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Good Times Bad Times: America’s Modern Gas Curse

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Nicholas Mastron
April 30, 2018

Natural gas, as America’s bridge fuel to alternative energies, provides well-paying jobs, enhances energy consumption, yields immediate government revenues and fosters energy independence. Yet, while many reports and data evidence the associated environmental tradeoffs of natural gas extraction, some leaders are now questioning whether natural gas extraction is even financially stable and jurisdictionally equitable.

Considering financial stability, the modern American natural gas industry remains cursed to localized boom-bust cycles, for both firms and localities. Trapped in highly pressurized subterranean shale basins, natural gas geologically increases firms’ capital costs for exploration and extraction, an endogenous migrant labor force to yield acceptable flow rates and a reliance on governmental incentives to ensure economic viability.

Most extracting companies must now use horizontal drilling and hydraulic fracturing to capture natural gas. These two processes involve vast amounts of capital as well as an immense support network to engage in activities, as the basic engineering involves pressurizing the deep natural gas basins through a mixture of water, sand and chemicals. Increased transportation and manufacturing needs for these intermediate goods and the development of support industries effectively crowds out other local industries and furthers competition among sectors.

Legal and regulatory aspects also further boom-bust cycles through public finance interventions and manipulations. Conflict between property tax, severance tax and leasing strategies impacts extraction timelines, which ultimately affects natural gas financial viability.

Annually collected during ongoing extraction activities, property taxes encourage rapid resource extraction and land development to lower firm tax liabilities. Conversely, severance taxes function as a wellhead or final sale excise tax, suggesting potential artificial reductions in flow rates. Finally, leasing options highlight the wide array of property holders’ retained rights to the resource revenues, which may also impact extraction decisionmaking, especially considering the fixed leasing timeframes for legal discovery.

To the untrained eye, these three options appear to balance each other’s policy predilections. However, natural gas extraction skews towards rapid development not because of macroeconomic returns to scale but because of firms’ economic vulnerabilities.

Upstream extraction companies remain almost exclusively small businesses that cannot function under economies of scale assumptions but that conduct the primary leasing operations and are responsible for property taxes. The larger and more familiar conglomerates, such as ExxonMobil or Shell, manage midstream refinement and downstream distribution subsidiaries. These entities are usually responsible for severance taxation, and because they (or perhaps their parent company) are publicly traded corporations, shareholder returns incentivize faster development, cancelling any initial extraction hesitancies from severance tax policies. Furthermore, the potential for natural gas leakage due to depressurization in unleased land incentivizes property owners to quickly lease their subterranean rights to reap any economic benefit.

In terms of natural gas equities beyond the firm, inequities occur at state, local and national environments, primarily through the creation of prisoners’ dilemmas and race-to-the-bottom incentive strategies.

At the state level, should natural gas basins cross jurisdictional lines, increased economic growth in resource support industries to more tax-friendly states could prompt reactionary tax policies in others that may not structurally benefit those other states. More tax-friendly states could also decrease the value of the oil and natural gas in the other state through natural gas depressurization in multi-state basins through expanded exploration.

Differing extraction histories define state financial priorities, which, in turn, drive local-level inequities. For instance, Pennsylvania uses its natural gas revenues to primarily plug local orphan well sites from previous periods, thereby creating jurisdictional friction through needing to remediate past. Other, more consistently extracting states, like Texas, primarily value present-impact effects and educational endowments. States like Alaska, who are fairly new to natural gas activities, tend to emphasize future industry impacts, leading to more long-term focused endowment funds. While these funds are collected locally, they are almost always distributed centrally from the state coffers, furthering economic apathy to the local needs of the extracting communities.

Finally, at the national level, the diversifying American portfolio of natural gas entities might also encourage regional price wars. Historically a non-traded good, natural gas functions as a stock-flow resource, meaning that a finite amount exists and that a price is set via the volume moving through a metered area. In the case of natural gas, the Henry Hub in Erath, Louisiana, serves as the flow channel that determines open market prices in speculative stock exchanges. However, developing liquefied natural gas terminals are redefining natural gas as a tradable American good, which might further certain locales’ abilities to dictate natural resource agendas beyond any existing governmental oversight mechanisms.

In short, a modern resource curse coupled with a rapid boom-bust cycle plagues the American natural gas industry. However, public administrators and policy analysts should carefully evaluate economic and equity impacts when designing improvements to natural gas policies, lest they inadvertently stunt communities’ economic sustainability.

Author: Nicholas Mastron is a current doctoral student in Public Policy & Administration at the George Washington University, with a field specialization in Social & Gender Policy. His email address is [email protected]. Follow him @NicholasMastron. The views expressed in this article solely reflect the author’s opinions and not those of any employer, university, or professional association that which he may associate.

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One Response to Good Times Bad Times: America’s Modern Gas Curse

  1. Robert Brescia Reply

    May 2, 2018 at 5:40 pm

    Nicholas – a nice overview of what we know to be true here in the Permian Basin. Thank you – Bob

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