Valuation of expectations: A hedonic study of shale gas development and New York’s moratorium

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Abstract

This paper examines the local impacts of shale gas development (SGD). We use a hedonic framework and exploit a discrete change in expectations about SGD caused by the New York State moratorium on hydraulic fracturing. Our research design combines difference-in-differences and border discontinuity, as well as underlying shale geology, on properties in Pennsylvania and New York. Results suggest that New York properties that were most likely to experience both the financial benefits and environmental consequences of SGD dropped in value 23% as a result of the moratorium, which under certain assumptions indicates a large and positive net valuation of SGD.

Introduction

Shale gas development (SGD) has dramatically changed the US energy landscape in the last decade. The Energy Information Administration (2013) predicts that the US will shift from being a net importer to a net exporter of natural gas by 2020 and domestic production will increase 44% by 2040. Much of the attention on SGD has been on the Marcellus Shale, which extends over 95,000 square miles across New York, Ohio, Pennsylvania, and West Virginia (Kargbo et al., 2010). Marcellus drilling began in 2005 and has been the source of considerable extraction. From 2005 to 2014, 7797 unconventional wells have been drilled in Pennsylvania alone.

While the macroeconomic benefits to the US economy are clear, there is uncertainty surrounding the local benefits and costs to households and communities impacted by SGD. Property owners with mineral rights can receive substantial gas lease and production royalties (Pennsylvania Department of Environmental Protection, 2012); however, little is known about the magnitude of payments due to the private nature of the contracts. Potential costs of SGD could include various health and environmental impacts such as water pollution, air pollution, and traffic congestion. The impacts from the health and environmental externalities are also highly uncertain.

Given the current scale of SGD and expected growth in the future, it is critical to understand the local valuation of SGD. This paper seeks to answer this question using a hedonic framework, as housing prices should reflect the future stream of benefits and costs tied to the property. Empirically, this is hindered in two ways. First, the location of wells may be endogenous. Second, expectations about SGD form in advance of actual drilling, and if expectations are capitalized into housing prices, then a simple before–after comparison may lead to incorrect inference about the valuation. We mitigate these confounding factors by specifically focusing on expectations and using an exogenous shift in expectations to reveal valuation.

Just as hydraulic fracturing was beginning its exponential increase in Pennsylvania, New York State implemented a de facto moratorium on hydraulic fracturing on July 23, 2008, citing uncertainty about health and environmental impacts (State of New York׳s Executive Chamber, 2008).1 The state extended the moratorium multiple times between 2010 and 2014 (e.g., Wiessner, 2011) and, on December 17, 2014, the New York Department of Environmental Conservation implemented a permanent ban (Kaplan, 2014). These decisions were highly contentious, as evidenced by several dozen towns in New York passing resolutions in support of SGD in the spring and summer of 2012 and 15 towns are currently considering secession (Mathias, 2015).2 To date, there has been no hydraulic fracturing in New York.

This paper exploits changes in expectations that resulted from New York’s moratorium on drilling and measures this event’s impact on housing prices. Importantly, the moratorium did not mark a change in the amount of hydraulic fracturing in New York – expectations about future SGD are the only thing that changed.

We estimate the effect of the statewide moratorium using a difference-in-differences methodology. We use Pennsylvania as a counterfactual because expectations about future SGD were likely similar to those in pre-moratorium New York, but in contrast with New York, those expectations were realized. Our aim is to identify the change in prices for properties in New York that are most likely to be impacted by SGD (both positively and negatively), relative to price changes for similar properties in Pennsylvania. We use private well water use as a proxy for properties likely to experience SGD.3 These are essentially rural properties outside of municipal water supply boundaries, meaning they have the space requirements for drilling. Further, contaminated well water is one of the most common and serious environmental costs.

