Do Firms Interact Strategically? An Empirical Analysis of Investment Timing Decisions in Offshore Petroleum Production

When individual petroleum-producing Þrms make their exploration and development investment timing decisions, positive information externalities and negative extraction externalities may lead them to interact strategically with their neighbors. This paper examines whether these inefficient strategic interactions take place in U.S. federal lands in the Gulf of Mexico. In particular, it analyzes whether a Þrm’s production decisions and proÞts depend on the decisions of Þrms owning neighboring tracts of land. Both reduced-form and structural econometric approaches are employed. The reduced-form approach is a discrete response model of a Þrm’s exploration timing decision, using variables based on the timing of a neighbor’s lease term as instruments for the neighbor’s decision. The structural approach is a structural econometric model of the Þrms’ multi-stage investment timing game. Although the models only permit the identiÞcation of the net effect of the two countervailing externalities, and not each individually, theory suggests that the importance of the extraction externality relative to the information externality should be greater on small tracts than on large tracts, and the data are consistent with this theory. Also as expected, the externalities intensify as the tract size decreases. The results suggest that the federal government best eliminates any inefficiencies in petroleum production that may result from non-cooperative strategic interactions when the tract size is large. JEL ClassiÞcation: C21, C25, C51, D92, L71 First draft: April 2, 2004 This draft: December 12, 2005 1Department of Economics, Harvard University; [email protected]. I am indebted to William Hogan, Dale Jorgenson and Robert Stavins for their support and encouragement throughout this project. This paper also beneÞted from discussions with Lori Bennear, Gary Chamberlain, Ulrich Doraszelski, Michael Greenstone, Joseph Harrington, Oliver Hart, David Laibson, Adrian Lajous (President, Petrometrica), Markus Mobius, Marcelo Moreira, Julie Mortimer, Michael Ostrovsky, Ariel Pakes, Jack Porter, James Stock, Stephen Weinberg, and Martin Weitzman, among numerous others. I received helpful comments from participants at the First Bonzenfreies Colloquium on Market Dynamics and Quantitative Economics in Alessandria, Italy in September 2004; at the Harvard Environmental Economics Workshop in September 2005; at the Harvard University Environmental Economics and Policy Seminar in October 2005; at student workshops in econometrics, in industrial organization, in microeconomic theory, in energy economics, and in environmental economics at Harvard University; and at the student workshop in econometrics at MIT. I thank Kenneth Hendricks and Robert Porter for sharing their lease sale data with me. Patricia Fiore, April Larson and John Shaw helped me to understand the geology of oil production. Robert Yantosca provided assistance with the IDL software. I thank the Minerals Management Service, and especially John Rodi, Marshall Rose and Robert Zainey, for answering my many questions about the OCS leasing program. I am indebted to Bijan Mossavar-Rahmani (Chairman, Mondoil Corporation) and William Hogan for arranging for me to visit Apache Corporation’s headquarters in Houston and a drilling rig and production platform offshore of Louisiana, and for their support of my research, and I thank the Repsol YPF Harvard Kennedy School Energy Fellows Program for providing travel funds. I received Þnancial support from an EPA Science to Achieve Results graduate fellowship, a National Science Foundation graduate research fellowship, and a Repsol YPF Harvard Kennedy School Pre-Doctoral Fellowship in energy policy. All errors are my own.