Hydraulic fracturing group final


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Hydraulic fracturing group final

  1. 1. Einav HenensonChris ConwayGuadalupe CandanedoRobby SittmanJustin Pfledderer Hydraulic Fracturing: Seeking Economic Solutions to an Incomplete Market As with many advanced and complicated technologies, the term ‘further studies areneeded’ is often the regulatory commonality linking the economic need for the technology withsurfacing environmental and health concerns well after the technology is in full blownapplication. The use of hydraulic fracturing as a means of expanding gas production in shalerock formations is one of these technologies. The oil and gas industry claims hydraulic fracturing is an economic necessity and is safein its current application. However, many environmentalists believe that gas production fromshale formations and the intensive use of hydraulic fracturing will potentially lead to a majorsource of ground water pollution, while producing more greenhouse gas emissions than doesour current use of coal. Although there are many competing voices and diverse views, fewwould argue that the current hydraulic fracturing process, which lacks complete informationand does not internalize all the costs of ill effects to producers, represents an incompletemarket.Hydraulic Fracturing – The Very Basics of a Complex Technology The process of hydraulic fracturing, known simply as ‘fracking’, is a well stimulationtechnique that results in creating conductive fractures in low porosity and low permeabilityrock. The process increases the area, or void space, from which natural gas and oil can berecovered, thereby increasing flow and production capability of gas and oil wells to create 1
  2. 2. economically feasible rates. In the context of this discussion, hydraulic fracturing is currentlyused in unconventional resources such as coal beds or shale rock formations that generally existdeep below the Earth’s surface from 5,000 to 20,000 feet. In the hydraulic fracturing process, amixture of water, sand, and a mix of chemicals is blasted into the wellbore at pressures that canreach 15,000 psi and flow rates up to 100 barrels per minute in order to break up the rock andfree the gas (Montgomery & Smith, 2010). In addition to the 1 to 7 million gallons of waterrequired to drill the original well, the hydraulic fracturing process requires an additional 1 to 7million gallons. Wells have been known to be fracked up to 18 times during their productive life(Montgomery & Smith, 2010). It is generally believed that over 80% of the wells drilled todayare not economically feasible without the hydraulic fracturing process.Changes in the last 10 years – Under the Radar Heralded has a tried, true, and safe technology by the oil and gas industry, hydraulicfracturing has been used for 60 years to stimulate millions of wells across the country (EnergyIn Depth, 2010). However, the hydraulic fracturing process used in the last few years differs inmany ways and bears little resemblance from historic fracturing. The modern technique useshigher pressures with increased water volume, the ‘frack job’ has a longer duration, thechemical cocktail used in the process has become much more complex, and the combination ofhydraulic fracturing and horizontal drilling has added a huge new aspect to the process so thata much greater area can be fracked per given well (Fox, 2010). Under pressure to discover the next economic mechanism that would positively drivethe national economy and create jobs, Congress and the Bush Administration passed the 2005Energy Act that essentially removed hydraulic fracturing from regulatory provisions of the Safe 2
  3. 3. Drinking Water Act and EPA oversight. With the removal of federal government oversight,regulation of hydraulic fracturing was then left up to the individual state governments(Wiseman, 2009).Shale Formations – The Game Changer Interest in developing America’s shale formations began to manifest itself only within arecent time frame, beginning with the drilling of the first test wells in the prolific Texas BarnettShale formation in the late 1990s. Soon to follow was the first test well in the PennsylvaniaMarcellus Shale in 2004 (Energy In Depth, 2010). Since then, the development potential ofNorth America’s deep shale formations has become enormous, possibly contributing trillions ofcubic feet of natural gas and creating thousands of jobs. Experts for the oil and gas industryhave compared the shale formations available in 30 states to a Saudi Arabia of natural gas. Withenergy provider spokesmen touting the discovery as a game changer for our