Fracking and Self-Sufficiency in Gas and Oil.

by Dr. Gary S. Becker.

Gary Becker.

More or less every American president starting with Dwight Eisenhower, and prioritized by Richard Nixon, called for American self-sufficiency in energy sources. In fact, America is now about self-sufficient in natural gas, and America’s oil imports have declined as a fraction of its total oil consumption from a peak of 60% in 2005 to about 50% in 2011. Part of the decline is due to the Great Recession’s effects on US output and automobile use. Another part is due to rising prices of oil that reduced oil imports, but increased spending on these imports. A third and growing part is due to increased domestic production of oil and especially gas that is likely to continue to grow rapidly during the next decade.

The main reason for the expansion in domestic gas and oil production is a technique called "hydraulic fracking". Texas wildcatter George Mitchell was the most important person responsible for the development of the fracking method to extract gas from shale formations in the 1980s. This method uses large quantities of water under high pressure with added chemicals to crack open rocks and extract the gas, and sometimes oil, hidden in these rocks. The cost of using fracking for natural gas extraction has become so competitive that most US natural gas production comes from fracking. As a result, the price of natural gas has fallen from a peak of about $10.80 per million BTUs to $2.20 currently.

Instead of building terminals that could import liquefied natural gas, energy companies are now trying to export more natural gas. US natural gas inventories are so bloated there is a possibility that the price temporarily could be forced down toward $0, or even to a negative level. Traditionally, a barrel of oil has sold for about 11 times the price of a million BTUs of natural gas. During the past few years, rising prices of oil and declining natural gas prices have raised that ratio to almost 50.

No wonder there has been a rush to substitute gas for oil in electric power generation and in other activities. Environmentalists have criticized the use of fracking techniques, and have pushed for bans or serious restrictions on their use. These critics claim that the techniques use too much water that could be used for other purposes, that it contaminates drinking water in areas surrounding fracking activities, and that it pollutes the air in surrounding neighborhoods.

I am not in a position to authoritatively evaluate these environmental claims. However, the chairman of Chesapeake Energy, a major fracking company, recently argued in a Wall Street Journal interview that fracking does not use so much water, and that in any case the company in most of its operations now recycles 90% to 100% of the water it does use. Furthermore, the EPA just dropped its claim that a different energy company contaminated drinking water in Texas. This is the third time in recent months that the EPA backtracked on claims that link fracking to pollution of surrounding water supplies. The size of the effects of fracking on air pollution is still an open question as the debate continues over this and other environmental effects of fracking.

Some political leaders have proposed a very bad idea: to restrict American output of oil and gas to use by American industry and consumers. If such laws were enacted and yet the US continued to import oil from abroad--which will be the case for the foreseeable future-- restricting US production of oil to American use would have no effect on the domestic price of oil.

The reason is that the global oil price would then determine domestic prices since no one would buy domestic oil if it were more expensive than imported oil, and no one would use imported oil if it carried a higher price than domestically produced oil. On the other hand, suppose domestic production was so large that oil imports were unnecessary and exports of oil were prevented. Then domestic oil (along with natural gas) would sell below the world prices for these fuels. This would be bad for the domestic oil and gas industry because it would be forfeiting profits from selling some of its production abroad. Moreover, the relatively low domestic prices of these fuels would encourage greater domestic use that would lead to more pollution, although cleaner gas or oil would be substituted for dirtier coal in the production of electric power and in other uses.

Fracking has made the US self-sufficient in gas, and it is leading to reduced imports of oil. If this progress continues, before too long US consumption of oil as well as natural gas would not be drastically affected even by an entire breakdown of imports from the Middle East. The early progress in fracking techniques was very much aided by federal support and the work of engineers in the Energy Department. However, fracking was made into a profitable technique mainly through the ingenuity of people like George Mitchell in search of financial gains from finding ways to expand domestic production of gas and oil.

About Dr. Becker
Dr. Gary Becker is a University Professor, Department of Economics, and Sociology Professor, Graduate School of Business, The University of Chicago. He won the Nobel Prize in Economics in 1992 for his groundbreaking work in "human capital." President George W. Bush awarded him the Presidential Medal of Freedom in 2007.

To keep track of Dr. Becker's continuing research and commentary, visit his website and blog.