Could Booming U.S. Natural Gas Production Come With a Dangerous Side Effect?

Will the United States economy be infected by Dutch Disease?

Feb 20, 2014 at 10:35AM

The U.S. economy has been underperforming for five years, but it could now be entering an economic golden age that will see a renaissance in the natural resource and manufacturing industries. The explosion in unconventional natural gas production, specifically from shale, is providing a boon to the U.S. economy, pushing it to new heights.

In 2013, the United States passed Russia to claim the top spot as the world's largest exporter of natural gas, in large part due to the increase in shale gas production. This was celebrated as our country becoming the "Saudi Arabia of natural gas." The irony became clear later in the year when it was revealed that U.S. oil production would overtake Saudi Arabia to become the number one or two oil producer in the world, depending on who you ask, by 2015.

This is all well and good. A golden age of manufacturing in this country that allows us to move away from the overwhelming service economy that we have become ought to be welcomed. It will provide plenty of benefits to the country, from much increased job creation to more money coming into the country, to the ability to supply the overwhelming demand to the many energy-hungry countries worldwide. Large energy companies like ExxonMobil (NYSE:XOM) and Royal Dutch Shell (NYSE:RDS-A), as well as producers with exposure to natural gas like Devon Energy (NYSE:DVN) and Anadarko Petroleum (NYSE:APC), will make a bundle. However, history shows us that like everything, there could be cons to even something as positive as the coming energy production boon -- more specifically, the looming danger of what's known as the "resource curse," or "Dutch disease."

Dutch disease
Dutch disease is a macroeconomic term that describes a correlation between an increase in exploitation of a prevalent natural resource and a decline in the competitiveness of the country's other industries unrelated to this common natural resource. The preeminent example is the Netherlands:The term was coined by The Economist in 1977 when describing the large decline in the manufacturing industry of the country after a large natural gas field was discovered there in 1959.

This Dutch disease model was developed in 1982 by two economists who hypothesized that the explosion in production in one sector would naturally create a polarization between the booming sector and all other industries, or lagging sectors (often other manufacturing or agriculture). This polarization would cause two things to occur: direct-deindustrialization, which is rapid movement of labor from the lagging sector experiencing less demand to the booming sector that would be starved of labor. The second effect is known as the spending effect, when the extra revenue that is being brought in through the booming sector is increasing the demand and investment in the last part of the economy, the non-traded goods, including assets such as water and electricity. Both of these effects severely impact the non-booming sector and hinder its future development.

Another effect of the "Dutch disease" is to cause a country's economy to become so tethered to its booming export that this completely controls the ebb and flow of the larger economy. Other countries buying large amounts of this resource increases the value of your currency, which makes your other industries less competitive globally. They also bounce up and down based on the movements of the market for your booming export. A country finds itself in a catch-22: The worse the other industries do, the more driven by your booming export your overall economy becomes. It's a vicious circle.

As you can see, a natural resource boom in a nation can have far-reaching effects, both positive and negative. Your economy enters a golden age, your currency gets more valuable, and especially with energy products, there is significant demand for your resource. Large energy companies like ExxonMobil or Royal Dutch Shell and natural gas drilling companies such as Devon Energy and Anadarko Petroleum will see historic profits. Conversely, this massive growth can drive your economy by itself and potentially set it up for a big fall as the global demand or domestic supply begins to decline. The question is whether there is any way to smooth out the oscillations of an economy that is showing early symptoms of this vicious disease.

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Karl Avard has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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