nation, oureconomy, and safe for our environment, arguments against anything short of full scaledevelopment are hard to find inside industry and government circles, or with desperate jobseekers.Environmental and Social Costs – Costs Externalized to the Current Market When addressing hydraulic fracturing environmental concerns, the first considerationinvolves the three primary issues surrounding water: the large amount of fresh water requiredfor the fracking process, possible ground water contamination, and proper disposal ofcontaminated water (flowback). Water is an essential component of shale gas development. It is used for drilling where amixture of clay and water is used to carry rock cuttings to the surface, as well as to cool and 3
  4. 4. lubricate the drill bit (Chesapeake Energy, 2010). With the amount of fresh water used to firstdrill the well requiring up to 7 million gallons, and then to frack it which requires an additional 1to 7 million gallons (Fox, 2010), it has become a major concern that gas production wells arebeginning to compete with local municipalities for precious ground water, especially in shaleformation areas of arid Texas. Although this extensive water use is permitted by and withinstate regulations, many environmentalists and the concerned public are starting to question ifthe sheer amount of water used in the process - which cannot be recycled - is the best andmost wise use of available water. In a geologic sense, the deep underground shale formation areas where hydraulicfracturing takes place are separated from aquifers by thousands of feet of permeable rock, thusleading to the theoretical unlikelihood that hydraulic fracking fluid could directly contaminateground water sources. However, poor cementing jobs near the surface or near the wellhead areof grave concern for drinking water contamination. Proper cementing of the well is one of thetrickiest and critical parts of the drilling process (Walsh, 2011). If done incorrectly, the pressurefrom the fracking process and the gas can leak into the surrounding area, with the potential tocontaminate ground water. This was determined to be the case in Dimrock, Pennsylvania whenmethane contaminated the water wells of 19 families. Although Cabot Energy claimed that themethane was naturally occurring, they none the less compensated the families for the watercontamination damage. It should also be noted that a bad cement job around the wellhead wasone of the leading factors in the Deep Water Horizon rig blowout and subsequent BP Gulf oilspill last year (Walsh, 2011). 4
  5. 5. The initial fracking process produces millions of gallons of waste water, with anadditional 1 million gallons of toxic and briny wastewater produced over the lifetime of afracked well. Waste water retrieved from the well can contain highly corrosive salts,carcinogens like benzene, and radioactive elements like radium that the fracking fluid comes incontact with. This contaminated fracking water solution can never be used again by humans,animals, or plants. Determining what to do with the waste water becomes the biggest challengeto drilling (Walsh, 2011). In many of the western states like Texas, the geology allows for thecontaminated fracking water to be pumped back underground and stored. Pennsylvania’sgeology makes storing fracked water underground difficult (Walsh, 2011). As a result, drillersoften have to rely on municipal wastewater treatment plants to process the water. Often theseplants are not set up to process all contaminates from the fracking water, resulting in releasesof toxic water from the plants into surface water systems. Much of the current concern with hydraulic fracturing surrounds the chemicals used inthe process. The Committee on Energy and Commerce launched an investigation to examinethe practice of hydraulic fracturing in the United States. They asked the 14 leading oil and gasservice companies to disclose the types, volumes, and chemical content of the hydraulicfracturing products they used in their fluids between 2005 and 2009. It was discovered that the14 companies use more than 2,500 hydraulic fracturing products containing 750 chemicals andother components, not including the large amount of water added at well sites (Waxman,Markey & DeGette, 2011). Some of these chemicals include benzene, lead, arsenic, copper,vanadium, and adamantine, which have been known to cause cancer, kidney failure, anemia,and fertility problems among other things. However, the most widely used chemical is 5
