Faculty in this Article

David Spence

Professor, Business, Government & Society

Professor Spence's research and teaching focus on business-government relations with emphasis on energy and environmental regulation. He received his...

David Spence teaches in the Texas Executive Education program, featuring open enrollment, custom and certificate classes for executives and organization teams.

About The Author

Sheridan Titman

Walter W. McAllister Centennial Chair in Financial Services, McCombs School of Business

Sheridan Titman is a professor of finance at The University of Texas at Austin and a research associate of the National Bureau of Economic...

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