Friday, June 21, 2013

How Adam Smith Revived America's Oil Patch

By Joel Kurtzman

Wall Street Journal

June 20, 2013

The debut of a new truck engine rarely attracts much attention. But this spring Cummins Inc. CMI -1.17% released two new truck engines worthy of notice: They are designed to run on natural gas, not diesel. Natural gas is abundant, domestically produced, cleaner and cheaper than oil-derived diesel. It could help set America free of foreign oil.

The natural-gas-powered ISL G and ISX 12 engines are the latest sign of the country's fundamental shift in energy resources and infrastructure. Cummins built its engines without a penny of government support—a reminder that free markets can solve problems that politicians argued about for decades but failed to fix.

Natural-gas reserves are plentiful but not always easy to recover. It took an individual entrepreneur, Texan George P. Mitchell, to perfect the technology of hydraulic fracturing beginning in the 1990s that has made so much more of the gas available. And fracking, it turns out, also can be used to recover oil from formations that could not previously be tapped.

Fracking technology is responsible for last year's 14% increase in oil production to 8.9 million barrels per day, the largest increase ever, and a massive, five-year increase in natural gas production, to 28 billion cubic feet a day from five billion in 2008. The increased supplies of both also are responsible for a drop in oil imports and declines in carbon-dioxide emissions to 1993 levels.

I have no idea what Mr. Mitchell's motivations were, but I'm confident that profits were at or near the top of the list. By serving his own interests, as Adam Smith put it more than 200 years ago, he served the interests of society.

The impetus for fracking cannot be found in four decades of presidential speeches about energy independence, or in any acts of Congress. Instead, it arose from economically painful spikes in oil prices engineered beginning in the 1970s by the OPEC cartel. High prices did what they always do—they set off a hunt both for substitutes and for more supplies to take advantage of high prices.

Fracking technology addresses both issues by increasing supplies of oil and of its cleaner, cheaper substitute, natural gas. These two forces—the search for substitutes and the rush to cash in on high prices—will change the nation's economy profoundly.

Another crucial factor contributed to the energy revolution. Plentiful oil and natural-gas reserves exist around the world, but the U.S. is far ahead of every other country in bringing those resources out of the ground and onto the market. The reason? America is one of the few countries where an individual or company can own the resources that lie beneath the ground.

Almost everywhere else—including even the United Kingdom—the rights to minerals of all kinds, including oil and natural gas, are claimed by the government. Unless the government wants you to drill, you might as well put your tools away. As a consequence, there is much less incentive to innovate. Why bother if you can't own what you produce, or you can't profit except at a bureaucrat's sufferance?

Today, because fracking is producing oil and natural gas at record levels, others are joining Cummins in getting into the act. Companies like T. Boone Pickens's Clean Energy Fuels are laying out a network of natural-gas filling stations on major U.S. highways so that trucks, using new engines, can fuel up. New pipelines, such as the one Spectra Energy proposes to connect New York and New Jersey, are in the works, in addition to the 16,000 miles of interstate natural-gas pipelines built over the past decade.

Most energy analysts, as well as big oil companies like Exxon, expect that the U.S. will become a net energy exporter between 2020 and 2030. When that happens, the $400 billion that Americans are on target to send overseas this year to pay for oil imports will shrink, perhaps to zero. A $400 billion swing from negative to neutral, or even to positive, in the energy trade balance is something no one would have predicted even a few years ago.

Letting markets do their work sometimes requires an act of faith. The temptation that many people have, especially in government, is to give those forces a shove in one direction or the other. But when people are allowed to use market signals to determine where and how to mobilize their creativity, resources, energy and effort, amazing things can happen. Abundant energy for the foreseeable future is one spectacular example.

Mr. Kurtzman is the executive director of the Milken Institute's Senior Fellows Program.