At Issue: Hydraulic Fracturing

All you need is regulation

By Thomas W. Merrill and David M. Schizer

Fall 2013

As any Beatles fan knows, Yoko Ono and Paul McCartney have had their differences over the years. So it is striking that they are now working together to stop hydraulic fracturing. In fact, Ms. Ono has described this new method of drilling for natural gas and oil, which is also called “fracking,” or “fracturing,” as an “assaul[t] with dirty water.” The truth is, though (borrowing again from the Beatles), that all you need is regulation. With the right regulatory strategy, we can manage the environmental risks, while reaping the extraordinary benefits of fracturing.

Those benefits were on display in 2009 when the  United States passed Russia as the world’s largest natural gas producer, and again last year when the world’s most respected energy forecaster predicted that the United States will overtake Saudi Arabia as the world’s largest oil producer by 2020. These developments would have seemed wildly improbable just a few years ago. But energy companies have learned to tap previously inaccessible shale oil and gas by pumping fluid into the shale at high pressure, cracking (or “fracturing”) it to release gas and oil trapped inside.

The result is a massive new domestic supply of natural gas and oil. In 2000, shale supplied negligible amounts of oil and only 2 percent of domestically produced natural gas in the U.S. As recently as 2007, we were preparing to import natural gas. Yet since 2008, domestic natural gas production has increased by 25 percent. Today, 50 percent of our gas comes from shale and tight sands, with 80 percent expected by 2035. Pennsylvania has the second largest natural gas field in the world, and there are also sizable deposits in other states, including Texas, New York, Louisiana, and Ohio. As President Obama said in his 2012 State of the Union address, fracturing may generate 100 years of natural gas supply for the United States.

Fracturing has also unlocked massive supplies of domestic oil in shale. While shale produced only 100,000 barrels per day (“bpd”) of oil in 2003, 2 million bpd were produced in 2012. The level is expected to rise to 4.5 million bpd in the coming years. Although U.S. oil production was in steep decline for decades, production increased by over 2.7 million bpd from 2008 to the first four months of 2013, which includes a 1 million bpd increase in 2012 alone. Although North Dakota was producing less than 1 percent of the nation’s oil as recently as 2008, by 2012 North Dakota—drilling in its Bakken Shale, a 25,000–square mile sheet of embedded oil—was the second largest oil-producing state after Texas.


Economic, National Security, and Environmental Benefits of Fracturing

A cheap domestic supply of energy is a powerful engine of economic growth. According to an October 2012 study by the consulting firm IHS, shale oil and gas contributed $237 billion to U.S. GDP (or about 1.5 percent) in 2012, an amount expected to almost double by 2020. Likewise, IHS credits the shale revolution with 1.7 million U.S. jobs in 2012, and expects 3 million in 2020, representing 2 percent of total U.S. employment. Obviously, this is a significant boon to an economy that shed 5 million jobs in 2008 and has created jobs haltingly in the years since.

The shale gas boom has also enhanced consumer purchasing power by causing natural gas prices to plummet to less than one-third of their 2008 level. By contrast, natural gas prices are three to five times higher in Europe and Asia, which gives a sense of what U.S. prices would be if set by gas imports. The savings (e.g., on home heating and electricity bills) averages $926 per year for every American household—almost 2 percent of the U.S. median household income—and is expected to grow to $2,000 in 2035. Since every business spends on energy, this savings also hits the bottom line of U.S. businesses, enabling them to cut costs, increase profits, and hire more people. The most significant impact is on energy-intensive industries such as the petrochemicals industry.

Reducing our dependence on imported energy has obvious geopolitical advantages as well. Some of the world’s oil and natural gas comes from nations that are either unstable or hostile to the United States, or both. The top eight oil-exporting nations are Saudi Arabia, Russia, Iran, the United Arab Emirates, Norway, Iraq, Kuwait, and Nigeria. Likewise, 70 percent of the world’s conventional gas reserves (i.e., not including shale gas) are in Iran, Qatar, and Russia. Some of these regimes consistently seek to undermine U.S. foreign policy goals, and added oil and gas revenue strengthens their ability to do so. Recent events in the Middle East—the terrorist attack at an Algerian natural gas facility, the nuclear program in Iran, the attack on the U.S. Embassy in Libya, etc.—suggest that, if anything, the Middle East is becoming more unstable and hostile to the United States. It is fortunate, then, that the United States has gone from importing 60 percent of its oil in 2005 to 36 percent in early 2013, with further reductions in U.S. oil imports expected in the next two decades. The increase in U.S. oil production since 2005 is more than what Iran was exporting before sanctions were imposed, a fact that has made those sanctions more viable. Amazingly, the United States is projected to be 97 percent energy self-sufficient in net terms by 2035. 

