Hotelling Under Pressure

83 Pages Posted: 24 Jul 2014

See all articles by Soren Anderson

Soren Anderson

Michigan State University - Department of Economics; Michigan State University - Department of Agricultural Economics; National Bureau of Economic Research

Ryan Kellogg

University of Michigan at Ann Arbor

Stephen W. Salant

University of Michigan; Resources for the Future

Multiple version iconThere are 2 versions of this paper

Date Written: July 2014

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.

Suggested Citation

Anderson, Soren T. and Kellogg, Ryan and Salant, Stephen W., Hotelling Under Pressure (July 2014). NBER Working Paper No. w20280. Available at SSRN: https://ssrn.com/abstract=2471173

Soren T. Anderson (Contact Author)

Michigan State University - Department of Economics ( email )

East Lansing, MI 48824
United States

Michigan State University - Department of Agricultural Economics ( email )

East Lansing, MI 48824
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ryan Kellogg

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

Stephen W. Salant

University of Michigan ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
313-764-2370 (Phone)
313-764-2769 (Fax)

Resources for the Future ( email )

1616 P Street, NW
Washington, DC 20036
United States

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