  6. 6. methanol, which is a hazardous air pollutant and is on the candidate list for potential regulationunder the Safe Drinking Water Act (Waxman, 2011). In addition, between 2005 and 2009, the oil and gas service companies used hydraulicfracturing products containing 29 chemicals that are known or possible human carcinogens.Studies have shown that anywhere from 20-40% of these fluids may remain underground,contaminating the surrounding area for many years to come (Waxman, 2011). There has been an array of complaints of toxic water pollution starting within the sametime frame as hydraulic fracturing events. People living in these areas are experiencing severeheadaches, loss of hair, breathing problems and other health issues due to toxins in drinkingwater sources likely caused by nearby hydraulic fracturing processes that are not closelymonitored (Foxx, 2009). Wildlife near hydraulic fracturing sites has also been harmed as theyare exposed to toxins in both the air and water. The exemption of hydraulic fracturing from the Clean Drinking Water Act externalizedmany of costs and consequences of the process onto the shoulders of the environment andsociety.Correcting the Missing Market – Internalizing Costs Through the analysis of the environmental and social issues, the hydraulic fracturingprocess presents a missing market that allows for market inefficiency. The many potential socialcosts and environmental damages that could result from produced water spills andcontamination are currently fully externalized to producers. Asymmetric information regardinghydraulic fracturing has put more weight on the benefits of a “cheap” energy source than onthe costs of potential negative externalities. The result of any cost-benefit analysis undertaken 6
  7. 7. in order to find an efficient level of fracking will have to combine the total costs internalized tothe industry, along with costs externalized to the environment and society. Any true cost-benefit proposal would likely suggest higher internalized costs to hydraulic fracturing producersand will result in a reduced amount of total fracking altogether.Uncertainty – Variables that Paralyze Policy With recent advances in hydraulic fracturing and horizontal drilling, secretive chemicalmixes, and changes in oversight policy, uncertainty surrounding all major aspects of hydraulicfracturing is at an all time high. The current uncertainty manifests itself in a variety of formswhich can affect our society, environment, and the economy. Uncertainties includetechnological advances, environmental damage, policy design and evaluation, and the costspolicies.  Technological advances – A great deal of uncertainty about future technological advances within the hydraulic fracturing industry exists. The public should expect a significant amount of technical advances associated with shale gas production that can significantly improve the efficiency of the production process, as well as reducing the environmental impacts (Kerr, 2011). As time passes, technology will develop that will reduce potential environmental damage and social costs, as well as increase market efficiency  Environmental damage - We as a society, our government, as well as the firms involved in hydraulic fracturing, have no true idea of the adverse effects that can take place within the environment due to the hydraulic fracturing process. Although negative environmental and social events have already happened, understanding complete long- term effects are currently out of our reach  Policy and design evaluation – With large uncertainty surrounding potential environmental damage and societal costs, it becomes nearly impossible to design and develop sound policy and determine evaluation and monitoring criteria that will best fit 7
  8. 8. the hydraulic fracturing process. Poor policy design and development, evaluation, or monitoring may have unintended consequences that make matters worse than better (Keohane & Olmstead, 2007)  Costs of policy – Government policy at the level needed for authority over the development of shale gas reservoirs will be costly in the least. It will be difficult for the government to determine the necessary cost to monitor potentially hundreds of thousands of gas wells. Transaction costs are sure to be large, given the large number of people who could possibly suffer damages from externalities It should be noted and highly understood that we are more uncertain about the affectsof hydraulic fracturing than we are certain. The high level of uncertainty combined with theinterweaved intricacies of any system, suggest that we currently lack sufficient information tomake sound economic, environmental, and social suggestions associated with hydraulicfracturing.Quasi-Option Value – A Precautionary Principle Cost and benefits are rarely known with certainty, but uncertainty can be reduced bygathering information. Any decision made now that commits resources or generates costswhich cannot be subsequently recovered or reversed, is an irreversible decision. In this contextof uncertainty and irreversibility it may pay to delay making a decision. The value of theinformation gained from that delay is the option value or quasi-option value (OECD Library,2011). Although not a solution in itself, exercising this precautionary principle would allow foruncertainty to be reduced by allowing time to gather information on the potentialenvironmental and social cost of the fracturing process, thus avoiding a decision that could 8
