Supply flexibility in the shale patch: Facts, no fiction

In two recent papers, Kilian and Zhou (2019) and Kilian (2019) have criticized Bjørnland, Nordvik and Rohrer (2017), arguing that our finding of a large price elasticity of oil supply for shale producers is not credible. We show that the criticisms made in these two papers are inaccurate and mischaracterize our analysis and results.

A recent controversy in the literature, between Baumeister and Hamilton (2019a) and Kilian and Zhou (2019), has involved our paper: Bjørnland, Nordvik and Rohrer (2017). The debate relates to the size of the price elasticity of oil supply. In particular, Baumeister and Hamilton (2019a) argue for the use of a sizeable supply elasticity, supported, among others, by the findings in our paper. Kilian and Zhou (2019), on the other hand, dismiss the results of our paper, and suggest the short run supply elasticity is closer to zero.

What did Bjørnland et al. (2017) find? We investigate the response of both shale and conventional crude oil wells to spot and expected future oil prices. In particular, constructing a novel well-level/firm-level monthly production data set from North Dakota, we find the supply elasticity of shale wells to be significantly positive and in the range of 0.3-0.9, depending on wells and firms characteristics. We find no such responses for conventional wells. 

The criticism put forward in Kilian and Zhou (2019) has been thoroughly addressed by Baumeister and Hamilton (2019b), showing that the criticism is inaccurate, both in broad substance and in specific details. In particular, they argue that Kilian and Zhou (2019) mischaracterize the literature on supply elasticity, and in particular the analysis and results of Bjørnland et al. (2017).

Then, in a follow up paper, Kilian (2019) has added a series of additional concerns related to the papers by Baumeister and Hamilton (2019a,b), and the literature on the supply elasticity. The paper, which is entitled: ”Facts and Fiction in Oil Market Modeling”, concludes that the result of a large oil supply elasticity found in Bjørnland et al. (2017) is not credible. Instead, Kilian (2019) refers to the results of a recent paper by Newell and Prest (2019), which finds the short run supply elasticity to be zero.

In Bjørnland (2019) I now discuss the criticism put forward by Kilian and Zhou (2019) and Kilian (2019) with regard to the supply elasticity literature. In particular, I describe how these two papers mischaracterise the model and results found in Bjørnland et al. (2017), and in so doing, downplay the importance and implication of shale oil producer’s behaviour. Bjørnland et al. (2017) have shown that the production of horizontally drilled shale oil wells differ from conventional operations in two important dimensions: 

• Shale wells may be stimulated with water and chemicals many times during their lifetime. This gives the well operator a certain degree of freedom to choose the timing of the fracking operations relative to conventional wells which are naturally flowing.
• Shale wells have a very front-loaded production profile relative to conventional wells, see the Figure. This production frontloading increases the incentive for shale producers to optimise the timing of well completion and production.

Our empirical results thus support the notion that the degree of output flexibility is dependent on the production technology in question. This is a new finding in the literature, that could have far reaching implications for the industry, for macroeconomic outcomes, and for policy analysis. For more details, see Bjørnland (2019).

Source:

• Baumeister, C. and J. D. Hamilton (2019a). Structural interpretation of vector autoregressions with incomplete identification: Revisiting the role of oil supply and demand shocks. American Economic Review 109 (5), 1873-1910.
• Baumeister, C. and J. D. Hamilton (2019b). Structural interpretation of vector autoregressions with incomplete identification: Setting the record straight. Manuscript, UC San Diego.
• Bjørnland, H.C. (2019). "Supply flexibility in the shale patch: Facts, no fiction", mimeo, BI Norwegian Business School.
• Bjørnland, H. C., F. M. Nordvik, and M. Rohrer (2017). Supply flexibility in the shale patch: Evidence from North Dakota. CAMP Working Paper 2/2017 – Manuscript revised May 2019, BI Norwegian Business School.
• Kilian, L. (2019). Facts and Fiction in Oil Market Modeling. Manuscript, September, Federal Reserve Bank of Dallas.
• Kilian, L. and X. Zhou (2019). Oil supply shock redux? Manuscript, July, University of Michigan.
• Newell, R. G. and B. C. Prest (2019). The Unconventional Oil Supply Boom: Aggregate Price Response from Microdata. The Energy Journal 40 (3).

 

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Published: 2019.11.17

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