Price Signals and Free Markets Lead to Oil Exploration: Who’d a Thunk It?

Lynne Kiesling

From a good article in today’s New York Times: 2009 is turning out to be a bumper year for new oil discoveries; new oil discoveries always occur, but this year has been unusually fruitful. This quote from the article illustrates the important dynamic intertemporal incentives that price signals provide:

These discoveries, spanning five continents, are the result of hefty investments that began earlier in the decade when oil prices rose, and of new technologies that allow explorers to drill at greater depths and break tougher rocks.

“That’s the wonderful thing about price signals in a free market — it puts people in a better position to take more exploration risk,” said James T. Hackett, chairman and chief executive of Anadarko Petroleum.

More than 200 discoveries have been reported so far this year in dozens of countries, including northern Iraq’s Kurdish region, Australia, Israel, Iran, Brazil, Norway, Ghana and Russia. They have been made by international giants, like Exxon Mobil, but also by industry minnows, like Tullow Oil.

Note here the hetergeneity of both the location of the discoveries and the types of firms that are exploring and discovering.

See also the comments and the tie to peak oil from Tim Haab at Environmental Economics.

There’s also an interesting similarity, and contrast, with how high natural gas prices have induced further exploration and discovery in the U.S. in the form of shale gas. Extracting shale gas is more costly because it’s embedded in shale rock, but the high natural gas prices since 2003 have induced innovation and exploration. That, combined with other discoveries, has led to historically high natural gas inventories (shifting out the supply curve); this year’s recession has reduced the demand for natural gas (shifting in the demand curve). Not surprisingly, therefore, the price of natural gas is about one-fourth of what is was back in, say, 2005. This week NPR has been running a series on natural gas innovation and exploration; the first in the series is here, and there are more resources associated with the series on their web site as well.