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Slaughter & Rees Report - Boom Time

June 3, 2013 --

The boom in America’s energy sector is in full swing. The most recent data on U.S. crude oil production reveals a higher three month output than in any other period since 1992, with daily output now exceeding 7 million barrels. And the Energy Information Administration projects that America’s natural gas output will reach a record high this year – for the sixth year in a row.

It is difficult to overstate how unexpected America’s energy boom has been to almost all business and government leaders. Think back 5 or 10 years. Wise people foresaw into perpetuity fading production and rising imports for America’s energy. The smart play in natural gas was thought to be investing billions in terminals equipped to import liquefied natural gas from the Middle East. Today investors are scrambling to convert these terminals to export, not import.

What explains this energy boom is a technology revolution: the combination of horizontal drilling and hydraulic fracturing—known, for better or worse, as fracking— extracts gas and oil from rock and other spaces previously thought impervious. Some are predicting this boom will transform the U.S. economy. It is “one of the most important developments for the economy in the last 60 years,” says Martin Baily, former chairman of the president’s Council of Economic Advisers, in a recent article.

Are such predictions of American economic transformation right? We don’t know. But we do know three things that the energy boom thus far shows us.

First, this energy boom exemplifies the serendipity of innovation. Fracking is the brainchild of a Texas oilman (and, please note all Senators debating U.S. immigration reform, a Greek immigrant) named George Phydias Mitchell. His animating insight was that there must be a way to extract natural gas from rock known as shale. He was right. But it took about two decades for the technology to be perfected, it took even longer to be adopted throughout the energy industry, and it is all based on some early-stage basic research funded by the U.S. government. Today many are smitten with innovators whose start-ups zoom to billion-dollar valuations practically overnight. Mr. Mitchell’s long slog is how innovation more commonly happens.

Second, this energy boom reminds us what economic growth looks like when driven by productivity growth rather than by fiscal and monetary stimulus. North Dakota now sits atop some of America’s largest oil reserves inside the Bakken Formation and other treasures. The state’s unemployment rate is today just 3.3 percent thanks to rapid job creation, not labor-force drop-outs. In many North Dakota communities even basic jobs fetch about double the federal minimum wage as workers jump from good opportunities to better, while home prices have nearly doubled. Overall state output is surging in energy, and many other industries, thanks to workers migrating in and expanding investment.

Third, this energy boom demonstrates how governments can support or stifle innovation. Like many promising new technologies, fracking is vulnerable to political intervention. In March, the New York State Assembly approved a two-year ban on the practice in the state (current New York unemployment: 8.2 percent). In Europe, a number of countries sitting atop their own Bakkens have imposed moratoriums on fracking, including France, the Netherlands, Bulgaria, and the Czech Republic. While health and safety concerns must be monitored and, if necessary, addressed, there is a clear risk that policy decisions will be driven by public anxiety and not by sound science.

Time will tell how this energy revolution plays out. And, we caution against hyperbole here. America still imports over 8 million barrels a day—and no matter what our future net imports, the price of oil will be set largely in the global market regardless of any proclamations of “energy independence.” No matter. For at least the time being, it is boom time for America’s energy industry.

Articles © 2013 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2013 Trustees of Dartmouth College. All rights reserved.

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