China’s enormous growth in the past few decades stimulated a high demand for energy that historically has been fueled by coal. However, obtaining natural gas from fracking shale formations is becoming an economical competitor to coal in China because of advances in technology and economic incentives provided by the Chinese government (Thomas, p.1). Between 1984 and 2000, China’s energy demand doubled, and has doubled again been 2000 and 2008 (Nemec, p.1).
As the table below suggests, China’s natural gas production is increasing, and in 2013 coal production actually fell.
As China prepares to emulate America’s shale gas revolution, questions arise regarding the benefits of natural gas compared to the potentially unseen social and environmental costs. It is unclear if substituting fracked gas for coal will have an overall positive or negative impact on health and the environment in China. This post compares the economic externalities of each energy source in a microeconomic context.
Sometimes the actions of economic actors create costs for third parties that are not directly captured in market transactions; these costs are called externalities. In China, burning coal has created severe air pollution, which is associated with health and environmental damages for the general population. It is estimated that 1.2 million Chinese people died in 2010 from air pollution (Lee and West, p.3). In addition to personal health damages, the costs associated with protection from air pollution (face masks and indoor air purifiers, for example) are borne by the general public and not coal-emitting power plants. Air pollution has also caused visibility issues, creating traffic jams and requiring new aviation safety measures (Lee and West, p.3).
In environmental economics, we represent these externalities with a marginal cost curve that is independent from the firm’s marginal cost curve (more often referred to as the ‘supply curve’). Labeled as MCexternality in the graph below, the cost of the externalities are not accounted for in the market equilibrium, and therefore there is too much economic activity that relies on the burning of coal. To take the negative externalities of coal into account, the marginal cost of the externality and private marginal cost should be summed, yielding a social marginal cost curve. It can be seen that the socially optimal quantity of coal demanded (Q’) is less once the externalities are accounted for, and the price of the good is higher (P’) because the firm has internalized the externality.
Given the high external costs of burning coal, natural gas is being considered as a viable and less damaging alternative. Substituting natural gas for coal is expected to reduce air pollution and in turn lessen the aforementioned health, environmental, and transportation issues. Fracked natural gas as an alternative is promising, since it is estimated that China’s shale gas reserves are the largest in the world, 1.7 times that of the United States (Lee and West, p.4). However, fracking shale formations for natural gas comes with its own set of environmental challenges.
Externalities associated with fracking include water pollution (surface and groundwater), noise pollution, explosions, and earthquakes. These externalities generate their own environmental, health, and safety costs. Since many factors in China differ from the United States, it is difficult to foresee the size of the social costs. Extracting these shale gas reserves has proven difficult, however. Chinese gas reserves are generally deeper than American reserves, meaning drilling operations differ and there is a chance for unforeseen problems to arise. Water scarcity issues in proposed fracking regions in China means that any water pollution that occurs would have an amplified effect. Low water availability also means that water needed to conduct the fracking will be costly to bring in to the region (Lee and West, p.10). These challenges make it unsurprising that China’s National Energy Administration recently reduced the forecast of fracked natural gas in 2020 by more than half. Recently, falling crude oil prices have further dampened enthusiasm for fracking China’s shale oil reserves (The Economist, 2014).
While fracked gas and coal production each generate externalities, the nature of their externalities are quite different and it is not clear if substituting fracked natural gas for coal would be beneficial. In general, the externalities of fracking are more localized than the externalities of burning coal. For example, a user of natural gas in Beijing would likely not be harmed by fracking operations hundreds of miles away, but they might experience reduced air quality from a nearby coal-fired power plant. The switching of energy sources will very likely involve a transfer of welfare, since externalities from fracking will be felt by a much more geographically localized population, which should be taken into account.
There are several policies that the Chinese government could undertake in order to make the industries operate at the socially optimal level. But since each of these solutions (pollution taxes, or cap-and-trade-type schemes, for example) ultimately proscribes reduced consumption of coal and natural gas, it does not seem likely that environmental concerns will take precedent over generating economic growth. It remains to be seen whether future growth will be fueled by coal or fracked natural gas.
This article is adapted from a paper the author wrote in Fall 2014 for ACE 500: Microeconomic Analysis, with Mindy Mallory.
Lee, Jaeah and West, James. “Will China’s great fracking leap help it wean off coal?” The Guardian. 18 September 2014. Web. 20 September 2014.
Nemec, Richard. “U.S. Shale Advances Destined to Fuel China’s Future, Report Says.” Natural Gas Intelligence. 2 February 2015. Web. 11 February 2015.
“Natural Gas in China: Shale Game” The Economist. 30 August 2014. Web. 11 February, 2015.
“Overview Data for China.”U.S. Energy Information Administration. Natural gas & Coal data. Web. 11 February 2015.
Thomas, Mark. “Momentum Builds in China’s Emerging Shale Gas Sector.” Hart Energy. 13 January 2015. Web. 11 February 2015.
“Top Ten Coal Producers 2013e.” World Coal Association. September 2014. Web. 11 February 2015.