Does high oil price lead to increased oilrig activity? An empirical analysis

1. Does high oil price lead to increased oilrig activity?An empirical analysis Guro Børnes Ringlund, Knut Einar Rosendahl and Terje Skjerpen

2. Introduction • Significant increase in the crude oil price last years • What happens to investments in new oil fields outside OPEC?

3. Motivation • Oil production outside OPEC is inflexible in the short run • Full capacity utilisation – low operating costs – long investment time • Oil production is mainly affected by developing new fields, and in the longer run by exploration • Drilling new wells is more flexible than production, and can therefore react more quickly to price changes etc.

4. Development of oil production since 1995

5. Development of oil production and oilrig activity since 1995

6. Purpose: Literature: • Analyse econometrically how oilrig activity is affected by the oil price • In different regions outside (core) OPEC • In the short and long run • No similar studies exist • Farzin (2001) estimates the relationship between oil price and reserve additions from known fields in the US • Iledare (1995) estimates the relationship between gas price and gas drilling in West Virginia • Mohn and Osmundsen (2006) estimates the relationship between oil price and exploratory activity in Norway • ”Rule of thumb” in the petroleum industry: • Rig activity follows oil prices with a time lag of 6 months

7. Important factors and assumptions • Profitability of drilling depends on future prices • Assume adaptive price expectations • Data on a monthly basis – prices are smoothed over x number of months (different x tested for all regions) • Smoothing makes it easier to catch up effects in the medium to long run • Oil rigs are not homogeneous • Different regions will demand different sorts of rigs • Offshore rigs are typically less flexible than onshore rigs • Market conditions differ • North America and the UK are more privatised and less regulated than Norway and most developing countries • Decision making takes longer time, and is more affected by non-economic factors in countries with strong public control

8. Technological change affects rig activity in various ways • Reduces costs of drilling • Reduces time of drilling • Makes new areas easier accessible • Resource situation is changed over time • Increased development reduces the number of remaining undeveloped fields • Increased exploration increases the number of remaining undeveloped fields • Increased development increases the area’s infrastructure • We introduce a stochastic time trend • Catch up changes in technology and resource situation etc. over time • Slow adaptation to changed oil price due to: • Slow adaptation in oil price expectations • Rising marginal costs in the rig market in the short run

9. Data • Data for oilrig activity : • Monthly data from BakerHughes for all important countries • Exception: Former Soviet Union and onshore China • Use BakerHughes’ regional division • Rig market is partly regional • Rather few rigs in many countries • Data for the period Jan.-95 to June-06 (from Aug.-87 for the US) • Price data: • Petroleum Intelligence Weekly • Converted to real prices by a US producer price index • Some dummy variables are also utilized