5 Pages Posted: 27 Aug 2018 Last revised: 8 Jul 2019
Quentin Bell, the owner of a small oil extraction firm, BE Oil, owns the rights to drill on six different wells. Drilling requires substantial up-front costs, and each well has different drilling costs and production capability. Bell's challenge is to decide which wells to drill based on his expectation of the price of oil when it is extracted.The case was written for use in Darden's global economies and markets (GEM) core course during a class on the economics of competitive markets. The concepts of supply, demand, and equilibrium are often obscure to students at this early stage in the course, and this case provides a concrete example of how a firm in a competitive commodity market determines how much oil to produce. Students are asked to derive the firm's supply curve, relate that to the oil market supply curve, and ultimately recommend how much oil the firm should plan to produce. The plan pushes students to think about marginal cost/ marginal benefit analysis, implicitly at first and explicitly at the end of class. Students are also asked to consider how exogenous variables in the oil market affect the oil price and the firm's decision.
Rev. Jun. 21, 2019
One morning in late January 2015, Quentin Bell was facing some hard truths about the near-term prospects for his four-year-old oil company, BE Oil. The company had leased drilling rights on land in Colorado that would potentially generate six new shale oil wells. Just five months earlier, with oil prices near $ 100 per barrel, these wells appeared profitable. But in late 2014, oil prices plummeted to under $ 45 per barrel, dragging Bell's anticipated drilling profits down with them. In fact, on that cold January morning, Bell had to determine if any of the six wells he had planned to drill were even worth starting. The only bit of good news was a slight anticipated increase in oil prices over the next six months. He hoped this would presage a more dramatic rise over time—otherwise, the market forces that drove oil prices might very well drive him out of business!
The Economics of Shale Oil Drilling
In 2003, a technological breakthrough combined horizontal drilling with hydraulic fracturing (“fracking”), enabling development of natural gas shale. In 2009, the innovation extended into oil development and dramatically reshaped the US oil industry. Before 2009, shale oil production contributed minimally to the global oil supply, but the technological change resulted in an increase of US oil production from 5.4 million barrels per day in 2009 to 9.4 million barrels per day by the end of 2014. This increase represented over half of the overall increase in oil production globally.
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Keywords: competitive markets, market supply, market equilibrium, marginal cost, marginal revenue
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