Frack to the future: What enticed small firms to enter the natural gas market during the hydraulic fracturing boom?

Highlights: • The U.S. natural gas market structure shifted during the shale gas boom. • Land lease speculation and a regime change in wellhead prices explain small firm entry. • Technological advances made it economically viable for small firm entry. • However, small firms were drilling vertical wells, not horizontally drilled and fracked wells. • Small firms would have entered the market in 2007 and 2008 regardless of these changes. -- Abstract: The shale gas boom of the early 2000s saw the highest and most volatile natural gas prices and production in history. Advances in horizontal drilling, 3-D seismic imaging, and hydraulic fracturing made it highly profitable for firms to produce large quantities of shale gas. This period was also characterized by a shift in market structure. The U.S. natural gas market was historically defined by large firms, but a large number of small firms began entering the market after 2000. While small firms made a negligible contribution to natural gas production during the shale gas boom, their entry may signal overcapitalization, productivity growth, and increased responsiveness of natural gas markets to exogenous shocks. We develop a real options model of market entry and exit and use data on natural gas drilling activity to test three potential explanations for small firm entry during the boom: 1. technological advances, 2. land lease speculation, and 3. regime change in natural gas prices. Our analysis provides mixed support for the first explanation but strong support for the last two.