The Relationship Between Oil Price and Costs in the Oil and Gas Industry

Abstract

We propose a simple structural model of the upstream sector in the oil and gas 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 are that (i) a 1% increase (decrease) int he oil price increases (decreases) global drilling activity by 1% and costs of drilling by 0.5% with a lag of a year; and (ii) shocks to drilling activity and costs of drilling do not affect the price of oil permanently.