Externality, PA: How Economics Can Be Used to Protect Pennsylvania’s Environment
by Ted Edwards
A farmer in Venango County, Pennsylvania is looking to sell her one hundred acre farm, but she
cannot find any buyers because of six rusting gas wells on her property. A father continually reminds his
children never to play near the large tanks of spent drilling fluid left on his property in Westmoreland
County, Pennsylvania. A retired navy veteran remembers hunting in his family’s woods in Butler County
Pennsylvania with his father. The woods have since been replaced by dirt roads and an impoundment
dam which seems eerily devoid of life. These stories are typical of Western Pennsylvania, where a
century and a half of drilling for oil and gas has left parts of the otherwise pristine countryside scarred.
Pennsylvania has long played a prominent role in the production of energy in the United States.
In 1859, the first oil well in the country was drilled in Titusville, Pennsylvania. By the dawn of the
twentieth century, Pennsylvania was far and away the national leader in coal production, according to the
United States Geological Survey (USGS). A century later, Pennsylvania again finds itself at the vanguard
of yet another energy revolution.
Pennsylvania sits atop a massive geologic formation known as the Marcellus Shale. The
Marcellus formation stretches from New York to Kentucky, covering a large swath of Pennsylvania. For
the past few years, The Marcellus Shale has been a topic of discussion in board rooms in Houston, Texas
and the object of Wall Street analysis because trapped within the rock is an almost unimaginable quantity
of natural gas. Until recently, the technology to harvest this gas did not exist or was simply too
expensive. The USGS estimates that the Marcellus formation contains 84 trillion cubic feet of natural
gas, making it the largest unconventional gas basin the USGS has examined. Researchers Timothy
Considine of The University of Wyoming and Robert Watson and Seth Blumsack of Penn State
University estimate that by 2020, Pennsylvania will bring in over $1.8 billion in local and state tax
revenue as a result of natural gas production in the Marcellus Shale. The nickname “The Saudi Arabia of
Natural Gas,” suddenly seems appropriate.
Not All that Glitters is Gold
While politicians, CEOs, and some private land owners might rejoice in light of their windfalls,
others are worried about adverse effects which could come as a result of the influx of industry in the state.
Drilling a natural gas well often requires clearing acres of pristine boreal forest for acres of concrete well
pads, access roads, and large impoundment dams for spent drilling fluids. Researchers from Carnegie
Mellon have stated that drilling activity in the Marcellus Shale could disturb upwards of 300,000 acres of
forested land in Pennsylvania, about the size of 225,000 football fields. If left un-reclaimed, the effects
on Pennsylvania’s wilderness could be dire.
The effects of un-reclaimed lands are numerous and almost exclusively adverse, according to the
Pennsylvania Department of Environmental Protection (PA DEP). Forest fragmentation, introduction of
invasive species, diminished biodiversity, reduction in migratory bird population, and contamination of
waterways have all been documented as results of un-reclaimed drilling sites. Research into the scope
and magnitude of effects is still being carried out by the PA DEP and other agencies.
For this reason, laws governing gas drilling in Pennsylvania require well operators to reclaim
sites after gas production. Reclamation is the process of returning a site to a condition as near as possible
to the site’s original state. This includes plugging the well itself, removing the concrete well pad,
regrading disturbed soil, planting native shrubs and trees, and implementing a long term wastewater
management plan. This process carries with it high costs, sometimes in excess of $100,000 according to
the PA DEP.
The issue of un-reclaimed land arises from the benefit/cost schedule inherent in natural gas
drilling. Benefits from natural gas drilling (i.e., revenues) are realized almost immediately. The costs of
reclamation do not arise until the well has stopped producing economic benefits. In short, firms have to
pay for something from which they will receive no future benefit. Prior to Pennsylvania’s Oil and Gas
Act of 1984, there was no mechanism in place to ensure that producers did not simply walk away from
these obligations, leaving sites un-reclaimed.
In 1984, the state began requiring natural gas producers to post a bond prior to commencing
operations in order to ensure that this reclamation process is carried out. This regulation is still in place.
The bonds are held by the state until it is determined that either, the operator has carried out its
reclamation obligations, or that the operator has not met the statutory reclamation requirements. In the
event that the operator performs reclamation, the bond is released back to the operator. In the event that
they do not, the bond is used to finance the site’s reclamation by the state. This is a pretty basic and
theoretically sound application of environmental bonding.
The idea behind environmental bonding is to force firms to internalize costs which otherwise
would be left up to society (i.e., taxpayers). In this case, the market price for natural gas does not reflect
whether or not a firm properly reclaims its sites after drilling. In a simplified model, the market price for
gas reflects demand and supply. Supply is a function only of the costs which go into procuring the gas.
Any costs which arise after the gas had been sold at market are not accounted for—and are thus left to
society. This is an example of what economists call an externality.
Unfortunately, Pennsylvania’s current laws regarding bonding requirements are woefully
inadequate. There are two types of bonds which firms may use to meet bonding requirements. Individual
bonds and blanket bonds. Individual bonds cover only a single well, while blanket bonds may be posted
to cover all of the wells which an operator owns within the state. In 2012, Pennsylvania adopted new
regulations regarding oil and gas development within the Commonwealth. In regards to bonding, the
state established two bonding schedules depending on depth and number of wells. For producers
operating between 1 and 50 wells of less than 6,000 ft, individual bonds are $4,000 and blanket bonds are
$35,000. For producers operating between 1 and 25 wells of at least 6,000 ft, individual bonds are
$10,000 and blanket bonds are $140,000. The table below displays these figures.
