Frackonomics: Why the Economics of the Gas Boom Doesn't Add Up
Between 1868 and 1969, Cleveland’s Cuyahoga river caught fire at least ten times, including one blaze that reached the Standard Oil refinery where storage tanks detonated. Ultimately, the seemingly impossible and unnatural phenomenon of burning water came to represent the dangers of unregulated industrial development and generated popular support for the environmental laws of the 1970s, including the Clean Water Act and the Safe Drinking Water Act.
Today the unsettling sight of burning water has returned, from a new industry that is exempt from both these laws. In homes near installations using the drilling technique known as hydraulic fracturing, or “fracking,” the tap water has been known to ignite with the touch of a lighter. The industry is relatively new, so the scientific literature yields only tentative results and provisional research conclusions. But the early research suggests fracking has serious negative consequences for public health and local ecology, from flaming tap water to toxic chemicals to ground tremors. Industry spokesmen insist that the negative side-effects of fracking are insignificant. But there’s one positive side-effect everyone should be able to agree upon: fracking is an ideal vehicle for explaining key economic concepts of market failure and market power, including externalities, asymmetrical information, and regulatory capture, along with brand-new ones, like science capture. Let’s start with the firewater.
Liar Liar, Taps on Fire
In the fracking process, natural gas (methane) is released from shale rock strata up to a mile underground, by injecting millions of gallons of water, along with sand and a variety of synthetic chemicals. The huge pressure of the water makes new cracks in the rock, allowing the gas to dissolve and be extracted. Natural gas is now responsible for 30% of U.S. electricity production and for heating half of all U.S. homes. The national and business media have breathlessly reported huge growth in gas production, and the oil-and-gas industry projects that North America will return to exporting energy by 2025. Besides the sheer growth in production, the Wall Street Journal reported earlier this year, the fracking boom has brought other economic benefits, “improving employment in some regions and a rebound in U.S.-based manufacturing,” and “greater defense against overseas turmoil that can disrupt energy supplies.”
As made notorious by the documentary Gasland, water supplies are a major focus of concern about fracking, especially since the emergence of dramatic footage of a number of Pennsylvania homes, near fracking pads above the Marcellus Shale formation, producing fireballs from the kitchen tap. Duke University earth scientists conducted a more rigorous exploration of this phenomenon, published in the Proceedings of the National Academy of the Sciences. They surveyed rural Pennsylvanian water wells for residential use, measuring concentrations of methane, the main chemical component of natural gas. Concentrations rose far above natural levels closer to drill pads, spiking within one kilometer of active gas development sites to a level that “represents a potential explosion hazard.” It was also found that the specific gas chemistry in the wells matched those produced through drilling, rather than through naturally occurring compounds. As the gas boom goes “boom,” the cautious scientists conclude: “Greater stewardship, knowledge, and—possibly—regulation are needed to ensure the sustainable future of shale-gas extraction.”
In parts of the country where water is scarcer, the issue is more ominous. The Environmental Protection Agency (EPA) and U.S. Geological Survey have found toxic alcohols, glycols, and carcinogenic benzene in underground aquifers in Wyoming, evidence that fracking has tainted precious underground water supplies. In press accounts, local residents who requested the study “expressed gratitude to the EPA, and perhaps a bit of veiled doubt about the zeal of local and state regulators.” In parched Texas, the volume of water adequate for irrigating $200,000 worth of crops can be used to frack $2.5 billion-worth of gas or oil. The Wall Street Journal reports that “companies have been on a buying spree, snapping up rights to scarce river water—easily outbidding traditional users such as farmers and cities.” A Texan rancher relates: “They’re just so much bigger and more powerful than we are...We’re just kind of the little ant that gets squashed.”
The heavy use of often-secret synthetic chemicals has also cast a shadow over the fracking debate. Bloomberg News reported in 2012 that energy companies and well operators were refusing to disclose the chemical formulas of thousands of substances used in the fracking process, enough to “keep [the] U.S. clueless on wells.” Many states have instituted a self-reporting law, modeled on one first developed in Texas, allowing drillers to withhold the ingredients used in their chemical mixes. Bloomberg reports that drillers “claimed similar exemptions about 19,000 times” in the first eight months of 2012 alone. The congressional exemption of the industry from federal water requirements (discussed below) makes this non-disclosure possible, so that “neighbors of fracked wells ... can’t use the disclosures to watch for frack fluids migrating into creeks, rivers and aquifers, because they don’t know what to look for.”
