World oil prices recently surpassed $75 per barrel for the first time since 2014. While a number of factors have contributed to the increase, including tighter physical market conditions, there is little doubt that at least two geopolitical crises are weighing on markets. First, the Trump administration’s withdrawal from the Iran nuclear agreement will crimp Iran’s oil production, though it remains to be seen by how much and when. Second, and perhaps more important, the deteriorating economic and political situation in Venezuela has led to a collapse in oil production, with the worst possibly yet to come.
Should the worst-case scenarios prevail, additional supply will be needed to avoid a substantial price spike. Where might new supply come from? One set of candidates are the nations of Russia and Saudi Arabia, which have been discussing increasing production and are believed to have the spare capacity to do it. But what about the United States? To what extent can U.S. oil producers play the role of swing producer?
Industry observers and academics have long noted that the price-responsiveness of U.S. oil supply—along with supply from other countries where extraction is dominated by private rather than nationalized oil firms—is minimal in the short-run. My colleagues Soren Anderson, Steve Salant and I show in a new analysis that these concerns are well-founded.
Using detailed data from Texas, we identify a set of wells that were producing oil in 1990 and then follow these wells all the way to the end of our sample in 2007. We find that existing wells do not respond to prices. Instead, production from the wells declines smoothly over time. This behavior is rather remarkable given the tremendous price swings that occurred over that period—a brief but substantial price spike during the first Gulf War in 1990 to 1991, a price collapse to almost $10 per barrel in 1999, and a price run up to over $100 per barrel before the 2008 Great Recession. Our results are echoed by another recent analysis that uses data through 2014, which includes the shale era.
Why don’t existing wells respond to prices? While producers have a strong incentive to produce more from a well when prices go up, and less when prices go down, their ability to follow-through is constrained by the capacity of the well and the underground pressure that pushes oil through the rock, to the wellbore and up to the surface. The reservoir and the well will only yield oil up to a maximum possible flowrate, so that when the oil price goes up, producers simply cannot squeeze more oil out of their existing wells.
As a result, U.S. oil producers are not able to pump large volumes of new production within a few months of an oil price shock. Private oil companies—unlike the state-controlled companies that run the show in Russia and Saudi Arabia—do not sit on idle production capacity that can be turned on within a few days or weeks.
More Info: www.forbes.com