  9. 9. potentially cause irreversible damage. Many states have utilized such a measure under theterminology of ‘moratorium’ to halt hydraulic fracturing. Concerned that the hydraulic fracturing process in the Marcellus Shale formations couldpotentially endanger the New York City and Syracuse watersheds, the state of New York putsuch a moratorium in place while the state’s Department of Environmental Conservationstudied the subject further (Navarro, 2010). Before the legislature agreed to lift the moratoriumin April of 2011, many new regulations were put in place, limiting the land areas wherehydraulic fracturing can occur, thereby protecting watersheds and aquifers (Hall, 2011). Asimilar moratorium is still in place today within the state of New Jersey protecting the DelawareRiver watershed and the drinking water supply of some 15 million people. Other states arelooking at the New York and New Jersey moratoriums and considering similar actions under theguise of allowing the necessary time to clarify uncertainties. With the EPA releasing an extensive time studied report that will likely clarify manyhydraulic fracturing uncertainties, along with suggesting national regulatory policy in early2014, there is no better time than the present for natural gas development and hydraulicfracturing players to consider exercising a quasi-option principle. However, it could be quicklyargued that the political will for such an approach does not exist at a national level.Potential Economic Solutions – Seeking Sound Polices to Reduce Risk and Uncertainty This report seeks policies that will address the current market failure and will benefit allparties involved in shale gas production. It is hoped that regulators will have more completeand accurate information, industry will achieve more efficient operations, and the public will 9
  10. 10. see continuous, measurable improvements limiting negative externalities in shale gasproduction activities.Three key economic approaches are suggested:  Repeal the 2005 Energy Act clause that excludes the hydraulic fracturing process from the Clean Drinking Water Act. This would also include oversight of the hydraulic fracturing process under additional EPA acts designed to protect the environment and public from adverse effects. This would be accomplished under the 2012 FRAC Act  Development of an ‘output based performance standard’ designed to limit potential damage from production water  Development of a performance bond system allowing for clean-up in the case of harmful surface spills and potential aquifer contamination2012 FRAC Act – An Avenue for National Oversight In Congressional policy circles, the future 2012 Fracturing Responsibility and Awarenessof Chemical Act (FRAC Act) represents the most prominent potential policy legislation toaddress fracing concerns at the national level. The act would ultimately amend the SafeDrinking Water Act, putting hydraulic fracturing and the chemicals used with the technologyback under the regulatory authority of the EPA. This authority was essentially stripped awaywith the passing of the 2005 Energy Act. This would, in effect, take the issue away from thefragmented state systems and bring the concern under one federal authority (Wiseman, 2008).Currently the act is held up in the Committee on Environment and Public Works, but will eitherbe assured new attention in the upcoming Congressional legislative session, or held off until2013 after the national election due to concern of not passing during the current Republicancontrol of the House of Representatives. Eventually the act will be addressed. 10
