This past June was a big month for fracking and oil markets around the world.
First, the U.S. Environmental Protection Agency (EPA) released its long-awaited draft report on the impact of fracking and drinking water, “Hydraulic Fracturing Drinking Water Assessment.” The report, which was commissioned in 2010, was designed to review all aspects of water management related to hydraulic fracturing, including any overall impact on water quality; the impact from withdrawals or use of surface or subsurface water; the storage, treatment and disposal of produced and flowback water; and the impact from contaminants that may affect drinking water, including those chemicals used in the fracking process itself.
Reporting on the Environment
In the draft report, EPA concluded that while there were many ways in which fracking had the potential to impact water sources, it has not contributed to widespread impact on drinking water. In the report, EPA does acknowledge that isolated incidents in which fracking itself or the ancillary operations required to run a fracking operation did impact water sources, but the number of these incidents is small compared with the overall number of fracking operations and wells. EPA estimates that 9.3 million people live within 1 mile of a hydraulically fractured well, and more than 6,500 sources of drinking water for public water systems serving approximately 8.6 million people are or were located within 1 mile of one or more fractured wells. The potential for impact is large, but, while incidents have occurred, widespread impact has not been realized thus far.
Although not stated in the EPA draft report, it is my guess that the frequency and nature of these isolated incidents is similar to the frequency of isolated incidents in general in oil drilling or other industrial operations where surface or subsurface water withdrawals occur. Accidents happen in all sorts of activities, and it is acknowledged that they have happened in a number of fracking operations. But EPA did not find that the frequency of fracking-related incidents or the nature of the incidents was particularly unique.
The study is, of course, controversial. In public statements and posts on social media, proponents of fracking have latched onto the EPA conclusion that “fracking has not led to widespread impact to drinking water,” while opponents of fracking have latched onto statements such as “EPA identifies many mechanisms by which fracking has the potential to impact drinking water.”
The EPA draft report will undergo review by the Science Advisory Board and will be open to public comment this fall. Regardless of the current controversy, it seems that the tone for the future environmental policy of fracking has been set. While the review and public comment certainly will shape the final report and agency policy, it seems unlikely that the outcome will be dramatically different from the conclusions in the draft. If that is the case, the environmental impact of fracking will be governed by reasonable controls and regulations and not nationwide restrictions or prohibitions and economics.
It is in this last area, economics, where fracking has and increasingly will continue to have great global impact.
Maintaining Oil Supply
This past June, at its regular meeting, the Organization of the Petroleum Exporting Countries (OPEC) decided to continue its policy of unconstrained production and not cut supply. Worldwide oil production currently exceeds demand, and OPEC’s decision not to curtail production should assure supply in excess of demand for the near future. But, more importantly, it signals that OPEC recognizes that it no longer can control pricing by controlling the supply of oil in world markets. This change is brought on largely by fracking.
In 1979, OPEC’s share of world oil output was about 50%. This allowed it, through collective efforts, to control world supply and therefore prices. There were no other large oil producers with sufficient capacity to close any gap in production that OPEC decided to create. Today, however, the share of world oil coming from OPEC countries is less than one-third, and worldwide oil production is estimated to be at least 2 million barrels per day higher than demand. This excess supply, created largely by fracking, limits OPEC’s ability to impact prices by restricting output. Furthermore, this additional supply has driven prices below the level that many of these countries need to balance their budgets. Further production cuts without being able to orchestrate a corresponding rise in price would only serve to reduce OPEC’s income.
Before fracking, OPEC was able to set world energy and oil prices through the control of supply. Today, the world price is controlled more than ever by supply and demand working through traders and energy markets. Unlike 30 years ago, when a single OPEC member may have controlled 5% to 10% of world supply and thus was able to have an impact on supply, today the additional supply coming onto the market comes from thousands of independently operating companies deciding how much to produce and sell by their own economics and business models, and current pricing. This creates a far more open free market for oil and gas, which can only be expected to expand as the use of fracking expands in the coming years. As fracking becomes more widely used outside of North America, thousands of producers will expand to tens or hundreds of thousands of producers, and output will become so diffused that it will only be able to be controlled through free market forces. Combine this dynamic with the dual impact of increased energy efficiency and climate change policies that will encourage the use of less carbon-intensive energy sources, and the demand for oil will further drop relative to the rising and increasingly less centralized supply. Lower prices and even more liberal open markets are here to stay.
These changes, of course, are not without disruption and risks. As I mentioned in a previous column (“The Butterfly Effect and Oil,” October 2014), some countries, especially oil-producing countries in West Africa such as Nigeria and Angola, are highly dependent on oil income and need far higher than current prices for their economy to be sound. Such prices are unlikely in the near future, putting these traditionally volatile countries at renewed risk for difficult economic conditions, tension and unrest. These will remain potential world hotspots.
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