How to keep the Bakken oil boom from becoming a bursting bubble

REUTERS/Jim Urquhart
Roughneck Brian Waldner is covered in mud and oil while wrestling pipe on a True Company oil drilling rig outside Watford, N.D.

The most recent issue of fedgazette, the Federal Reserve Bank of Minneapolis’ regional business and economics newspaper, devotes most of its space to the economic effects of the Bakken oil boom. The lead article summarizes North Dakota’s situation: “Congratulations on your oil boom…now the real work begins.” (If you don’t already subscribe to fedgazette, you should do so right away.  Go ahead, I’ll wait…)

In particular, North Dakota’s 13.4 percent growth rate of GDP in 2012 led the nation. What might surprise you is that Minnesota was in fifth place at 3.5 percent, with part of that growth driven by the Bakken boom. (In the rest of the neighborhood, it was Iowa in 16th at 2.4 percent, Wisconsin 32nd at 1.5 percent and South Dakota 46th at 0.2 percent.)

These numbers raise a couple of questions: Can North Dakota and Minnesota profit in the long term? And do plentiful natural resources promote economic development?

As with most economics questions, the answer is “on the one hand… but on the other hand…” Adam Smith, one of the founders of our discipline, was adamant that mining and other types of natural resource extraction were dead-ends, that “they are the projects, therefore, to which of all others a prudent law-giver, who desired to increase the capital of his nation, would least choose to give any extraordinary encouragement.”  

Resource curse

Smith’s skepticism has been generalized as the concept of the resource curse.  The general idea goes like this: An oil boom draws workers and capital out of long-run productive sectors (for example, high-tech manufacturing) for short-term gain. Once the boom is over, incomes grow more slowly and there is nothing much to build on for future productivity.

But the American experience is a counter to this view. In a series of papers, Gavin Wright of Stanford University, along with his co-authors have written that “not only was the United States the world’s leading mineral economy in the very historical period during which the country became the world leader in manufacturing (roughly from 1890 to 1910), but linkages and complementarities to the resource sector were vital in the broader story of American economic success.”

So where does that leave North Dakota?  As Ronald A. Wirtz writes in the fedgazette, “local communities and the state Legislature are realizing that oil production and its concomitant economic activity and wealth come with a laundry list of things to fix and otherwise spend money on.”  

In other words, North Dakota can avoid the resource curse if it uses its bounty wisely and invests its short-term gains in projects that have long-run payoffs. North Dakota took a step in this direction by creating the North Dakota Legacy fund, into which 30 percent of the state’s oil and gas taxes are deposited annually.

Kevin Allenspach of the St. Cloud Times wrote an award-winning series on the economic effects of the Bakken oil boom on central Minnesota. (Go read it here; I’ll wait.) He identified a number of routes through which the boom traveled to the St. Cloud area, including central Minnesota businesses opening offices in the area (Coborn’s grocery stores, among others) and participating in construction projects (for example, Lumber One of Avon and Cold Spring building apartments).

Minnesota can continue to earn returns from this relationship by being ready to take advantage of these types of indirect benefits. Minnesota health-care networks are looking at opportunities to expand in North Dakota, Minnesota law and accounting firms can work on Bakken projects, Minnesota engineering companies can gain expertise in oil field work and leverage that knowledge into projects outside the upper Midwest.

Lessons from the Gold Rush

One of my favorite stories I tell students is about the California Gold Rush.  When the dust settled and people took stock of who benefited most, it was clear that miners and mine owners profited the least. In the end, it was the shopkeepers who sold miners and mine owners the provisions and equipment they needed who benefitted. Collis P. Huntington and Mark Hopkins, two of the “big four” who founded the Central Pacific Railroad, made their fortune by doing exactly this in Sacramento, Calif.

Minnesota entrepreneurs should keep their eyes open for these opportunities, especially those that have the potential to create spin-offs and long-term growth after the oil boom settles down to more regular production. And policy makers in Minnesota should make it possible for Minnesota companies to take advantage of these opportunities and not get bogged down in border conflicts on taxes and the like.

Comments (4)

  1. Submitted by Neal Rovick on 08/26/2013 - 10:43 am.

    The best description I have heard of the Bakken is that it is a “Red Queen” play. In order to stay in the same spot, you have to run ever faster (Alice in Wonderland).

    The amount of oil produced per well is relatively small, the rate at which the production declines is high (40% decline per year) and the costs of production are near to the world oil price of $100/barrel.

