Fracking Free Trade

0
Print Friendly

140807_04

Hydraulic fracturing and horizontal drilling have unlocked shale gas and other types of natural gas from geologic formations, opening up a new frontier for the oil and gas industry.  In contrast to conventional fields that trap large, free-flowing reservoirs of natural gas, shale fields consist of tiny pores of natural gas that are scattered within sedimentary rock (Figure 91).  The boom in gas production from these unconventional shale fields has created a glut of natural gas in the U.S., driving prices – and profits – to new lows.  But energy-producing companies figure they can profit from American shale investments if they export Liquefied Natural Gas (LNG) abroad, even after factoring in the costs associated with liquefaction and transportation.  Since natural gas prices are approximately $12 and $16 per million British thermal units in European and Asian markets, respectively, prices around $4 in the U.S. present a unique opportunity for energy exporters to take advantage of vast price differentials.

Ironically, however, the fate of U.S. natural gas exports is not entirely in the hands of energy producers.  Having approved four export license applications so far, the Department of Energy (DOE) is set to render a decision on nearly two dozen more applications this year or next.  The DOE gave its first green light in 2011, and following a nearly two year pause in reviewing applications, has already approved three additional export terminals this year.  While energy companies may export LNG to any U.S. partner in a free trade agreement (FTA), the DOE must determine whether applications to export domestically produced LNG to non-FTA nations are in the country’s national interest.  The question is as much economic as it is political, and the debate surrounding LNG exports will encompass an environmental dimension as well.  Thus, in fulfilling its responsibilities to the American people, the DOE will need to evaluate LNG exports in light of economic, political, and environmental considerations. 

This article explores the various ways in which we can think about LNG exports in relation to the multifaceted notion of U.S. national interests.  The article also sheds light on what approval of LNG export licenses might mean for the country, and what the DOE and the Obama administration consider to be in the national interest of the U.S.  Our analysis suggests that bolstering American economic and geopolitical clout is the most important element in the DOE’s conception of national interest.  Environmental issues assume a secondary role in the DOE’s prioritization of national interests.

Disaggregating U.S. National Interests

Economic Considerations

From a purely economic point of view and using GDP as our benchmark for national income, the U.S. as a whole stands to gain from LNG exports.  Granted, gains to GDP will be relatively small, with one study estimating the net effect to be as low as $15.6 billion annually between 2016 and 2035.  Figure 2 shows that as the volume of natural gas exports rises, U.S. GDP consistently increases (Figure 2).  If the DOE’s conception of U.S. national interest were based solely on this economic fact, it would obviously be in the interest of the U.S. to grant further export licenses.  But economic changes (such as increased LNG exports) create winners and losers, and the notion of national interest becomes less clear-cut.  Although studies present different estimates of how much more Americans will spend on natural gas due to LNG exports, the highest such value is around 16 percent (Table 3).  In other words, American consumers and businesses will face higher natural gas prices as foreigners enjoy lower prices due to more competitive international gas markets.  Meanwhile, American energy producers will reap greater profits as they gain access to new energy markets. 

140807_02

Figure 2

140807_03

Clearly, further LNG export licensing will create shifts in economic well-being as consumers and businesses face changing prices.  Is it in the national interest of the U.S. to keep energy prices low for American consumers, or should the country be more concerned with its overall economic performance (i.e. GDP)?  Many economists avoid these normative questions and instead focus on positive questions such as efficiency.  Scholars at the Brookings Institution and Peterson Institute for International Economics view the limitation of LNG exports as a de facto subsidy to domestic consumers, with domestic energy producers paying a de facto tax; they argue that such governmental intervention would create economic distortions and market inefficiencies.  But is the most efficient outcome necessarily the best outcome?  Many economists would say yes; but in this case, many American consumers would say no.  It is clear that the notion of U.S. national interest becomes more complex as more parties are involved; shaping economic policy inherently involves tradeoffs, and learning what tradeoffs are made can help us understand what the DOE considers most important to U.S. national interests.

Geopolitical Considerations

The concept of national interest takes on a geopolitical dimension when one considers the international ramifications of an export-oriented policy stance.  Scholars at the Peterson Institute for International Economics assert that the U.S. should continue granting LNG export licenses because not doing so would violate free trade rules.  In particular, restrictions of LNG exports would violate World Trade Organization (WTO) standards; except under a few outstanding circumstances, countries can only impose temporary export restrictions on goods undergoing critical shortages, which the U.S. obviously could not justify with its shale gas boom.  Since the U.S. has long promoted free markets and advocated punishment against non-compliant nations, restricting LNG exports would be hypocritical and could undermine the authority of the U.S. on the international stage.  Thus, national interest assumes an element of national prestige, reputation, and power.  

Other countries in the WTO could also challenge the U.S. if it limited its exportation of natural gas; losing such an international lawsuit could lead to harmful economic sanctions against the U.S. across many sectors of international trade.  Moreover, scholars believe that ‘resource nationalism’ by the U.S. (in the form of limited LNG exports) could lead to similar protectionist policies abroad for a variety of natural resources, damaging the world trading system.  

