The Fracking Ledger

It’s an understatement to say that the shale natural gas boom in the U.S. has rippled many facets of society since the early 2000s: fuel markets, water supplies, and a public awareness over drilling are just a few.

Fracking.

The term for the recently-improved technical process that has made natural gas extraction from shale deposits so easy has a kind of dissonance to it, a dissonance that echoes the mixed feelings that come with discussions about the extraction trend. On the whole, has fracking been good for us?

On the benefit side of the ledger, one could list extraction profits and royalties to landowners, town-level increases in employment and business activity near wells, a reduction in U.S. greenhouse gas emissions and other local pollutants, and national energy security. Costs include local air and water pollution from fracking. Additionally, the “boomtown” nature of spikes in economic activity in drilling towns could include increases in crime rates or other negative effects—and a vacuum of inactivity after such development during subsequent economic “busts.”

It can take time to understand the total costs and benefits from new human activity, especially if markets that capture resulting exchanges might include externalities. A recent paper published in the American Economic Review, one of the world’s top economics journals, adds to our understanding of the net benefits of fracking in a novel way.

“While there are valid arguments on both sides of the debate surrounding shale gas development, the question of whether the benefits outweigh the costs has not yet been answered,” write the authors Lucija Muehlenbachs, Elisheba Spiller, and Christopher Timmons, of the University of Calgary, the Environmental Defense Fund, and Duke University, respectively. Ten years into this ripple, we still don’t know, from a social welfare standpoint, whether it’s worth it.

The authors use a standard method in economics, a hedonic property study, to estimate the effect of gas extraction in Pennsylvania on residential property values. This method uses price changes in the private residential housing market to estimate the value people place on environmental quality. While this is a tried-and-true empirical strategy (used since the 1960s), the case of shale gas extraction is especially tricky: drilling wells have not been placed randomly. If we estimate the effect a home’s distance from a well on the home’s price, we might actually detect the influence of other location characteristics that attracted the drillers to that spot, such as major highway access. There are also neighborhood features that could deter drillers, such as wealth and lobbying power.

After providing evidence that wells are indeed not placed randomly, Muehlenbachs, Spiller, and Timmons work around that issue by using data that spans seventeen years—from 1995 to 2012—to look at how property values have changed over time. This allows them to look at how house prices changed in response to the drilling, as they have data from homes near wells from both before and after drilling. Previous studies have looked at the differences in house prices in different locations, not accounting for the non-randomness problem.

The authors find that homes reliant on groundwater experienced a net 6.5% decline in value when a natural gas well was drilled within 1.5km (nearly a mile) from the home. The possibility of groundwater contamination alone actually caused homes to drop 9.9% in value, but the positive impacts of being near a well—such as royalties or lease payments given to property owners from natural gas companies—led to a 3.4% increase in value. This dampened the effect of perceived groundwater contamination risk.

Because the authors looked at the impact of proximity of wells (not groundwater contamination) on home prices, these changes reflect how homebuyers think about the risk of groundwater contamination from fracking. Their estimates capture the overall effect of drilling on the housing market. Homes dependent on groundwater within 1.5km of a well lost, on average, $30,167 per year.

Interestingly, Muehlenbachs, Spiller, and Timmons were able to dissect the benefits of being near wells by looking at areas that don’t depend on groundwater for their water supply. They found that homes near wells actively used for gas extraction experienced an increase in value, whereas homes near wells not producing gas did not jump in price. This indicates that the price increases seen in homes close to wells is likely due to royalty payments.

Home prices jumped in response to non-visible wells, evidence that wells in view of homeowners’ property offset any benefit from royalty payments. So, homeowners are paid for the presence of the wells, but this payment makes no difference to homeowners if they have to stare at a well. Homeowners probably also find well-drilling noisy or generally undesirable, as new drilling in old wells does not add value to homes.

When it comes to understanding the tradeoffs involved in shale gas development, these estimates are very helpful. They tell us that not only is fracking affecting residential home values, but it is doing so through the perceived risk of groundwater contamination and disruptions that residents experience from drilling, such as the sight or noise of drilling. These costs are offset, at least in part, by the benefit of communities receiving royalties from the drilling operations. Perhaps, the authors conclude, these hits to the housing market could be less severe if residents were better informed about groundwater contamination risk. Additionally, decreasing some of the traffic, noise pollution, or unsightly nature of drilling activity could reduce the impact of fracking on the housing market.

From an economist’s perspective, the ability to see how a market such as the housing market is “internalizing” what are common market externalities, such as pollution or unsightliness of a production activity, informs how we think about whether or to what degree that activity should be regulated. In this case, homeowners and natural gas drilling companies use land property rights to negotiate the terms of royalties. If royalties paid to homeowners fully capture the negative effects those homeowners experience from drilling, then economists would say that a Coasian solution has been reached, and regulation is unnecessary, at least regarding drilling’s affect on homeowners.

In this case, homeowners are not fully compensated for the damages drilling brings. There are many possible reasons for this, including the inability of homeowners to understand how future buyers will value being close to wells or collectively bargain with drilling companies. Homebuyers likely do not understand groundwater contamination risk well. Future research might be able to clarify these dynamics, perhaps alleviating the mixed feelings so many of us still have about fracking and allowing us to make informed decisions about whether we should intervene in the drilling business or the housing market to make everyone better off.

 

Image courtesy of Flickr. Originally published by S&S on October 6, 2016.

 

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