Energy Policy Opportunities and Continuing Challenges in the Presence of Increased Supplies of Natural Gas and Petroleum

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Released: June 2012

Related Topics: Employment & Wages, Energy & Environment

Authors:

  • Michael GreenstoneFormer Director, The Hamilton Project; 3M Professor of Environmental Economics, MIT
  • Adam LooneySenior Fellow, The Brookings Institution
 
 

Introduction

We are in the midst of one of the most significant transformations in the energy sector in many decades. This transformation is the result of the development of new recovery techniques, such as hydraulic fracturing (fracking), that have unlocked massive supplies of previously unrecoverable fossil fuels, primarily natural gas and, to a lesser degree, petroleum. Since 2007, natural gas supplies and production in the United States have increased dramatically, and the price of natural gas-powered energy has plummeted. Only a few years ago, many in the United States were concerned about the prospects of dwindling supplies of natural gas in North America; today, we must determine how to manage vast new reserves. The implications of this natural gas revolution will be profound and are only now coming into focus.

On the positive side, there are several benefits to this technological revolution. Most immediately, it has created economic opportunity in several regions of the country, which is especially important in this extended period of weak economic growth. Additionally, it has reduced the cost of energy for American businesses, manufacturers, and consumers, and freed up resources for other important uses. Over the longer run, it will improve our energy security, making it easier to realize our foreign policy objectives, and making us less susceptible to oil price shocks in global markets by diversifying our fuel sources away from petroleum, especially in the transportation sector. Finally, natural gas has already begun to replace coal as an electricity source; this transition will improve our health and slow down the rate of climate change because the combustion of natural gas only leads to one-twentieth of the release of local pollutants and half the greenhouse gas emissions as coal.

Nevertheless, many are concerned that these advances represent a “white elephant”—a rich gift, but one that is costly to manage. Fracking itself may have significant environmental effects on local communities and on air and water quality, a fact which has caused many to question the wisdom of embracing this new technology, as evidenced in Vermont’s recent decision to prohibit fracking entirely, and New York State’s continued uncertainty about whether to allow it. Furthermore, low prices for natural gas reduce the economic incentive to invest in nuclear energy and newer technologies that can reduce the build-up of greenhouse gases in the atmosphere that cause climate change.

Policymakers have spent the last several decades searching for ways to facilitate the development of energy sources to power our economic growth, while protecting us from the harmful byproducts of our energy choices. There have been some successes along the way, including the regulation-induced reduction of particulate air pollution concentrations, but there have been too many failures, ranging from costly subsidies that have produced few benefits, to unnecessarily expensive regulations. While the dramatic increase in the supplies of natural gas and the expanding petroleum production offer many potential benefits, it is as important as ever to implement sound policies to manage the development of these energy sources. Poor policy could expose us to even greater risks or cause us to squander an opportunity to make progress on the energy and environmental challenges that our country and the world continue to face.

This framing paper provides a summary of some of the recent changes in the energy sector, tallies the benefits and costs, and speculates about the changes yet to come. It also introduces three new discussion papers written for The Hamilton Project that aim to harness the opportunities that the technological advances in the recovery of natural gas offer, while managing the risks. It then assesses the energy challenges that continue to confront the United States, and reiterates four principles for sound energy and environmental policy developed in The Hamilton Project’s paper, “A Strategy for America’s Energy Future: Illuminating Energy’s Full Costs” (Greenstone and Looney 2011). Finally, it introduces a fifth principle motivated by the vast increase in the supplies of natural gas and petroleum in the United States. These five principles follow:

1. Appropriately price the social cost of energy production and use. Many sources of energy, especially fossil fuels, have costs beyond what users pay at the pump or to the utility company. Because consumers and companies do not face the full costs of their energy use, they overconsume fuels that harm the environment and human health. Pricing these costs through cap-and-trade or tax policies would give consumers and firms the incentive to make decisions that are more informed and socially efficient, and that induce innovation in the energy sector.

2. Fund basic research, development, and demonstration of new energy technologies. Basic research and technology demonstration projects today are necessary to lay the groundwork for future technologies that can provide cleaner, low-cost energy. However, the private sector does not have sufficient incentives to undertake all beneficial projects because they benefit multiple firms so individual firms cannot recoup the full benefits of these activities; this creates a critical role for government in funding and supporting the early stages of research and demonstration in the energy sector.

3. Make regulations more efficient. Regulation helps create a balance between the benefits of energy consumption and the negative environmental and health consequences of energy production. In order to create the right balance, regulation should be subject to rigorous cost-benefit analysis and retrospective review.

4.Address climate change on a global scale. Any solution to climate change will require an international effort by both the developed countries that currently lead the world in emissions, and the developing countries that will drive emissions growth in the future. Negotiations must play a large part in this effort, but some smaller steps can be taken in the interim to begin setting the stage for a global solution.

5. Capitalize on the economic opportunities arising from new domestic natural gas and oil discoveries, while protecting the environment. The increased production of domestic supplies of natural gas and oil can help reduce energy prices for American consumers and businesses; enhance the country’s energy security and reduce its susceptibility to macroeconomic shocks arising from oil supply disruptions; reduce pollution emissions; and boost employment, incomes, and economic output. In order to achieve all these gains, energy policies should facilitate domestic gas and oil production in settings where the benefits exceed a full accounting of the social costs.

In accordance with these principles, three new Hamilton Project discussion papers propose new ideas on how to position public policy to take better advantage of the economic opportunities presented by the increased supplies of natural  gas and petroleum, while also taking into account risks to the environment and to the health and safety of American families.


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