A more apparent geopolitical dimension to U.S. national interests also emerges since American gas exporters could control a larger share of the global LNG market.  If the DOE does not act quickly enough to grant LNG export licenses, the U.S. could lose import markets to LNG-exporting countries such as Australia and Canada.  Australia, with its abundant natural gas supplies and unrestricted exports, enjoys close proximity to Asia and could become the central supply hub for the region.  Already, seven export terminals are under construction and are scheduled for start-up between 2014 and 2018.  Canada, endowed with huge shale gas formations in the Western Canada Sedimentary Basin, is expected to begin exporting LNG in 2015.  Shipments from Canada’s western coast can reach East Asia in eight to ten days, less than half the time it takes for shipments from the U.S. Gulf Coast.  

140807_05An important implication of market share, then, is realization that the U.S. could exert geopolitical influence through its LNG exports.  For three-quarters of the last century, the U.S. was the world’s largest oil producer.  In Oil and the American Century, Professor of History David S. Painter argues that control of oil bolstered America’s military and economic might and played an integral role in protecting U.S. national security interests.  The  shale boom presents a similar opportunity for the U.S. to maintain its power throughout the 21st century.  Possessing huge natural gas reserves will certainly help in realizing America’s vision of becoming energy independent and energy secure.  Just as important, though, is America’s potential to exert geopolitical influence through LNG exports, as other countries become reliant on American shale.  The U.S. is projected to become a net exporter of natural gas by 2020, with net exports projected to rise at least through 2040 (Figure 89).  As energy prices stay low due to the American shale boom, the geopolitical clout of oil-producing countries such as Russia, Iran, Venezuela and the middle eastern oil states will decrease as America’s ‘energy clout’ increases.  Thus, if the DOE considers geopolitical clout to be an important determinant of national interest, it will likely continue accepting LNG export applications.

Environmental Considerations

There is an important environmental dimension to the LNG export debate as well.  Some environmentalists argue that the greenhouse gas footprint of shale gas production is even worse than that of coal, since methane leaks from wells during the fracking and well completion processes.  While the veracity of these claims is currently a topic of debate, experts generally agree that the impact of methane on climate change is 20 times greater than that of CO2.  In addition to concerns regarding methane leakage, gas-producing companies use chemicals in the hydraulic fracturing process that could potentially contaminate groundwater.  Thus, since LNG exports to non-FTA nations would likely increase production of shale gas in the U.S., the policy debate surrounding LNG exports also becomes an issue of obligation to future generations.  There is certainly a degree of risk in continuing shale gas production when a lack of consensus on environmental issues still exists within the scientific community.  In reviewing LNG export license applications, the DOE will have to weigh these environmental considerations against the other elements of national interest outlined in this article.

The Obama administration will also have to inspire greater confidence in the general public that LNG exports – and more generally, shale gas production – are indeed in the nation’s interest.  The Environmental Protection Agency has conducted several studies on groundwater contamination due to hydraulic fracturing; however, the agency has had a mixed record of transparency, having censored a groundwater contamination study in Texas and delayed the release date of another study from 2014 to 2016.  Until these studies are publicly accessible, the American people will continue to question the safety of hydraulic fracturing.

Where We Are

DOE approval of four LNG export terminals so far suggests the U.S. government believes the economic and geopolitical benefits of exporting natural gas outweigh the potential environmental ramifications of increased natural gas production.  Geopolitical supremacy, international clout, and economic might are perhaps the main components of the DOE and the Obama administration’s conception of U.S. national interest.  This conclusion can possibly inform our understanding of other actions made by the administration and provide a framework of analysis for future policy decisions, such as the Keystone XL pipeline, whose fate could be decided as late as 2014.  

While the environmental dimension to shale gas production may only be a secondary factor in the DOE’s national interest equation, the Obama administration must take further steps to ensure that the pursuit of greater economic and geopolitical clout does not come at the expense of the environment.  Proper regulation and enforcement at the federal, state, and local levels remain crucial in ensuring that shale gas production proceeds in a safe and sustainable manner.  

Lastly, the DOE and the Obama administration should continue to evaluate the effect of LNG exports on the domestic price of natural gas.  While the current academic literature suggests that domestic price increases due to LNG exports will be mild, further research and careful study of America’s first-constructed export terminals will shed light on whether these studies are correct.  The boom in shale gas production presents a once-in-a-generation opportunity for America to adopt a new and comprehensive energy policy framework – for instance, to tap natural gas as a prime transportation fuel.  Such a vision will require massive infrastructure and capital investment from the private sector.  But the most important element underpinning this energy vision is cheap domestic natural gas.  America must not pursue LNG exports blindly, at the ultimate expense of its energy future.

Share.

About Author

Jon-Jon Lam

Jon-Jon Lam is the editor-in-chief of the Yale Economic Review. Contact him at jonathan.lam@yale.edu.

Leave A Reply