Do Earthquake Compensations Restore Housing Prices?
Even with the current oil price at USD 60, fracking remains a popular method to extract oil and natural gas. Some countries and U.S. states have banned fracking due to environmental concerns. Another concern, or by now reality, is that fracking may result in earthquakes, affecting the local housing market. While fracking activity is mostly focused on the U.S., the largest source of natural gas in Europe is located in the north of the Netherlands. With several fields laying between underground layers of rocky sand and clay, it has provided most Dutch households with a cheap and reliable energy source for heating and cooking since the ‘50s.
Gas extraction has been producing earthquakes in the Netherlands for quite a while. These earthquakes are usually very mild, with local magnitudes not exceeding 1.5 on the Richter scale. Nevertheless, homeowners in the region have long claimed that the tremors damage homes and decreases the market value. However, the firm holding the concession to exploit the field (a JV between Royal Dutch Shell and ExxonMobil) mostly denied responsibility. With a strength of 3.6 on the Richter scale, the strongest earthquake to this day was registered on August 16, 2012. Almost immediately after, the firm began attending homeowners’ claims at large, leading to the settlement of more than 80,000 individual compensations for just over EUR 4,000 on average between 2012 and 2018, representing a 2% of the average house price during this period.
In theory, these compensations should restore housing prices, since spending on future earthquake-induced damages falls to nearly zero. However, claiming homeowners face some uncertainty about whether they will get granted the compensation, since their claim has to stand the scrutiny of experts who study if the damages were earthquake-inflicted. So, did this compensating mechanism lead to an increase in housing prices? Well, yes and no.
Damages depend on the earthquake’s magnitude and on the distance from its epicenter to the house. Any given earthquake will damage to the same extent two similar houses located near each other. Provided a homeowner is granted a compensation, there is little uncertainty that similar nearby houses also get compensated. Hence, compensations will affect housing prices according to the distance to other already compensated houses. In the Netherlands, postal codes composed with four digits and one letter (PC5) indicate small areas of about 300m squared. Four digits postal codes (PC4) indicate significantly larger areas including many PC5s.
The figure above visualizes regression results that use data on housing transactions and very detailed information on the granted compensations, to show how housing prices evolved during the two years prior to and following the date the first compensation was granted within PC5 (small), and PC4 (large) areas. The graph shows that housing prices increased significantly after the first compensation was granted in small areas (PC5). However, in larger areas (PC4), prices continue to fall as before the first compensation was granted. Research on the effects of earthquakes on housing prices in this region range widely, going from less than 2% to more than 20% in the worst hit areas. The compensations-led recovery in house prices within small areas seems to cover the lower bound of those estimates. However, compensations did nothing for house prices in small areas where no homeowner has been compensated.
Seemingly, but not surprisingly, compensating mechanisms are effective in restoring housing prices as long as homeowners can trust that they will receive a compensation should they need it in the future.