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UBC Theses and Dissertations

An economic model of oil extraction : theory and estimation Livernois, John R.


Although the field of Natural Resource Economics is relatively young, its growth has been rapid and it is now of substantial size. In that part of the field devoted to exhaustible resources, however, the literature is primarily qualitative with relatively little attention having been directed towards empirical testing of the qualitative predictions. The purpose of this dissertation is to construct a dynamic model of extraction for a specific exhaustible resource, to obtain empirical estimates of the extraction technology and to perform hypothesis tests of the model's predictions. The specific resource chosen is oil and the empirical work is based on oil reservoir data from the Province of Alberta. The building of the oil-reservoir extraction model draws on the principles of oil-reservoir engineering. Under the assumption that a rational agent manages the reservoir, the empirical implications for the number of wells to be used and the strategy for pressure maintenance activities are derived. A dual, restricted cost function forms the basis of the empirical work. Estimation of the parameters of this cost function through its implied factor demand equations permits information about the extraction cost characteristics of individual reservoirs to be obtained and hypothesis tests on the structure and characteristics of the cost function to be performed. It is found that oil pools producing in the sample year (1973) in Alberta are not homogeneous with respect to cost. Rather, the pools in the sample show a high degree of variation in geological factors that significantly affect extraction costs. The evidence strongly suggests that marginal extraction costs are a non- increasing function of extraction rates in the range of observations. In addition, marginal extraction costs vary systematically across pools with variation in key geological factors. Since the current system of prorationing in Alberta allocates monthly demand among the producing pools in the province, the above results imply that a marginal reallocation which increases the share of demand produced by the relatively low-cost pools will lead to an efficiency gain. The empirical results are found to support the model's predictions regarding the behaviour of the shadow price (or costate variable) for pool pressure. Finally, the results are used to test and conditionally confirm the hypothesis that oil reservoirs in Alberta have been exploited in order of declining quality over time.

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