Economics Research Seminar
Hotelling Under Pressure
Sponsored by: Economics Department
Speaker(s): Ryan Kellogg, Ph.D., Univ. of Michigan
Date & Time: Thursday, April 17 from 4:15 p.m. to 5:45 p.m.
We show that crude oil production from existing wells in Texas does not respond to current or expected future oil prices, contradicting a basic prediction of Hotelling's (1931) canonical model of exhaustible resource extraction. In contrast, the drilling of new wells exhibits a strong price response, as does the rental rate on drilling rigs. To explain these observations, we reformulate Hotelling's model as a drilling problem, in which firms choose when to drill new wells, but flow from existing wells is limited by a capacity constraint that decays toward zero as reservoir pressure declines. This drilling problem implies a modified Hotelling rule for discounted revenue flows net of drilling costs. Our model rationalizes the empirical findings from Texas and can replicate several other well-known features of the oil industry: local production peaks, backwardated price expectations following unanticipated positive demand shocks, and expectations that prices will rise faster than the interest rate following large, unanticipated negative demand shocks.
Please join the Economics Department for a research seminar. This event is open to all Case Western Reserve University faculty, Ph.D. students, economic majors and minors, and those interested in economics research.
Peter B. Lewis Building
11119 Bellflower Road, Room 118
Cleveland, OH 44106-7235
Attachment: Htelling Under Pressure