Measuring cost and efficiency in United States crude oil resource development, 1977--1990: A frontier translog cost function approach

The U.S oil industry provides an exceptional example of adjustment to a dramatic and disastrous price collapse. After a decade of high (or rising) oil prices, the oil price collapse of 1986 forced oil companies to reduce the cost of developing reserves. This research isolates the individual effects of input price reductions, resource depletion, and technical and firm-specific strategic changes over time on the major U.S. oil companies' cost of finding crude oil in the United States over the period 1977-1990. The model used in this study is a translog specification of the cost-minimization model of firm behavior, combined with econometric techniques for estimating a frontier cost function. The estimates of the marginal cost of crude oil resource development provided by this research can aid others in the debate over the Hotelling Valuation Principle, and shed light on the competitiveness of U.S. crude oil reserves in the world oil market. This research concludes that resource depletion had a significant cost-increasing effect on onshore operations, while showing no statistically significant effect on relatively newer offshore operations. Of particular interest are the estimates of the marginal cost of crude oil resource development, which indicate scale economies for both onshore and offshore operations. Efficiency tests indicated the major U.S. oil companies did not exhibit technical inefficiency relative to the frontier cost function in any given year, although there were systematic differences in the ability to improve efficiency over the 1977-1990 period.