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Methane (CH4) is both the primary component of natural gas and also a highly potent greenhouse gas. Methane routinely leaks out from oil and gas wells, pipelines, and processing facilities into the atmosphere, exacerbating climate change. While there is a private incentive for operators to reduce methane leaks to capture and sell it as a valuable commodity, the private incentive to capture the gas falls far short of — around 1/10th of — the social costs imposed by its leakage. As a result, basic economics demonstrates that industry will exert insufficient effort to capture that gas, relative to the social optimum. To combat this problem, economists and policymakers have proposed methane fees to both reduce greenhouse gas emissions and raise federal revenues (for example, as seen in S.645, H.R.4084).

While, on the one hand, fees on methane leaks will further encourage oil and gas operators to proactively seek out and mitigate methane leaks, the additional fees will also raise the marginal cost of producing each unit of gas (typically measured in either thousand cubic feet, mcf, or million British thermal units, MMBtu). This increase in marginal cost is the net of three effects, two of which are cost increases (+) and one which represents a decrease (–).

1. (+) The methane fee, assessed as a percentage of each MMBtu of gas production, represents a direct increase in gas producers’ operating cost;
2. (+) The fee will induce gas producers to deploy more time, effort, and resources to reduce methane leaks, representing an indirect, induced operating cost; and
3. (–) The reduced leakage rate resulting from (2) will mean more produced gas can be sold, reducing the cost of each delivered unit of gas.
   
   

On net, these effects are likely to increase the marginal cost of gas production. In this issue brief, I use a simple economic model to estimate the effects of proposed methane fees on the marginal cost of gas production, methane leakage rates, and the resulting increase in wholesale natural gas prices. While the details are presented in the Appendix, the model simulates how a gas producer would respond to alternative methane fees, based on an augmented version of the model in Marks (2018). The model simulates, for each of a variety of potential methane fees (in units of $/ton CH4), how much gas producers may mitigate their methane leak rates and how much those fees may increase the cost of producing each unit (MMBtu) of gas, as well as how much of those resulting costs may be passed on to consumers. Finally, as a point of comparison, this brief presents as reference points various natural gas prices, such as wholesale and retail prices of natural gas delivered to different end-users (e.g., residential, commercial, industrial, and electric power).