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June 7, 2018
U.S. Oil Production Can Help Blunt the Impact of Oil Price Shocks, But It Has Limits
New research shows that existing wells do not increase production in response to price spikes. New oil requires drilling and well completions, which take money and time.
With world oil prices climbing passed $75 a barrel for the first time in four years, Russia and Saudi Arabia have discussed increasing production to avoid a substantial price hike. But what about the United States? Can U.S. oil production quickly respond to changes in global oil prices, allowing the United States to play the role of a swing producer? A new study published in the June issue of the Journal of Political Economy shows increasing production is not so easy for countries dominated by private rather than nationalized oil firms.
“While there is a strong incentive to produce more from a well when prices go up and less when prices go down, producers’ ability to do so 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,” explained co-author Ryan Kellogg, a professor at the University of Chicago Harris School of Public Policy. “The reservoir and the well will only yield oil up to a maximum possible flow rate, and there’s not much an oil producer can do about it short of spending money to drill a new one or re-frack an old one.”
Kellogg and his co-authors, Soren Anderson from Michigan State and Steve Salant from the University of Michigan, studied how production responds to crude oil price swings using detailed well data from Texas from 1990 to 2007. They found that production from existing wells declines smoothly as reservoir pressure declines, showing no response to prices. This was the case despite large price swings that occurred over the period studied—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 more than $100 a barrel before the 2008 Great Recession.
While bumping up production of existing wells is not an option, new wells could be drilled. The problem there, the authors note, is that this takes not only money, but also time. When they study the drilling of new wells, they see that drilling activity follows oil prices very closely. However, there is always a lag of a few months as the new drilling takes place.
“While the U.S. oil industry’s ability to drill and complete more wells after a price shock will eventually lead to increased oil production, the inability to jack up production from the wells already in the ground severely limits the amount of new oil that can quickly come on stream,” Kellogg said. “Private oil companies like we have in the United States simply do not sit on idle production capacity that can be turned on within a few days or weeks, unlike the state-controlled companies that operate in other countries such as Russia and Saudi Arabia.”
The study offers lessons for those observing futures markets, as large changes in oil demand will have an immediate impact on oil prices and drilling activity—but, not on production from existing wells. Further, while U.S. oil can respond to price shocks over the long- and medium-term, there are several obstacles. Increasing production by drilling new wells puts a strain on the supply of workers, equipment and supplies needed. Infrastructure investments would also be required to move the oil from where it is produced to the U.S. coasts where it can be refined or exported abroad.