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Better E&P Technology and Falling Oil Prices

Technological improvements have proven a key driver of America’s serious growth in oil production over the past five years.  Advances in everything from drilling technology to well performance analytics have opened up once uneconomic oil fields to American drillers. Oil prices might have rebounded slightly over the past two weeks, but they are still below 50% of what they were a year ago.

Much Fed chatter has questioned the effect oil prices might have on inflation. However, I also wonder if it is possible to isolate the oil industry as an example of deflation caused via technical change. I am not entirely sure of the best way to think of oil as a good. Its true supply is fixed, yet its effective supply is determined by the oil price and drilling costs. Recent technical change has perhaps effectively increased the supply through increasing the productivity of capital and labor. It would be interesting to look within the oil industry to see if technical change has improved the productivity of one sectoral input more than another.


  1. HeeJu HeeJu

    We can also look at the change in price of oil from demand side. I remember Professor Casey telling us in Development Economics last term that the major driving force of current oil price is the fact that China is cutting down significant amount of its oil import. The increase in supply due to technological development may have some effect, but only because it has been combined with the change in China’s demand for foreign oil.

  2. Yes: both supply and demand operating, alongside technical change, complicated by the lead times to bring a well into production (including to connect wellheads to regional pipelines). So if (say) global growth picks up and China and others increase their demand, the price rises, then exploration and drilling pick up, then supply comes onstream. However, the oil companies don’t coordinate in advance (even if they tried, the amount of oil they would actually be able to produce is unknown), and the Saudis and others raise/lower their output to achieve revenue targets. So when petroleum supply does eventually respond to higher prices, demand may not be there, or there may be too much supply. Add technical change to the mixture, and higher prices may produce much more oil than anticipated, further accentuating the boom-bust cycle.

    What I don’t know is how fast supply will now adjust. In some geological formations there’s an optimal draw rate from the well, particularly on the high side: too fast and rocks can compress and shut off extraction before oil from areas far from the well bore can flow that far. My recollection is that there are factors (beyond the desire for cash flow) that may prevent you from simply capping a well and waiting for higher prices, but I don’t know and assume those are less. In any case, a well will only produce for a modest period of time, particularly in “tight” formation (fracking). Furthermore the new technologies are expensive, and (Mary Beth’s project!) drilling in the US is stopping. At some point (2 years? 3 years?) output will begin declining. Today the EU and China and Brazil and others are in recession or at least seeing sharply lower growth. Three years from now? — the cycle begins again?

  3. moores15 moores15

    It has been interesting how technological improvements have opened up various shale regions throughout the United States, but, as the professor pointed out, these fracking techniques are still very expensive. This can be seen by how back in the Fall, Saudi Arabia increased their supply in hopes to drop oil prices beyond a profitable margin for the shale companies. I am no geological expert, but I would be interested to see if the United States shale companies could continue to cut the costs of fracking through technological improvement.

  4. Back to Christian’s point: at any time there are (duh!) many industries in which productivity is increasing faster than average (and of course many in which it is lower). So it is likely that (to the extent this is a matter of supply and not demand), technology has driven down prices. Should we however call this “deflation” or merely point to it as a change in relative prices? This hinges on the underlying dynamics of inflation, which rests (at least in our models) on what happens to wages as the proximate cause. So can we speak of “good” deflation if real wages are rising? Or is deflation always undesirable when we factor in the impact on creditors?

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