Tuesday, January 1, 2013

HOW WE WERE FOOLED (Pub Date 1/12/2013)

Thus far West Virginia’s Marcellus shale natural gas boom has been a myth. While production has grown significantly, predicted economic benefits – tens of thousands of new jobs, tens of millions of dollars in new tax revenue, and hundreds of millions of dollars pumped into local economies– have failed to materialize.

Workforce West Virginia calculates the number of jobs added by the oil and gas industry since 2008 to be 916 – less than 10% growth in four years. Meanwhile, severance tax receipts haven’t grown since 2008. And you don’t have to be an economist to see that Marshall, Wetzel, Doddridge, and Harrison counties, which host the bulk of drilling activity, are not booming.

The question is, why? Haven’t our leaders told us natural gas is a game-changer for West Virginia? Aren’t they supported by studies such as the 2010 Marcellus Coalition study and most recently a report by the U.S. Chamber of Commerce's Institute for 21st Century Energy, which suggests the industry could generate 29,000 jobs by 2020 and 58,000 by 2035?

The answer is, yes, they are. So, why have they and the studies been wrong? Let’s look at the reasons.

Studies are based on statistical models, which can suffer from two kinds of errors: factual and methodological. The studies upon which policy-makers have based their optimistic expectations for economic growth in West Virginia have suffered from combinations of both. Here are some examples.

Overestimating the price of natural gas. Tax revenues and royalties are determined in part by the market price of natural gas, which studies from two to three years ago typically assumed would bottom out at about $4.50/thousand cubic feet and then gradually rise to between $6 and $8.

Instead, the supply glut brought about by fracking caused pricies to descend to $2 and recover only to the present level of $3.25 -- far below the amount expected.

Underestimating the effect of absentee ownership. One study that overestimated economic impact in West Virginia also did so in Pennsylvania where it was shown that the authors assumed 95% of royalty payments would go to Pennsylvania residents and into Pennsylvania’s economy. In fact, only 63% did so vastly undercutting the local economic impact.

Misunderstanding what people do with royalty payments. At least one major study assumed property owners would treat royalties like regular income and spend it within a year. In fact, recipients saved more than 40%, greatly lessening economic impact.

Overestimating the share of goods and services the gas industry purchases from West Virginia suppliers. These purchases drive “indirect” job growth. However, gas companies, virtually all of which are out-of-state entities, seem to be purchasing less than expected from West Virginia suppliers.

Overestimating the share of jobs occupied by West Virginians. At least one study assumed that the share of natural gas jobs occupied by West Virginians would mirror the share in other industries. This assumption seems to have been spectacularly inaccurate.

In addition to these factual errors, studies have also had methodological flaws.

Some studies get primary data from surveys of drilling company executives who report their expectations for production, purchasing, and hiring. This group, which seeks to attract investors and curry favor with politicians, tends to be overly optimistic, which may explain why many companies haven’t fared any better than West Virginia. Chesapeake Energy, West Virginia’s largest driller, has seen its stock price drop by two-thirds since 2008.

Finally, studies often fail to fully account for the costs of natural gas drilling. These costs offset some benefits. For instance, if a gas well that generates $10,000 in income replaces a cornfield that generated $7,500, the economic gain is only $2,500, not $10,000. Similarly, if the presence of a gas well diminishes the value of the property for commercial or residential purposes, there is also an economic loss.

Natural gas drilling also costs individuals and communities in other ways. It requires the construction and maintenance of roads and other infrastructure. Sales tax exemptions and other subsidies granted to companies can detract from economic benefit. And there’s the problem of risk. Laws designed to encourage development sometimes shield companies from full responsibility for damages resulting from their activities. So taxpayers bear the costs.

These factors and the others previously mentioned have caused studies to consistently exaggerate the economic benefits of natural gas development. The effect has been compounded by uncritical acceptance by politicians and journalists who repeat the claims and, thereby, confer credibility on them.

Perhaps now that discrepancies between predictions and performance are becoming apparent, journalists will begin to question assertions of job growth and economic stimulus or at least note that previous predictions have been unduly and even wildly optimistic.

And maybe we and our leaders will adopt realistic expectations of the economic benefits. The market price of gas may never be as high as we once hoped. And the problems of absentee ownership and development are structural, which means there are no easy remedies. Consequently, whether or not the price of natural gas rises, much of the wealth that’s generated will continue to drain from West Virginia.

So, while we can make things better by training West Virginia workers to fill jobs, by driving the hardest possible bargain on taxes, and by assuring that the industry shoulders the economic consequences of health and environmental risks, we should also recognize that the term, “game changer” has been and probably will always be a misleading rhetorical flourish.

Sean O’Leary can be contacted at seanoleary@citlink.net. A version of this column containing links to references and statistical sources may be found at www.the-state-of-my-state.com.

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