from Energy, Security, and Climate and Energy Security and Climate Change Program

Should the United States Export Natural Gas?

June 29, 2011

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Fossil Fuels

The boom in shale gas production has changed the conversation in Washington from one of how to manage dependence on imported natural gas to a debate over whether (and to what extent) to export the fuel. I’m unsure of exactly where I come down on the matter. But I want to lay out a series of questions that I think ought to be addressed before policymakers make a decision one way or the other.

The standard economic argument in favor of exports is straightforward: All economies gain from trade. If the United States starts exporting gas, that will raise average U.S. gas prices. But this damage will be more than offset by increased revenues to U.S. producers and those they support.

This is a good starting point for discussion, but it is just that. Here are four potential complications that policymakers and analysts should be thinking about:

Volatility. The standard argument in favor of market linkage is that integrating markets reduces volatility. People typically use a bathtub analogy: if I double the size of my bathtub (read: gas market), any disturbance I encounter (read: weather events or political turbulence) will be dispersed in a larger body of water, thus reducing the size of any waves (read: price spikes) that result. But this argument has limits. If my initial market has relatively low volatility, and I integrate it with another that has considerably bigger swings, I may end up facing more volatility myself. To push the bathtub analogy a bit further, if I double the size of my bathtub, but I now need to share it with a bear, I might not actually be better off.

This matters because volatility, in itself, creates economic losses, since it becomes more difficult to efficiently allocate resources in the face of changing resource prices. This is uncontroversial. If international linkages (i.e. allowing exports) result in greater volatility, then there will be a balance to be struck: policymakers will need to ask whether or not the equilibrium gains from trade outweigh the losses from increased volatility. In principle, of course, one could simply internalize the losses from volatility through an appropriate tax, rather than incorporating volatility considerations into export policy decisions. But since such a tax is likely to be politically infeasible, that is not a fallback upon which one can rely.

One caveat to all this: It is not obvious that allowing exports would increase volatility in the U.S. natural gas market. To be certain, one would expect that geopolitical shocks elsewhere in the world would have a greater impact on U.S. gas markets if the United States were exporting robustly. But the existence of international demand could also reduce U.S. volatility in the face of periodic domestic demand shortfalls. (Of course, full integration could also help blunt domestic shocks through increased imports, but that isn’t what’s being debated here.) The net impact is something that needs to be examined quantitatively.

Gas-Oil Substitution. There are few cheap opportunities to substitute natural gas for oil in the U.S. economy. The same isn’t true in those parts of the world that still use considerable amounts of oil in power generation. Exporting gas to those countries could help reduce global oil consumption, resulting in a range of benefits to the United States.

Foreign Policy Opportunities. Not everything in life is about economics. I can imagine, in particular, a few areas where the foreign policy benefits or damages of exports would be impossible to put a dollar figure on. The first is climate change. It does not really matter from the atmosphere’s perspective whether U.S. gas is used to displace coal fired generation in the United States, China, or elsewhere. But it may matter considerably for climate diplomacy. Insofar as increasing gas exports reduces the amount by which the United States is able and willing to cut its own greenhouse gas emissions, that could be damaging to the U.S. position in the world.

The second area involves exports to strategically important countries. U.S. gas exports to Europe, for example, might help wean the continent off Russian gas, with attendant international security benefits to the United States. Similarly, if U.S. gas exports help integrate global gas markets, resulting in more transparency in the setting of gas prices, that could have widespread diplomatic consequences.

The last area involves the potential to get dragged into international disputes in which the United States would otherwise have little interest. If increased exports tie the U.S. economy (through trade) to the vagaries of conflicts in other parts of the world, U.S. policymakers may feel more compelled to intervene, lest the economic consequences become unpleasant. This is currently a fact of life in the oil markets; might it become more of one in the world of gas too?

Distributional Consequences. I noted at the outset that standard trade theory points out that losses to U.S. consumers from exports should be more than outweighed by gains to producers. But that is little solace to those who consume gas. I am partial to the theoretical argument that says that policy should largely be determined by macroeconomic efficiency considerations, and that progressive taxation and other government policy should be used to deal with any distributional problems that arise. The reality, though, is that the second part – i.e. rectifying inequality – often doesn’t happen. In such cases, it strikes me as appropriate to take distributional issues into consideration in the initial decisionmaking process.

Different policymakers and analysts might be pulled in different directions depending on their answers to these questions. As I noted at the top, I’m not sure where I personally come down in the end. I do know, though, that before charging full speed ahead into exporting U.S. natural gas, it’s important that people think through these issues.