The design of our preferred sample is motivated by a border discontinuity and underlying shale geology. We begin with property transactions data for two Pennsylvania and three New York counties along the border. In the vein of recent border discontinuity designs (e.g., Grout et al., 2011; Turner et al., 2014) and specifically those that use state borders (Holmes, 1998, Rohlin et al., 2014), we restrict observations to be within five miles of the border in order to minimize unobserved differences in price determinants and best model the counterfactual for New York residents. Even after these restrictions, there are still substantial shale geology differences across the border. Thus, we further restrict observations to be in a specific band of shale thickness, a geological characteristic that strongly affects the amount of gas or oil in a reservoir (Advanced Resources International, 2013). These restrictions are meant to improve the similarity of expectations about future SGD. Post-moratorium spillovers across the border are a threat to identification. However, we contend that these effects are minimal due to pre-moratorium expectations about spillovers, the rapid pace of drilling stemming from high initial prices, the area comprising a single labor market, and southerly flow of surface water.

Using the 5-mile border and shale geology restrictions, our results suggest that the statewide moratorium decreased New York property values 23.1% for those properties most likely to experience SGD. Relaxing the sample restrictions leads to smaller estimates in the range of 10–21%, which suggests that effects are heterogeneous across our New York counties and that accounting for shale geology is critical for understanding expectations. We estimate a series of robustness checks that test additional shale geology restrictions, test for spillover effects across the state border, and use municipal water properties as an additional control, and results are consistent with point estimates in the range of an 18–26% drop in housing values.

We interpret these results as a positive net valuation of SGD by buyers and sellers in New York and Pennsylvania. However, this interpretation relies on two assumptions: the expected probability of SGD in pre-moratorium New York is 1 and the expected probability of post-moratorium SGD is 0 and New York and Pennsylvania property owners and buyers accurately valued the negative and positive aspects of SGD prior to the moratorium.4 We estimate several models that bolster our confidence in these assumptions. However, if either of these assumptions are false, we are still recovering the effect of the moratorium on property values, which is driven by expectations over financial benefits and environmental externalities of SGD, and this is an important estimate for areas considering bans on hydraulic fracturing. Further, the estimates serve as a validation that expectations are capitalized into property values.

One of the models we use to test the assumptions needed for an interpretation of net valuation is a more traditional model of the effect of proximity to drilling using only our Pennsylvania observations. The results suggest no price impacts of proximity. While one interpretation is that the impacts of drilling are small, we interpret this to mean that ex ante expectations established in the initial expansion of SGD in Pennsylvania were capitalized into property values and were accurate ex post leading property values not to change. These results corroborate our claim that New York households near the border have accurate expectations about SGD, which in turn supports a rational expectations assumption in hedonic valuation.

There are two major contributions of this paper. First, we provide new evidence of local impacts of SGD. Existing hedonic studies (Gopalakrishnan and Allen Klaiber, 2013, Muehlenbachs et al., 2015) find negative impacts of nearby drilling for well-water dependent properties as large as −22%. However, Gopalakrishnan and Klaiber 2013 also find that negative effects dissipate to a statistical zero 6–12 months after a permit is issued. Our results lead to very different conclusions. One reason may be that both of these studies either use data exclusively from western Pennsylvania or derive most of their identifying variation from western Pennsylvania. A concern is that split estates, where mineral rights are sold separately from the property, are common in western Pennsylvania due to the area’s more extensive history of resource extraction (Kelsey et al., 2012). In contrast, split estates are relatively uncommon in our focus area of eastern Pennsylvania and south-central New York. Thus, our data are more likely to recover net effects of SGD because property owners hold mineral rights and will benefit from royalties and lease payments.5 Our interpretation of Gopalakrishnan and Klaiber (2013) and Muehlenbachs et al. (2015) is that their estimates capture the negative externality of SGD near private well water, which is critical to understand, but mostly exclude the financial benefits because of the area of study. Consistent with this interpretation are recent survey findings that indicate a majority of property owners that do not hold the mineral rights to their property are dissatisfied with local drilling, whereas a majority of property owners holding mineral rights are satisfied (Collins and Nkansah, 2013).6

While the split estate issue is perhaps the most critical, there are other differences between our study and others that could lead to different estimates of the local impact of SGD. We incorporate physical attributes of shale geology into the analysis, which existing valuation studies have not utilized. This appears to be important to creating valid counterfactuals in a difference-in-differences framework. Further, our treatment group has no direct experience with SGD, though they seemingly would learn about it as SGD expanded right across the border. Additionally, we are estimating area-level impacts that capture impacts occurring to whole areas, as opposed to a proximity analysis that captures differential impacts for properties nearby drilling. This focus may average away some of the negative effects of SGD if property owners in NY expect that they would be minimally impacted by negative externalities since the placement of future shale gas wells is unknown.

