Working Paper: NBER ID: w20280
Authors: Soren T. Anderson; Ryan Kellogg; Stephen W. Salant
Abstract: We show that oil production from existing wells in Texas does not respond to price incentives. Drilling activity and costs, however, do respond strongly to prices. To explain these facts, we reformulate Hotelling's (1931) classic model of exhaustible resource extraction as a drilling problem: firms choose when to drill, but production from existing wells is constrained by reservoir pressure, which decays as oil is extracted. The model implies a modified Hotelling rule for drilling revenues net of costs and explains why production is typically constrained. It also rationalizes regional production peaks and observed patterns of price expectations following demand shocks.
Keywords: oil production; Hotelling model; geological constraints; drilling activity
JEL Codes: E22; L71; Q3; Q4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Drilling activity (L71) | Oil production from existing wells in Texas (L71) |
| Oil price shocks (Q43) | Drilling activity (L71) |
| Extraction (Y60) | Future production capacity (D25) |
| Initial high reservoir pressure (L95) | Rapid production (L23) |
| Cumulative extraction (L72) | Decline in reservoir pressure (Q31) |
| Positive global demand shocks (F69) | Oil prices (L71) |
| Positive global demand shocks (F69) | Drilling activity (L71) |
| Positive global demand shocks (F69) | Rig rental prices (Q31) |
| Negative demand shocks (E31) | Expectations of rising oil prices (Q47) |
| Conserving pressure (Q38) | Future production decisions (D25) |