This development is a perfect example of what economists call asymmetric information, where one participant in a transaction knows relevant information that is unknown to the other party. The lack of information on one side can put the other party at an advantage, like the seller of a used car who knows more about the car’s problems than the prospective buyer. For example, a team of Colorado endocrinologists set out to catalogue these synthetic compounds used in wells across the country, based on regulatory filings. The survey was limited due to the “void of environmental authority” to compel chemical disclosure, and thus the data sheets and reports are “fraught with gaps in information about the formulation of the products.” Many of these reports only specify the general chemical class or use the label “proprietary,” providing no additional information. Ultimately, the scientists found that over 75% of the chemicals were harmful for the sensory organs, nearly half could affect the nervous and immune systems, and 25% could cause “cancer and mutations.”
Another report by Colorado scientists observed that fracking development is increasingly located “near where people live, work, and play.” The study used air sampling to find strongly elevated health risks within a radius of about half a mile from fracking sites. The effects ranged from “headaches and eye irritation” up to “tremors, temporary limb paralysis, and unconsciousness at higher exposures.” A larger review by Pennsylvania scientists reached similar conclusions, based on local resident reporting and finding a match of over two-thirds “between known health effects of chemicals detected and symptoms reported.”
The scientists caution that their findings “do not constitute definitive proof of cause and effect,” but they do “indicate the strong likelihood that the health of people living in proximity to gas facilities is being affected by exposure to pollutants from those facilities.” They frequently advocate the precautionary principle—that careful study showing that a product or process is not harmful should precede its use—as when they recommend “health impact assessments before permitting begins,” and note that “scientific knowledge about the health and environmental impacts of shale gas development ... are proceeding at a far slower pace than the development itself.” These conclusions contradict the industry’s claim that fracking is both safe for public health and not in need of any further study. Especially considering the earthquakes.
Perhaps more alarming than the burning water and secret chemicals is the association of fracking with earthquakes. An early report of this development came from the Oklahoma Geological Survey, which surveyed the timing of tremors and their proximity to fracking sites and found a “strong correlation in time and space” and thus “a possibility these earthquakes were induced by hydraulic fracturing.” Earthquake epicenters were mostly within two miles of wells, and any earthquake disruption or damage caused by fracking-related activities represents an externality, a side effect of an economic transaction that affects parties outside the transaction.
These findings are backed up by a review in the prestigious research journal Science, in which cautious scientists note that fracking itself is not responsible for “the earthquakes that have been shaking previously calm regions.” Yet they find that the induced earthquakes do arise from “all manner of other energy-related fluid injection—including deep disposal of fracking’s wastewater, extraction of methane from coal beds, and creation of geothermal energy reservoirs.” A surveyed area in Arkansas typically had about two quakes a year, before the beginning of fracking-water disposal. The year water disposal began, the number rose to ten. The next year, to 54. After water injection was halted, the quakes tapered off. The Science authors observe the “strongly suggestive” correlation between water disposal and seismic activity: “The quakes began only after injection began, surged when the rate of injection surged, were limited to the vicinity of the wells, and trailed off after injection was stopped.” The scientists’ main conclusion is the adoption of the precautionary principle: “look before you leap ... Stopping injection has stopped significant earthquakes within days to a year. ... The new regulations in Ohio and Arkansas at least move in the direction of such a learn-as-you-go approach.”
You might wonder why the EPA has not limited or regulated fracking operations, in light of the combustible water, cancer-causing chemicals, and earthquake clusters. The EPA might well have adopted significant national policies on fracking by now, had the practice not been made exempt from the main national environmental laws in the Energy Policy Act of 2005, an offspring of Dick Cheney’s secretive energy committee. The exemptions from the Clean Water Act, the Safe Drinking Water Act, the Clean Air Act, and the Superfund law drastically limit the agency’s authority to act on fracking.
The drive to limit even EPA research into fracking is decades old. An extensive New York Times report, based on interviews with scientists and reviews of confidential files, found that “more than a quarter-century of efforts by some lawmakers and regulators to force the federal government to police the industry better have been thwarted, as EPA studies have been repeatedly narrowed in scope and important findings have been removed.” When Congress first directed the EPA to investigate fracking in the 1980s, the Times reported, EPA scientists found that some fracking waste was “hazardous and should be tightly controlled.” But the final report sent to Congress eliminated these conclusions. An agency scientist relates, “It was like science didn’t matter. ... The industry was going to get what it wanted, and we were not supposed to stand in the way.”