Shale gas is also an important component of any viable strategy to combat climate change. Natural gas burns cleaner than other carbon-based fuel, producing less carbon dioxide, sulfur dioxide, particulate matter, and carbon monoxide than coal. Until recently, coal generated almost half of the electricity in the United States, but this level declined to 42 percent in 2011 and 36 percent in 2012, the lowest levels since these numbers were first tracked in 1949. This shift from coal to natural gas is one reason why U.S. greenhouse gas emissions have declined by 12 percent from 2005 to 2012 (including a 5.3 percent decline in 2012 alone), and are at their lowest level since 1994. This decline is the largest anywhere in the world, and occurred during a period when global emissions rose by 8 percent. Fracturing thus facilitates the use of natural gas as a bridge fuel, reducing carbon emissions in the near term, while solar and other renewable technologies are developed over the long term.


Air Pollution, Traffic, Water Usage, and Competition With Renewables

Yet the picture is not uniformly rosy. For example, although burning methane (the main ingredient in natural gas) releases relatively small amounts of CO2, releasing methane into the atmosphere—for instance, during drilling or from pipeline leaks—is a potentially significant source of greenhouse gas emissions.

Emphasizing this point, Professor Robert Howarth of Cornell has argued that shifting from coal to natural gas actually does not reduce greenhouse gas emissions when measured on a “lifecycle” basis. Yet this conclusion is not widely accepted. A number of studies fault Professor Howarth’s assumptions and analysis, and reach a more favorable conclusion.

Indeed, in an April 2013 study, the Environmental Protection Agency (EPA) concluded that methane emissions declined by 8.2 percent between 1990 and 2011. Although this period coincides with a dramatic increase in natural gas production, methane emissions from natural gas production are down even more—by 10.2 percent.

Obviously, to the extent that methane leakage is contained, the benefits of using natural gas become even clearer. Fortunately, energy companies have an economic incentive to keep methane from escaping, so they can sell it. In addition, EPA regulations finalized in April 2012 reinforce this incentive, requiring energy companies to capture or burn methane released during drilling.

The fracturing boom also creates traffic and congestion. Fracturing itself uses significant amounts of water, although, as a recent Department of Energy study observed, “in most regions water used in hydraulic fracturing represents a small fraction of total water consumption.” Fracturing may also increase the risk of minor earthquakes. Yet air pollution, traffic, water usage, and seismic activity all arise with other sources of energy, such as coal mining and conventional gas drilling, and the U.S. has experience handling them. Because these risks are familiar in other contexts, most are already governed by existing regulatory regimes.

Another concern might be that the shale oil and gas revolution could undercut the economic viability of renewable energy. This is not necessarily the case, though. Shale gas is often viewed as a bridge fuel, which will help satisfy the nation’s energy needs until renewables are more competitive. In addition, since wind and solar are intermittent sources of energy, they need another source to fill in when they are unavailable, which usually is natural gas. Likewise, renewables and natural gas do not compete head-to-head, to the extent that government initiatives guarantee a percentage of the energy market to renewable energy. Nevertheless, there is some risk that cheap natural gas will undercut the political support for these initiatives and, more generally, will outcompete renewables so that they never become economically competitive. 

In any event, while we agree with the goal of using taxes and other policy instruments to ensure that carbon fuel prices reflect their true social cost, including externalities, this strategy does not make sense if applied only to shale gas and oil, but not to other carbon fuels. If fracturing is banned or becomes significantly more expensive, while coal remains cheap, the result will not be more solar and wind energy, but more coal. This is not an outcome that environmentalists should favor.


Water Contamination

The most unique risk from fracturing—and the one attracting the most attention—is water contamination. There are three different aspects of this risk, and their magnitude is uncertain and intensely debated. 

First, fracturing fluid can contain toxic chemicals, so it is important that it not seep into water wells after cracking the shale. Fortunately, this is quite unlikely, since thousands of feet of dense rock separates the “payzone” where drilling takes place (which is usually 5,000 to 10,000 feet down) from water wells (which are only 500 to 1,000 feet down). Fracturing fluid is also unlikely to leak into a water well on the way down, since state regulators generally require oil and natural gas wells to have thick protective layers of steel and concrete, called “well casings,” extending past the water table. According to a number of studies, therefore, after more than 2 million oil and gas wells have been fractured in the United States—including thousands fractured in shale—there are no documented cases of fracturing fluid migrating into water wells during the fracturing process. “It is noteworthy,” observes a 2011 MIT report authored by Ernest Moniz, the new secretary of energy, “that no incidents of direct invasion of shallow water zones by fracture fluids during the fracturing process have been recorded.” 

A second (and more meaningful) risk is that fracturing fluid might accidentally spill on the surface and seep down into the water table. Some spills have been reported in the media although, as EPA has observed, “the frequency and typical causes of these spills remain unclear.” Surface spills of toxic chemicals obviously are a risk in many industrial and commercial activities; the chemicals in fracturing fluid are also found in swimming pool cleaners, detergents, hair cosmetics, and other products. A range of federal and state regulations already address this risk, governing the storage of chemicals and requiring spill prevention plans. Of course, by increasing the volume of toxic chemicals that are transported, fracturing makes this risk all the more significant. The bottom line, then, is that fracturing fluid needs to be transported and stored carefully. 