    In order to maintain or increase production from the field, 2000 wells need to be drilled a year–with about 45,000 wells in the area by 2030. If you can imagine the changes wrought by the relatively paltry couple thousand of wells already drilled and multiply that by 10, you have the North Dakota of the future.

    The best producers are already in production with later wells expected to need more cost inputs and resources to develop–meaning that Bakken does not lower oil cost.

    Consider that each well drilled requires the use of 1 to 3.5 million gallons of water extracted from limited aquifers and other shared resources, what will be the ultimate cost of the withdrawal of 40 to 140 billion gallons of water to an area where irrigation is the only means by which modern agriculture is sustained? Even if partial “returned” to the aquifer, the re-injected water is severely degraded. And consider that the other product , natural gas, is so plentiful and unprofitable that it is flared off–making the US a top gas flarer in the world for the first time in recent years. How could there be any possible economic or ecological costs to burning off gas that we will need someday when it is not so cheap. By the way, the flared gas from the Bakken results in the greenhouse gas equivalent of 1 million addition cars on the road every day.

    As is true for so many things, the accumulated “profits” largely result from unrecognised costs.

    http://www.reuters.com/article/2012/11/21/column-kemp-oil-bakken-idUSL5E8MLJ6V20121121

    http://www.theguardian.com/environment/2013/jul/31/us-fracking-industry-gas-flaring

  2. Submitted by Ray Schoch on 08/26/2013 - 02:36 pm.

    They’re going to need

    …those Legacy funds. Having just returned from the fringes of the Bakken, where 24 and 30-wheeled “big rigs” are destroying US 85 from Dickinson to Watford City about as quickly as it can be rebuilt (largely at state cost), there seems likely to be a laundry list of infrastructure and other (i.e., water quality) issues with which North Dakota will have to deal in decades to come, and those issues will remain persistent problems long after the oil in question has been sold on the world market.

    My impression is that, despite considerable enthusiasm along these lines in some domestic political circles, oil from the Bakken field will not somehow be reserved for exclusively American refining and sale — it ain’t gonna drive down fuel prices at your local gas station. Having been pumped out of the ground by international consortiums, it will be sold on the world market at whatever price the buyer(s) might be willing to bear. The notion that the typical American driver will save substantially on fuel costs through the purchase of oil from regional sources simply doesn’t hold up. Oil is a fungible commodity, sold all over the world to the highest bidder(s).

    One might argue — I might argue — that one country’s resources ought not to leave that country, but adopting that view would likely produce an oil war rather quickly. Saudis and citizens of other Middle Eastern countries have no particular affection for the American secular state, but they don’t mind at all collecting American dollars in exchange for stuff they pump out of the ground underneath them, and in quantities that they simply cannot use.

    Save those Legacy funds, North Dakotans. You’re going to need them.

  3. Submitted by David Frenkel on 08/26/2013 - 11:53 pm.

    ND is making plenty of money

    A Univ of ND study indicated over a thousand people in ND have become millionaires because of the oil boom. The comparison to past mineral mining booms is irrelevant. As with any booms there are certainly some problems but the bottom line is the oil will be coming out of the ground for a few more decades. The natural gas flaring is a problem but it has been slowly reduced over the years to probably a third of the gas is flared.

    • Submitted by Neal Rovick on 08/27/2013 - 08:59 am.

      Some of the millionaires are the people who have installed high capacity water pump wells used to withdraw large volumes of groundwater for use in the fracking process.

      10 years from now, when the aquifers are dry, they will have their millions and they will leave a land and people that will have to survive only on the water that falls from the sky.

      And…
      (quote)

      Roughly 29 percent of natural gas extracted in North Dakota was flared in May, down from an all-time high of 36 percent in September 2011. But the volume of natural gas produced has nearly tripled in that timeframe to about 900,000 million cubic feet per day, boosting flaring in the state to roughly 266,000 million cubic feet per day, according to North Dakota state and Ceres data.

      http://www.reuters.com/article/2013/07/29/us-bakken-flaring-idUSBRE96S05320130729

      (end quote)

      Flaring is down in percentage terms but a very real increase in absolute terms.

      I would guess that water usage and flaring would be a practical indicator of the “boom-ness” of the boom…..it’s the propensity to waste other valuable resources in the scramble to get the highest amount of the target resource.

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