Similarly, when an EPA public-advisory letter to the state of New York called for a moratorium on drilling, the advice was stripped from the released version. A staff scientist said the redaction was due to “politics,” but could as well have said “business power.” More importantly, the first major EPA review of fracking found “little or no threat to drinking water.” This was an eyebrow-raising claim, given that five of seven members of the peer review panel had current or former energy industry affiliations, a detail noted by agency whistle-blower Weston Wilson. Other studies have been narrowed in scope or colored by similar conflicts of interest. More recently, the agency announced that its study finding contamination of Wyoming groundwater will not be subjected to outside peer review, and that further work instead will be funded directly by industry. As the EPA is presently drafting a brand-new report on the subject, these past embarrassments should be kept in mind.
This brings up the problem of regulatory capture, where an industry to be monitored gains major influence over regulators’ policies. As mentioned above, fracking is very loosely regulated by the states, which is always a favorite outcome for corporate America since the regulatory resources of state governments are far smaller and the regulators are even more easily dominated than those of the federal government. The industry-sponsored FracFocus website is the state-sanctioned chemical-information clearing house, and a masterpiece of smooth PR design, suggesting clear water and full transparency. But Bloomberg News reports that “more than 40 percent of wells fracked in eight major drilling states last year had been omitted from the voluntary site.”
Other state reactions have varied. In 2010, the New York State legislature voted to ban fracking, but then-Governor Paterson vetoed the bill and instead issued a temporary moratorium on the practice, though fracking remains illegal in the New York City watershed. Finally, while the EPA’s main study is still pending, the agency has taken some steps, as in 2012 when it required well operators to reduce methane gas emissions from wells and storage pits to limit air pollution. But even here the regulation wears kid gloves: The new moves do not cut into industry profits. In fact, capturing the “fugitive” methane, the agency estimates, will save the industry $11 to $19 million annually. Also, the regulation won’t take effect until 2015.
Mainstream, or “neoclassical,” economic theory considers itself to have solutions to these problems—solutions centered as always on “free markets.” The idea is that if firms create chronic health problems or combustible tap water, market forces should drive up their costs, as landowners learn of these firms’ practices and demand higher payment for drilling. But as seen above, even households that have already leased their land for gas development remain unaware of the identities and effects of the obscure synthetic chemicals to which they are exposed. This informational asymmetry—the firms know things the landowners don’t—significantly attenuates the ability of landowners to make informed choices.
On the other hand, households that are located near a drill pad but uninvolved in licensing the drilling will experience the ill effects as externalities. Neoclassicals suggest these can be fixed through a better property-rights system, where surrounding individuals can sue drillers for injuring their health. But this solution runs up against another problem: proving cause-and-effect from a drilling pad to a particular individual’s health problems is extremely difficult. The tobacco industry notoriously made this point in court for many years, arguing that it was impossible to prove if a man’s lung cancer was caused by a four-pack-a-day cigarette habit, as opposed to, say, local auto exhaust. If cause-and-effect is hard to prove in court for cigarettes, doing so for air-delivered volatile organic compounds will be almost impossible.
This problem is aggravated by the use of corporate resources to influence research. The showcase example is a study produced by the University of Texas, “Fact-Based Regulation for Environmental Protection in Shale Gas Development.” The study gave fracking a guardedly positive bill of health, finding no evidence of negative health impacts. The commercial media gave the study a good deal of favorable attention, until the revelation that the lead researcher, Dr. Charles G. Groat, formerly of USGS, sits on the board of the Plains Exploration & Production Company, a Houston-based energy firm heavily invested in gas development. His compensation from the board was several times his academic salary, and he also held 40,000 shares of its stock. An in-house review by the university was outspoken, saying “the term ‘fact-based’ would not apply” to the paper, which was “inappropriately selective ... such that they seemed to suggest that public concerns were without scientific basis and largely resulted from media bias.” Groat retired from the university the day the review was released, but this practice has become increasingly common from industries under fire for environmental or public-health impacts. Bloomberg News flatly stated that “producers are taking a page from the tobacco industry playbook: funding research at established universities that arrives at conclusions that counter concerns raised by critics.” This raises the ugly possibility of science capture.
No Frackin’ Way
Not that Americans are taking it lying down. A diverse popular coalition successfully fought to block a Gulf Coast gas terminal that stood to inflict major damage on local wildlife. The Oil & Gas Journal reports on the “firestorm” of activism: “In an unlikely but massive undertaking, environmental activists, sports fishermen, local politicians, media groups, and other citizens formed a coalition known as the ‘Gumbo Alliance’ that united opposition to the technology.” The Louisiana governor vetoed the project “under considerable public pressure.” Elsewhere, local residents have taken action to keep fracking and its negative externalities out of their communities. New York State “fractivists” have won an impressive 55 municipal bans and 105 local moratoriums against fracking, to date. The state’s Court of Appeals—New York’s highest court—recently upheld the bans against an industry lawsuit. These activist successes are an early challenge to what the Wall Street Journal called the new “shale barons.”
