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Does the Oil Price Adjust Optimally to Oil Field Discoveries?

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    Abstract

    The Hotelling rule argues that the price for a non-renewable resource adjusts to the shadow value of the resource, reflecting its remaining availability. This study provides an empirical test of this hypothesis. It investigates whether the price of crude oil does adjust to unexpected news about oil field discoveries. The observed price reaction is compared with a prediction of the price decline as derived from the Hotelling model. This study finds evidence for an adjustment of the price to news about greater resource availability: the price of crude oil declines on average by 0.88% on discovery days. The degree of adjustment to the new level of scarcity is not found to differ significantly from the social optimum. Thus, there is evidence for the existence of a shadow cost component - a necessary pre-requisite for the Hotelling rule to hold.

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    Bibliographic Info

    Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 12/169.

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    Length: 31 pages
    Date of creation: Nov 2012
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    Handle: RePEc:eth:wpswif:12-169

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    Keywords: Non-renewable resources; Oil Price; Exhaustible Resources;

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    1. John Livernois & Henry Thille & Xianqiang Zhang, 2006. "A test of the Hotelling rule using old-growth timber data," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 39(1), pages 163-186, February.
    2. John C.B. Cooper, 2003. "Price elasticity of demand for crude oil: estimates for 23 countries," OPEC Energy Review, Organization of the Petroleum Exporting Countries, Organization of the Petroleum Exporting Countries, vol. 27(1), pages 1-8, 03.
    3. Miller, Merton H & Upton, Charles W, 1985. "A Test of the Hotelling Valuation Principle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 93(1), pages 1-25, February.
    4. Fama, Eugene F, et al, 1969. "The Adjustment of Stock Prices to New Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 10(1), pages 1-21, February.
    5. Bentley, R. W., 2002. "Global oil & gas depletion: an overview," Energy Policy, Elsevier, Elsevier, vol. 30(3), pages 189-205, February.
    6. Slade, Margaret E., 1982. "Trends in natural-resource commodity prices: An analysis of the time domain," Journal of Environmental Economics and Management, Elsevier, vol. 9(2), pages 122-137, June.
    7. James D. Hamilton, 2008. "Understanding Crude Oil Prices," NBER Working Papers 14492, National Bureau of Economic Research, Inc.
    8. Jeffrey A. Krautkraemer, 1998. "Nonrenewable Resource Scarcity," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 36(4), pages 2065-2107, December.
    9. Margaret E. Slade & Henry Thille, 1997. "Hotelling Confronts CAPM: A Test of the Theory of Exhaustible Resources," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 30(3), pages 685-708, August.
    10. Halvorsen, Robert & Smith, Tim R, 1991. "A Test of the Theory of Exhaustible Resources," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(1), pages 123-40, February.
    11. Krichene, Noureddine, 2002. "World crude oil and natural gas: a demand and supply model," Energy Economics, Elsevier, Elsevier, vol. 24(6), pages 557-576, November.
    12. Höök, Mikael & Hirsch, Robert & Aleklett, Kjell, 2009. "Giant oil field decline rates and their influence on world oil production," Energy Policy, Elsevier, Elsevier, vol. 37(6), pages 2262-2272, June.
    13. Denise Young, 1992. "Cost Specification and Firm Behaviour in a Hotelling Model of Resource Extraction," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 25(1), pages 41-59, February.
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