  11. 11. The 2012 FRAC Act is, of course, highly opposed by the oil and gas industry on thegrounds of lost jobs and lost economic revenues. The preferred policy adjustment sought by theindustry would only include state level oversight and monitoring. With many states seekingeconomic fixes to ongoing budgetary dilemmas, states are in need of tax dollars and are hopingsuch a fix will come from the oil and gas industry through the expansion of shale gasproduction. Authority held at the state level would allow the industry to retain greater controlover future policy utilizing the tax dollar argument as leverage. Passing of the FRAC Act will also be economically advantageous to the public byproviding a judicial avenue for internalizing the external costs in third-party situations(Tietenberg & Lewis: 2008: 504). Third parties are defined by Tietenberg & Lewis as victims whohave no contractual agreement with a potential polluter. In the case of hydraulic fracturing, athird party would be any entity that is affected by point source or non-source point pollution,and cannot bring any direct market pressure to bear on the source (Tietenberg & Lewis: 2008:504). Since the hydraulic fracturing process is currently not under EPA authority, governmentsupport and organization for third-party liability suits is limited at best. This leaves the affectedparty on their own, facing the ‘lawyered-up’ oil industry with no government support forproving wrongdoing. In principle, a judicial liability law avenue can force pollution producers tochoose efficient levels of precaution (Tietenberg & Lewis: 2008: 504) and can also act has athird source of enforcement outside of the typical state and federal government agencies.Output Based Performance Standard - Seeking Pollution Prevention while Utilizing ‘BestPractices’ Technologies 11
  12. 12. An output-based regulation (OBR) is a tool that can be used as part of a regulatorystrategy that encourages pollution prevention and the use of innovative and efficienttechnologies. Typically, an output-based regulation, as it has been used in the past, is moresuited to an air emission regulation approach associated with electrical energy generation.However, the concept can easily be converted to industrial water pollution and the hydraulicfracturing process in general. An output-based performance standard utilized within thehydraulic fracturing process would potentially reduce point source and non-point sourcepollution. According to the EPA, output-based regulations are gaining greater attention as theEPA, states, and regional planning organizations strive to find innovative ways to attain today’swater and air quality goals (EPA, 2004). The major benefit of an output-based pollution concept is that they encourage cost-effective, long-term pollution prevention through the process of efficiency (EPA CHP, 2008).Under an output-based pollution standard recognizing and rewarding efficiency within thehydraulic fracturing process, benefits would include:  Reduced fracking fluid inputs – Encouraging water input efficiency will reduce the use of fracking chemicals in volume and therefore total pollutant output  Multipoint emission reductions – Simply, less individual fracking chemical inputs result in reduced overall chemical mix of pollutant outputs  Multimedia environmental reductions – By encouraging reduced fracking chemical and water use, an OBR reduces water, air, and solid waste impacts that result from the production, processing, and transportation during the shale gas development process  Technology innovation – Encourages more efficient, environmentally friendly, and innovative fracturing technologies such as the recent industry innovations Chesapeake’s Green Frac (Chesapeake, 2011), and Halliburton’s CleanStim Formulation (Halliburton, 2011) 12
  13. 13.  Compliance flexibility – Supporting the use of water efficiency as part of a pollution control strategy provides regulated sources with additional compliance options by allowing operators to determine internal variables that comprise the most cost-effective way to reduce pollution outputPerformance bonds – Insurance against the Inevitable It is inevitable that even under the most stringent precautions, spills and contaminationduring the hydraulic fracking process are likely to occur. In the past, when it came time for thecleanup of toxic substance spill situations, responsible parties often either utilized the lengthyand costly court system to alleviate costly damages, or declared bankruptcy to isolatethemselves from cleanup costs altogether. This approach externalizes the cleanup cost ontosociety through taxpayer funds and government agency facilitators. One proposed solution (Russell, 1988; Costanza and Perrings, 1990) would require theposting of a dated performance bond as a necessary condition for disposing of hazardouswaste, or in the case of hydraulic fracturing, contamination, spills, or disposal of productionwater. The amount of the required bond would be equal to the present value of anticipateddamages. Any restoration of the site resulting from a produced water leak or contaminationcould be funded directly and immediately from the accumulated funds; no costly and time-consuming legal process would precede receipt of the funds necessary for cleanup. Any unusedproceeds would be redeemable, with interest, at specific dates if the environmental coststurned out to be lower than anticipated. Although performance bonds are similar to liability lawin their ability to internalize costs, performance bonds are different in that they require themoney for damages be available up-front (Tietenberg & Lewis, 2008, 519). 13
