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Hotelling under Pressure

Author

Listed:
  • Soren T. Anderson
  • Ryan Kellogg
  • Stephen W. Salant

Abstract

We show that oil production from existing wells in Texas does not respond to oil prices, while drilling activity and costs respond strongly. To explain these facts, we reformulate Hotelling’s 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, explains why the production constraint typically binds, and rationalizes regional production peaks and observed patterns of prices, drilling, and production following demand and supply shocks.

Suggested Citation

  • Soren T. Anderson & Ryan Kellogg & Stephen W. Salant, 2018. "Hotelling under Pressure," Journal of Political Economy, University of Chicago Press, vol. 126(3), pages 984-1026.
  • Handle: RePEc:ucp:jpolec:doi:10.1086/697203
    DOI: 10.1086/697203
    as

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    References listed on IDEAS

    as
    1. Ron Alquist & Lutz Kilian, 2010. "What do we learn from the price of crude oil futures?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(4), pages 539-573.
    2. Ryan Kellogg, 2014. "The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling," American Economic Review, American Economic Association, vol. 104(6), pages 1698-1734, June.
    3. Hogan, William W., 1989. "A dynamic putty--semi-putty model of aggregate energy demand," Energy Economics, Elsevier, vol. 11(1), pages 53-69, January.
    4. Léonard,Daniel & Long,Ngo van, 1992. "Optimal Control Theory and Static Optimization in Economics," Cambridge Books, Cambridge University Press, number 9780521331586.
    5. 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, vol. 24(2), pages 97-106, March.
    6. Cairns, Robert D., 2014. "The green paradox of the economics of exhaustible resources," Energy Policy, Elsevier, vol. 65(C), pages 78-85.
    7. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-1069, June.
    8. Carol Dahl & Mine Yucel, 1991. "Testing Alternative Hypotheses of Oil Producer Behavior," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 117-138.
    9. Miller, Merton H & Upton, Charles W, 1985. "A Test of the Hotelling Valuation Principle," Journal of Political Economy, University of Chicago Press, vol. 93(1), pages 1-25, February.
    10. Nirupama S. Rao, 2010. "Taxation and the Extraction of Exhaustible Resources: Evidence From California Oil Production," Working Papers 1006, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
    11. Salant, Stephen W, 1995. "The Economics of Natural Resource Extraction: A Primer for Development Economists," World Bank Research Observer, World Bank Group, vol. 10(1), pages 93-111, February.
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    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • L71 - Industrial Organization - - Industry Studies: Primary Products and Construction - - - Mining, Extraction, and Refining: Hydrocarbon Fuels
    • Q3 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy

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