Third, natural gas itself also can cause health issues if it migrates into drinking water.  Yet the reality is that natural gas is commonly found in rural water wells because it migrates there naturally; so far, there is little evidence that fracturing increases the probability of this. For example, a 2011 Pennsylvania study found methane contamination in 40 percent of the wells tested before drilling began; the study then compared levels of contamination after the drilling, and found no statistically significant difference. After all, energy companies drill there because there’s methane in the ground—and, therefore, sometimes in the water as well. Similarly, a 2013 study concluded that the presence of methane in water correlated better with topography than with shale gas production—it is more common in valleys and low areas—so that “the use of hydraulic fracturing for shale gas in northeastern Pennsylvania has not resulted in widespread gas migration into the shallow subsurface.”


Regulating Water Contamination

Even so, effective regulation is needed to ensure both that drilling is safe and that the public believes it is safe. We recommend a two-pronged strategy.

First, for issues that are already well understood, we would rely on command and control regulations to enforce best practices. Best practices regulation has three advantages. First, it is especially well suited to risks that are either common to all forms of oil and gas production or are familiar from other types of industrial operations, including well casing leaks, surface spills, and disposal of drilling waste. Second, the idea that a public regulatory body is “on the case” is reassuring to the public. Third, because energy companies have to make substantial investments to drill in shale, they need to estimate what regulatory costs they will face. Best practices regulation offers this predictability. The states, which are the principal regulators of oil and gas drilling, already impose a broad range of “best practices” regulations on oil and gas producers.

Second, we would backstop best practices regulations with liability rules. After all, best practices regulations are only as effective as the resources committed to enforcing them. A further limitation is that best practices regulations are less effective for novel risks, since it is impossible to mandate best practices until we know what they are. 

These two pillars of our regulatory effort—best practices and liability—should be coordinated. To do so, we need three different liability rules, depending on how our best practices rules treat the conduct that caused the water contamination. First, if an energy company violates a best practices regulation in contaminating water, the company should be negligent per se. Second (and conversely), if the company complies with the relevant best practices regulations, it generally should not be liable (unless the regulations are much less protective than those in other jurisdictions). These two per se rules, working in tandem, create a powerful incentive for industry to help regulators develop protective best practices rules and to comply with them. 

The third rule fills any gaps. If there is no relevant best practices rule, the doctrine of res ipsa loquitur should apply. This means an energy company is presumed negligent—and thus is liable—for any water contamination it causes, unless it can show that the contamination was an inevitable accident. This difficult showing means the standard of care, as a practical matter, approaches strict liability. As a result, energy companies have a strong incentive to reduce residual risks not governed by best practices regulations, and to help regulators develop new best practices regulations.

Of course, the incentives are right only if liability assessments are accurate—that is, only if the system makes reliable judgments about whether an energy company actually caused the contamination and any resulting health effects. This will not always be easy. If a water well contains an unusual chemical, how do we know it comes from fracturing, as opposed to a natural cause or some other source of pollution? If someone who lives near a drilling site becomes ill, how do we know that fracturing caused the illness?

To generate reliable answers to these sorts of questions, we should create incentives to develop better information. The most important step is to test water quality before fracturing begins in order to establish a benchmark of water quality, and then to retest it periodically. If contaminants are found that were not present in the baseline sample, this supports the allegation that fracturing caused the contamination. But if the contaminants were already there, this powerfully rebuts such a claim.

Once landowners establish that fracturing has caused water contamination, they can recover, at a minimum, the loss in property value attributable to the contamination. If contamination goes undetected for some time it might also cause more serious injuries, such as health effects, although this will be much harder to show. We should use presumptions to help plaintiffs prove their case, while burdening energy companies to show otherwise. While this may seem unfair to energy companies, they can mitigate this risk with self-help. By periodically testing the water, they can either ensure that it is not contaminated or act promptly to clean or replace it. After all, energy companies cannot be liable for health effects unless there first is a showing that they contaminated the water.

We can refine the common law with select legislation to make it more effective as a regulatory strategy. For example, to ensure that lawyers are willing to bring cases, we can require defendants who lose to pay the other side’s legal fees. We can also oblige energy companies to have insurance to cover the damages if they are insolvent. We may also want narrowly targeted prohibitions on fracturing in environmentally sensitive areas, such as the Catskills watershed that supplies water to millions of people in New York City. Some of the necessary steps may be taken by Congress, while others can be taken by state legislatures or even state courts.

The bottom line, though, is that reasonable and effective regulation is possible for fracturing. The right regulatory strategy can protect our water resources, while also harnessing the substantial economic, national security, and environmental advantages of the shale oil and gas revolution.