The Relationship Between Oil Price and Costs

Jan 2015 | 152

Authors: Alexander Naumov

We propose a simple structural model of the upstream sector in the oil industry to study the determinants of costs with a focus on its relationship with the price of oil. We use the real oil price, data on global drilling activity and costs of drilling to estimate a three-dimensional VAR model. We use short run restrictions to decompose the variation in the data into three structural shocks. We estimate the dynamic effects of these shocks on drilling activity, costs of drilling and the real price of oil. Our main results suggest that (i) a 10% increase (decrease) in the oil price increases (decreases) global drilling activity by 4% and costs of drilling by 2% with a lag of 4 and 6 quarters respectively; (ii) positive shocks to drilling activity affect the oil price negatively; (iii) shocks to costs of drilling do not have a permanent effect on the price of oil.

JEL Codes: Q31

Keywords: Natural Resource Extraction, Crude Oil Price, Upstream Cost

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