The second contribution is to add to our understanding of how expectations are capitalized into property values. While many hedonic papers implicitly assume expectations exist and recent structural models have incorporated expectations (e.g., Bishop and Murphy, 2011; Ma, 2013), we offer a particularly clean, reduced-form illustration of how expectations factor into prices. The effect of the New York moratorium is to change expectations, whereas the results of the proximity analysis using only Pennsylvania properties support the idea of rational expectations because no price changes occur once drilling commences. This work also complements hedonic studies that show new information can cause capitalization of dis-amenities, even when levels of dis-amenities do not change (e.g., Pope, 2008; Guignet, 2013).

Section snippets

Background

The first objective of this section is to catalog various estimates of benefits and costs of SGD, which is critical for putting our estimates of the net valuation of SGD in context. Given the private and dispersed nature of financial benefits, it is a contribution of this paper to compile these estimates. The second objective is to give a timeline of SGD in Pennsylvania and SGD regulation in New York.

Conceptual framework

In this section we present a hedonic property model that incorporates the phenomena of interest, the valuation of expected shale gas development through the enactment of a moratorium. The hedonic valuation methodology, originally presented by Rosen (1974), posits that the price of a heterogeneous good can be decomposed into implicit prices associated with its individual characteristics. By separating the price of the good into its implicit prices, the technique can help illuminate the value of

Methodology

We develop a model that identifies the impact of the New York statewide moratorium on housing prices, and thus reveals the net valuation of expectations about SGD. We employ a difference-in-differences model, which compares properties in New York before and after the moratorium to similar properties in Pennsylvania. As discussed in more detail in the next section, our preferred sample is comprised of properties within five miles of the state border with similar shale geology and only includes

Data

This study was conducted with property transaction data from five counties along the New York – Pennsylvania border: Chemung, Steuben, and Tioga counties in New York; Bradford and Tioga counties in Pennsylvania. We specifically chose these five counties because (1) the two Pennsylvania counties constitute one of the major clusters of drilling in that state, (2) all five counties are primarily agricultural and rural in character and thus make for good comparison, and (3) they border each other

The effect of the statewide moratorium

Table 2 presents the main results of our analysis of the effect New York’s statewide moratorium on housing prices (Eq. 3). We present the double difference coefficients from five models, each with the same specification, but with progressively more stringent sample criteria. As controls, all models include a variety of property-specific characteristics, year fixed effects and township fixed effects. Column 1 includes all transactions in each of our five sample counties. Column 2 restricts

Conclusion

This paper proposes to view hedonic analysis through a different lens by focusing on the formation, realization, and change of expectations to inform environmental policy. We provide area-level impacts of the statewide moratorium on SGD for households living in New York. Under assumptions of rational expectations of benefits and costs of SGD and the statewide moratorium causing a 100% change in expectations about the probability of SGD, the results are interpreted as the net valuation of the

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  • Cited by (0)

    We thank Branko Boskovic, Michael Delgado, Dennis Guignet, Martin Heitzelmann, Gal Hochman, Neha Khanna, Lucija Muehlenbachs, Tom Sproul, Chris Timmins, Jeremy Weber, Nikolaos Zirogiannis, seminar participants at Cornell University, Fordham University, Rutgers University and University of Minnesota, participants at the 2014 NAREA workshop on non-conventional oil and gas energy and the 2014 NARSC conference, and two anonymous referees for useful suggestions. We are grateful to county planning and real property departments, Nicholas Berry of the NYS Department of Taxation and Finance, Southern Tier Central Regional Planning and Development Board, Debbie Kolodziej, FracTracker Alliance, Natural Gas Forum For Landowners, Elisabeth Radow, David Messersmith, and Attorney Douglas Clark, who have helped us obtain data, understand the timeline of shale gas development, regulation and financial impacts. We acknowledge funding from Rhode Island Agricultural Experiment Station (contribution #5438). Any errors are our own.

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