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Hotelling Under Pressure

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  • 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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 20280.

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Date of creation: Jul 2014
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Handle: RePEc:nbr:nberwo:20280

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  1. Alquist, Ron & Kilian, Lutz, 2007. "What Do We Learn from the Price of Crude Oil Futures?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6548, C.E.P.R. Discussion Papers.
  2. Léonard,Daniel & Long,Ngo van, 1992. "Optimal Control Theory and Static Optimization in Economics," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521337465.
  3. Kilian, Lutz, 2006. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5994, C.E.P.R. Discussion Papers.
  4. Ramcharran, Harri, 2002. "Oil production responses to price changes: an empirical application of the competitive model to OPEC and non-OPEC countries," Energy Economics, Elsevier, Elsevier, vol. 24(2), pages 97-106, March.
  5. Ryan Kellogg, 2010. "The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling," NBER Working Papers 16541, National Bureau of Economic Research, Inc.
  6. Hogan, William W., 1989. "A dynamic putty--semi-putty model of aggregate energy demand," Energy Economics, Elsevier, Elsevier, vol. 11(1), pages 53-69, January.
  7. 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.
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