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Is Oil Well in Texas?
Subject Supply
Topic Supply and Demand
Key Words Price, boom, downturns, busts, investors, finance, output, companies, production, supply
News Story

The higher price of crude oil means West Texas is littered with new and reopened oil and gas wells. However, this boom is quite unlike the early 1980s when places like Midland, Texas were full of people so rich it had a Rolls-Royce dealership. The busts of the 1980s and 1990s, when oil prices fell to $6 a barrel, caused many to leave the industry. Some are afraid to return for fear of more downturns. Fewer petroleum geologists are being educated. Investors are equally skeptical that oil prices will remain high, so finance for drilling is harder to raise. Further, larger companies are tending not to drill in the area because the output is lower than offshore and smaller companies tend to have lower overhead and lean operations. Consequently, fewer wells are operative than twenty years ago.

Nevertheless, some companies have expanded production, drilling expensive holes in search of wells that may be able to produce a steady supply of oil. For example, one company, Home-Stake, is drilling a hole that will cost $900,000 to bore, and more to maintain, because the oil flow is expected to generate $1.6 million a year at $30 a barrel. When prices were only $10 a barrel, drilling did not make economic sense.

(Updated October 1, 2000)

Questions

1.
a) What happens to the quantity of oil supplied as the price increases? Draw a diagram to illustrate.
b) Why does the supply curve you have drawn have this slope? Couch your answer in terms of opportunity cost.

2. The news story reports that higher oil prices have led oil producers to open or reopen oil wells. Why does an increase on the price of oil induce an increase in the quantity of oil supplied?

3. For West Texas, the boom of 2000 is less than that of the early 1980s, although oil prices are similar.
a) Draw a diagram of the supply of oil in the two time periods to illustrate. Show a common price and mark the quantities supplied.
b) Explain, in the light of the news story, which determinants of supply have changed over the two decades.

4. Small oil companies dominate the West Texas oilfields.
a) Draw a diagram of the supply of oil in West Texas, showing two curves representing the supply by small and large companies.
b) Why are the curves different? Explain in terms of the determinants of supply.

Source George Hager, "Texas drillers enjoy high oil prices, for now," USA Today, July 28, 2000.

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