Depth
Number of Wells
Individual Bond
Blanket Bond
Less than 6,000 ft.
1-50
$4,000
$35,000
At least 6,000 ft.
1-25
$10,000
$140,000
Have you noticed a problem?
Wells are bonded for just $4,000-$10,000, while reclamation costs can, and often do, run into six
figures. Under this condition, firms are better off forfeiting their bonds and simply walking away after a
well has stopped producing without performing any reclamation, thereby leaving taxpayers to cover the
balance—and cover the balance they have. Between 2007 and 2008, over $1 million of tax payer money
was put to use reclaiming abandoned and orphaned gas wells, according to Pennsylvania’s Growing
Greener program, a state-administered program aimed at rehabilitating and protecting land and waterways
throughout the Commonwealth. Growing Greener focuses its efforts on addressing environmental
concerns such as watershed restoration, protection of open space, development of recreational trails and
parks, and other initiatives.
The problem of abandoned wells is not going away for Pennsylvanians, either. PA DEP
estimated in 2004 that it would take 160 years to plug all of the orphaned wells which existed throughout
the state. It should be noted that the number of abandoned and orphaned wells will likely increase due to
the recent increased drilling activity in the state as a result of the Marcellus Shale.
Addressing the Problem
The existing misalignment of incentives does not doom Pennsylvania to become a wasteland of
rusting drilling rigs and contaminated waterways. There is a simple solution to avoid this: Realign
incentives. Realigning incentives would consist of the common sense policy measure of increasing the
requisite bonding amount, thereby forcing producers to internalize the complete cost of reclamation.
Currently, only a small portion of reclamation costs are internalized via bonding, this creates a
disincentive to reclaim sites. By forcing firms to internalize all of the costs, the state will incentivize
operators to fully reclaim sites.
So what is the cost of reclaiming a site? PA DEP estimates the cost of site reclamation to wells of
less than 3,200 feet to be around $60,000. Matthew Andersen and Roger Coupal, economists from The
University of Wyoming estimate the cost of plugging a well to be $34.45 per meter of well bore. In 2010,
the PADEP stated that the average depth of unconventional gas wells was 3,254 meters. This puts the
cost of plugging the average unconventional gas well in Pennsylvania at over $110,000.
Thus, a reasonable approach would be to mandate bonding levels of $60,000-$100,000,
depending on depth of wellbore and conditions such as proximity to water sources and communities.
Further, blanket bonds should be eliminated. Instead, Pennsylvania should require all sites to be bonded
independently. This measure would ensure that all sites have dedicated funds for reclamation in the event
of operator insolvency or neglect.
Pennsylvania’s rich history of energy production has not come without costs. Look at the streams
of western Pennsylvania to see this point illustrated, where a strange orange hue in the water is indicative
of decades of acid mine drainage resultant from mining and poor mine reclamation. The development of
Pennsylvania’s natural gas resources need not follow the same pattern. With prudent foresight and a bit
of political will, we can compel natural gas producers to perform proper site reclamation. This in turn,
will encourage responsible use of our resources, while at the same time contributing to a robust and
growing economy.
References
Andersen, M.; Coupal, R., Economic issues and policies affecting reclamation in wyoming’s oil and gas
industry. The University of Wyoming. In National Meeting of the American Society of Mining
and Reclamation, Billings, MT, 2009.
Cabot Oil & Gas Corporation. Summary of Cabot’s Good Faith Efforts, 2010.
http://cabotog.com/pdfs/ExhibitB.pdf (accessed February 5, 2013).
Considine, T.; Watson, R.; Blumsack, S. The Economic Impacts of the Marcellus Shale Gas Play: An
Update. May 24, 2010. http://marcelluscoalition.org/wp-content/uploads/2010/05/PA-MarcellusUpdated-Economic-Impacts-5.24.10.3.pdf
Jason F. Shogren, Joseph A. Herriges, Ramu Govindasamy. Limits to Environmental Bonds: Lessons
from the Labor Literature. November 1991.
http://www.card.iastate.edu/publications/synopsis.aspx?id=635
Mitchell, Austin L.; Casman, Elizabeth A. Economic Incentives and Regulatory Framework for Shale
Gas Well Site Reclamation in Pennsylvania. Carnegie Mellon University, Department of
Engineering and Public Policy. October 10, 2011.
http://pubs.acs.org/doi/pdfplus/10.1021/es2021796
PennsylvaniaDepartment ofConservation andNaturalResources. Bureau of Topographic and Geologic
Survey,Well Completion Reports . In Pennsylvania Internet Record Imaging System/Wells
Information System (PA*IRIS/WIS); Pennsylvania Department of Environmental Protection:
Harrisburg, 2010.
Pennsylvania Department of Environmental Protection, Orphan Oil and Gas Wells and the Orphan Well
Plugging Fund. In Pennsylvania Department of Environmental Protection: 2007.
http://www.elibrary.dep.state.pa.us/dsweb/Get/Document-82185/5500-FSDEP1670.pdf
United States Geological Survey. The CoalProd Database: Historical Production Data For the Major
Coal-Producing Regions of the Coterminous United States. Jan 10, 2013.
http://pubs.usgs.gov/of/1997/of97-447/text.htm
United States Geological Survey Press Release. USGS Releases New Assessment of Gas Resources in
the Marcellus Shale, Appalachian Basin. August 10, 2011.
http://www.usgs.gov/newsroom/article.asp?ID=2893#.URz0UK_NkS8