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 Literature: 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 Purpose: Analyse econometrically how oilrig activity is affected by the oil price – In different regions outside (core) OPEC – In the short and long run

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