  14. 14. A performance bond approach shifts the financial risk of damage from the victims to theproducers and by doing so, provides incentives to ensure a safe process (Tietenberg & Lewis,2008, 520). Internalizing the costs of fracking fluid contamination and produced water spillswould sensitize producers not only to the risks posed, but also to the amounts of fracking fluidused. Utilizing performance bonds also provides an incentive for fracking firms to monitor theconsequences of their choices because they will then bear the ex post burden of proving thatthe processes utilized were safe.Conclusion – Completing the Market There is no doubt that hydraulic fracturing is economically necessary and thatdevelopment of shale gas formations is necessary in order for America to meet its futureenergy needs. Due to the many recent events outlining and bringing awareness to hydraulicfracturing, it can be ascertained that policy will be addressed at the federal, state, and locallevels moving into the future. As the U.S. considers how to address concerns with shale gasexploration and production, it is crucial that our approach is grounded in a clear understandingof the risks involved, the drivers of risk, and the many different interests that must be balanced.New policy will ultimately lead to regulation that will carry more weight toward internalizingthe costs to producers, creating a more complete market. 14
  15. 15. ReferencesChesapeake Energy (2010). Natural gas Water Usage Facts. Retrieved from: http://www.hydraulicfracturing.com/Pages/information.aspxEnvironmental Protection Agency. (2004). EPA Study on Hydraulic Fracturing. Retrieved from http://www.epa.gov/ogwdw/uic/pdfs/cbmstudy_attach_uic_ch07_conclusions.pdfEnergy in Depth. (2010, June 9). Debunking Gasland. Retrieved from http://www.energyindepth.org/2010/06/debunking-gasland/Fox, J. (Director). (2009). Gasland [Motion Picture]. United States: Docuramafilms.Fox, J. (2010, July 12) Affirming Gasland: A De-debunking Document in Response to Specious and Misleading Gas Industry Claims against the Film. Retrieved from http://1trickpony.cachefly.net/gas/pdf/Affirming_Gasland_Sept_2010.pdfGoodstein, E. (2011). Economics and the Environment. Danvers: John Wiley & SonsKeohane, N. & Olmstead, S. (2007). Markets and the Environment. Washington: Island PressKerr, R. (2011, August 11). Federal Committee: Shale Gas Needs Openness, Better Data. Science Insider http://news.sciencemag.org/scienceinsider/2011/08/federal-committee-shale- gas-need.html?ref=hpMontgomery, C. & Smith, M. (2010, December). Hydraulic Fracturing: History of an Enduring Technology. Journal of Petroleum Technology (Society of Petroleum Engineers) 62 (12): 26-32OECD. (2006) Cost-Benefit Analysis and the Environment: Recent Developments, OECD Publishing. doi: 10.1787/9789264010055-enTietenberg, T. & Lewis, L. (2008). Environmental and Natural Resource Economics. New Jersey: Prentice Hall. P. 463-522.U.S. Environmental Protection Agency. (2004, August). Output-Based Regulations: A Handbook for Air Regulators. Retrieved from http://www.epa.gov/chp/documents/obr_final_9105.pdfU.S. Environmental Protection Agency. Combined Heat and Power Partnership. (2008, March 8). Output-Based Environmental Regulations: An Effective Policy to Support Clean Energy Supply. Retrieved from http://chpcenternw.org/NwChpDocs/4_Factsheet_EPA.pdf 15
  16. 16. Walsh, B. (2011, March 31). Could Shale Gas Power the World. Time Magazine. Retrieved from: http://www.time.com/time/health/article/0,8599,2062331-4,00.htmlWilson, W. (2007, October 4). Letters from EPA Fracking Study Whistleblower. Earthworks: Protecting Communities and the Environment. Retrieved from: http://www.earthworksaction.org/publications.cfm?pubID=372Wiseman, H. J. (2008, September 23) Untested Waters: The Rise of Hydraulic Fracturing in Oil and Gas Production and the Need to Revisit Regulation. Fordham Environmental Law Review. Vol 20. P. 115, 2009. SSRN: http://ssrn.com/adstract=1595092 16