Economic analysis of the US unconventional oil and gas revolution

Mathilde Mathieu, Thomas Spencer, Oliver Sartor

The US unconventional energy boom has reversed the decline of domestic production, lowered oil and gas imports, reduced gas prices, and created political space for tougher regulations on coal-fired power plants. This column argues that it is not a panacea, however. Even if current estimates prove accurate, the long-run benefits to the US economy will be relatively small. Improving energy efficiency and promoting low-carbon technologies will be just as important as before – especially for the EU, given its more limited known reserves of unconventional oil and gas.

The recent rapid growth in the production of unconventional oil and gas (shale gas and tight oil) in the US has led to a significant decrease of natural gas prices as well as reduced oil imports. This has raised questions about the impacts of the unconventional oil and gas revolution on the US macroeconomy, industrial competitiveness, and energy sector. It has also raised questions about its implications for the EU (e.g. Beffa and Cromme 2013). Given the considerable discussion about the impacts of shale, in a recently published study by the Institute for Sustainable Development and International Relations (IDDRI), we aimed to address these questions empirically (Spencer et al. 2014).

Energy-sector impacts of unconventional oil and gas in the US

Between 2005 and 2013, US production of natural gas increased by 33% from 18 to 24 trillion cubic feet per year. Most of this was due to production of shale gas, which increased from 0.75 to 8.5 trillion cubic feet (Gruenspecht 2013). Over the same period, US production of liquid fuels increased by 52%, and the contribution from tight oil increased from 0.29 million to 3.48 million barrels/day.

As a result, net oil imports have also fallen, from over 11 million barrels/day in 2007 to 8 million barrels/day in 2013. Less well known, however, is that this has occurred as much due to a broader drop-off in energy demand. Alongside greater domestic production, US energy consumption has been moderated by a combination of recession, new energy efficiency standards, and changed consumer behaviour – in particular in response to higher global oil prices and an ageing population. For example, in 2012, per capita energy use in the US actually fell by 5% versus 2011, despite economic growth in that year.

The conventional wisdom also holds that the US consumer has received a massive boost from lower energy prices resulting from the gas glut. In reality, the unconventional oil and gas revolution has actually had a quite uneven impact on consumer energy prices. Gas prices for residential consumers have fallen around 20% from their pre-2008 peak, while industrial and power-sector gas prices fell by about 50% from their 2008 peaks. Residential electricity prices have continued to rise, and industrial electricity prices have also risen – albeit at a lower rate. For households, however, the effects of the unconventional oil and gas revolution have been largely outweighed by continued rises in electricity and in particular gasoline prices (Table 1).

Table 1. Average household energy expenditure, 2005–2012

Data: US Census Bureau, 2012, Consumer Expenditure Survey.

Outlook for the US energy sector

It is likely that the US will become a net gas exporter around the end of this decade, subject to political approval of export infrastructure. This would lead to some narrowing of price gaps over time between US and regional gas prices. However, the range of scenarios assessed in the study suggest that the US will remain a significant importer of crude oil in coming decades. Policies to improve the efficiency of the transport sector will therefore be crucial for reducing US crude imports and costs to US motorists.

The scenarios examined do not suggest that the US shale revolution will lead to a significant emissions reductions from the US energy sector. Indeed, historical data shows that the recent decline in the share of US coal-fired electricity was due to the cyclical drop in natural gas prices, which has largely reversed (Figure 1). Longer-term production cost expectations for shale gas are closer to $6–$10/MBTU. In the absence of further policy, such as the currently-proposed emissions standards for new power plants, the shale revolution will be insufficient on its own to drive coal out of the US power fleet or decarbonise the US energy sector.

Figure 1. Coal-gas share in US electricity and natural gas prices for power generation

Source: US Energy Information Administration, 2013, Net Generation by Fuel Type, Natural Gas Electric Power Prices. http://www.eia.gov/oiaf/aeo/tablebrowser/

Macroeconomic impacts of the unconventional oil and gas revolution

Impact on productivity and GDP of lower gas prices

The impact of lower gas prices on US productivity can be broadly categorised into two parts: a) the income effect, resulting from the fact that the same economic good, gas, can now be produced more cheaply and so, if the same amount of gas is consumed as before, more income can be spent on other goods; b) substitution effects, resulting from the fact that changing gas prices may change the relative prices of other goods in which gas is an input and this may in turn have a range of knock-on consequences for productivity in other sectors.

A detailed microeconomic analysis suggests that the impact on GDP of these latter effects is likely to be negligibly small, affecting sectors representing only 1.2% of the US economy (see Figure 2). Assuming a persistent gap of -$4/MBTU to -$8/MBTU between US gas prices with shale compared to the no-shale scenario, we estimate a total income effect of around 0.575% of GDP on average between 2012 and 2040. This is a long-term increase in the level of GDP, not the growth rate. A multi-model comparison study by Stanford University came up with a similar figure for the long-term GDP impact of shale gas (0.46% of GDP) (Huntington 2013).