American job markets remain highly depressed and state budgets are strained. What we need, instead of dogged extraction of every particle of fossil fuels from the ground, is a public employment program geared toward the construction of a new sustainable energy system. This would be a far superior alternative to fracking—on grounds of health, ecology, and employment. It could also serve as a springboard for a broader questioning of the suitability of capitalism for the challenges of the 21st century. That kind of radical approach would see the glass of water as half full, not half on fire.
Note: The online version of this article was updated on August 13, 2013, to correct an error. The earlier version of the article stated that gas from fracking is responsible for 30% of U.S. electricity production and for heating half of all U.S. homes. In fact, natural gas, irrespective of method of extraction, is responsible for 30% of U.S. electricity production and for heating half of all U.S. homes.
SOURCES: Russel Gold, “Gas Boom Projected to Grow for Decades,” Wall Street Journal, February 28, 2013; Tom Fowler, “US Oil Sector Notches Historic Annual Gusher,” Wall Street Journal, January 19, 2013; Stephen Osborn, Avner Vengosh, Nathaniel Warner, and Robert Jackson, “Methane contamination of drinking water accompanying gas-well drilling and hydraulic fracturing,” Proceedings of the National Academy of the Sciences, Vol. 108, No. 20, May 17, 2011; Kirk Johnson, “EPA Links Tainted Water in Wyoming to Hydraulic Fracturing for Natural Gas,” New York Times, December 8, 2011; Tennille Tracy, “New EPA Findings Test Fracking Site,” Wall Street Journal, October 11, 2012; Felicity Barringer, “Spread of Hydrofracking Could Strain Water Resources in West, Study Finds,” New York Times, May 2, 2013; Russel Gold and Ana Campoy, “Oil’s Growing Thirst for Water,” Wall Street Journal, December 6, 2011; Ben Elgin, Benjamin Haas and Phil Kuntz, “Fracking Secrets by Thousands Keep US Clueless on Wells,” Bloomberg News, November 30, 2012; Theo Colborn, Carol Kwiatkowski, Kim Schultz and Mary Bachran, “Natural Gas Operations form a Public Health Perspective,” Human and Ecological Risk Assessment: An International Journal, Vol. 17, No. 5, September 20, 2011; Lisa McKenzie, Roxana Witter, Lee Newman, John Adgate, “Human health risk assessment of air emissions from development of unconventional natural gas resources,” Science of the Total Environment, Vol. 424, May 1 2012; Nadia Steinzor, Wilma Subra, and Lisa Sumi, “Investigating Links between Shale Gas Development and Health Impacts Through a Community Survey Project in Pennsylvania,” New Solutions, Vol. 23, No. 1, 2013; Austin Holland, Oklahoma Geological Survey, “Examination of Possibly Induced Seismicity from Hydraulic Fracturing in the Eolga Field, Garvin County, Oklahoma, August 2011; Richard Kerr, “Learning How NOT to Make Your Own Earthquakes,” Science, Vol. 335, No. 6075, March 23 2012; Zoe Corbyn, “Method predicts size of fracking earthquakes,” Nature News, December 9, 2011; Ian Urbina, “Pressure Limits Efforts to Police Drilling for Gas,” New York Times, March 3, 2011; Devlin Barrett and Ryan Dezember, “Regulators Back ‘Fracking’ in New York,” Wall Street Journal, July 1, 2011; John Broder, “US Caps Emissions in Drilling for Fuel,” New York Times, February 4, 2012; Norman Augustine, Rita Colwell, and James Duderstadt, “A Review of the Processes of Preparation and Distribution of the report ‘Fact-Based Regulation for Environmental Protection in Shale Gas Development,’” University of Texas at Austin, November 30, 2012; Jim Efsthathiou, “Frackers Fund University Research That Proves Their Case,” Bloomberg News, July 23, 2012; Daron Threet, “US offshore LNG terminals face technical, legal maze,” Oil & Gas Journal, December 24, 2007; Ellen Cantarow, “New York’s Zoning Ban Movement Fracks Big Gas,” Truthout, May 9, 2013 (Truthout.org); Alyssa Abkowitz, “The New Texas Land Rush,” Wall Street Journal, April 25, 2013; Daron Threet, “US offshore LNG terminals face technical, legal maze,” Oil & Gas Journal, December 24, 2007.