Improvement in the US trade balance due to decreased oil imports

Increased production of oil and gas has lowered US imports. Since gas imports are small at the level of GDP, essentially this means that oil producer surplus is being transferred from non-US oil exporters to US oil producers and thereby into the US economy. Assuming a long-run marginal production cost of around $70–$80/barrel for light tight oil and a long-run oil price of $114/barrel, we estimate that the long-run GDP effects of reduced oil imports would be roughly equivalent to a 0.35% increase in the level of GDP in the period to 2040 relative to 2012 levels. This may be offset slightly, but not entirely, by a small increase in the exchange rate and other crowding-out effects in US capital and labour markets, but we ignore these effects. As with the point above, this is a long-term increase in the level of GDP, not the growth rate.

Combining the two calculations would lead to a change in the long-run level of GDP of 0.875% on average over the next two to three decades. As discussed further below, we do not see a significant positive impact on the US manufacturing deficit in aggregate.

Stimulus effect due to the recessionary circumstances in which the unconventional oil and gas revolution took place.

The US economy was not and is not at full employment of labour and capital during the recent shale boom. We estimate the short-term stimulus of lower gas bills and increased investment, employment, and spending on intermediate inputs in the oil and gas sector at 0.13% of GDP and 0.48% of GDP, respectively.

Impact on manufacturing competitiveness

Figure 2 shows the share of gas as a feedstock and fuel in value added in gas-consuming manufacturing subsectors. This is compared with sectoral expenditure on employer-sponsored health insurance in order to give a point of comparison. Gas-intensive sectors make up a relatively small share of the US manufacturing sector, and only about 1.2% of US GDP. There is no evidence that the shale gas revolution will contribute to a ‘reindustrialisation’ in the US at the level of the manufacturing sector as a whole. Exports have increased in gas-intensive sectors, but only to a total of $23.6 billion in 2012 compared to a US manufacturing trade deficit of $779.4 billion (Figure 3). Coupled with other factors since 2007 which would tend to boost exports and reduce imports, including declines in the US real exchange rate during this time, and the effects of the recession on net imports, it is difficult to conclude that any evidence exists of a US manufacturing renaissance led by shale gas. This conclusion is similar to that reached in an IMF staff working paper which concluded that the benefits of cheaper gas are likely to be limited to the chemicals, primary metals, and paper and print sectors, and that, on average, a doubling of the US–G7 gas price gap was associated with only a 1.5% increasing in US manufacturing production (Celasun et al. 2014).

Figure 2. Gas and health care expenditures in the manufacturing sectors, 2010

Data: US Energy Information Administration, US Census Bureau.

Figure 3. US real trade balance by product type, millions of 2009 dollars

Data: US Energy Information Administration, US Census Bureau Foreign Trade Statistics.

Conclusions: A revolution, not a panacea

Our analysis suggests that commentators and policymakers need to better distinguish between the ways in which the US shale gas boom constitutes a ‘revolution’ and the ways in which it does not. The US unconventional energy boom has reversed the decline of domestic production, significantly lowered oil and gas imports, reduced gas costs for consumers, and created a political space for tougher regulations on coal-fired power plants. But it is not a panacea. Even if current estimates of production turn out to be accurate, the benefits to the US economy in the long run are relatively small, and the benefits to manufacturing competitiveness in most sectors are even smaller. In the longer term, US energy security and climate goals will still require a strong role for public policy frameworks. Improving energy efficiency and promoting low-carbon technologies will be just as important as before. For the EU, given its more limited known reserves of unconventional oil and gas, these conclusions are likely to be all the more relevant.

References

Beffa, J and G Cromme (2013), “Competitiveness and Growth in Europe”, report of the Franco-German Working Group.

Celasun, O, G Di Bella, T Mahedy, and C Papageorgiou (2014), “The US Manufacturing Recovery: Uptick or Renaissance?”, IMF Working Paper 14/28.

Cheah, L, J Haywood, R Kirchain (2010), “The Energy Impact of U.S. Passenger Vehicle Fuel Economy Standards”, MIT Sloan School.

Huntington, Hillard (2013), “Changing the Game? Emissions and Market Implications of New Natural Gas Supplies”, Energy Modeling Forum Report 26, Stanford University.

Fatthou, B and A Sen (2013), “The Tight Oil Revolution in a Global Perspective”, Oxford Energy Comment Paper, Oxford Institute for Energy Studies.

Gruenspecht, Howard K (2013), “Annual Energy Outlook (Early Release): with projections to 2040”, presentation on behalf of US Energy Information Administration for Center on Global Energy Policy, Columbia University, 18 December.

Spencer, T, O Sartor and M Matthieu (2014), “Unconventional Wisdom: An Economic Analysis of US Shale Gas and Implications for the EU”, IDDRI Study 02/14.