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Falling Oil Prices: Where Is the Floor?

The recent precipitous decline in world oil prices from $28 per barrel in November 1985 to $12 per barrel in March 1986 has perplexed most industry analysts and OPEC watchers. As oil prices continue to deteriorate, the central question now seems to be: "Is there a price floor below which oil prices will not fall; and if so, where is it?" Economic theory would suggest that at some price level, short-run marginal extraction costs of oil will eventually exceed marginal revenues from that production, leading to the widespread abandonment of the relatively higher-cost oil wells currently operated by competitive producers in non-OPEC areas. Presumably, once the price of oil falls to this floor, massive production cutbacks in high-cost, non-OPEC areas due to abandonment and reductions in new drilling activity would enable the lower-cost OPEC producers to significantly expand their market shares, thereby eliminating any incentives for further price reductions.

Purchase ( $25 )

Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products

JEL Codes: Q41: Energy: Demand and Supply; Prices, Q38: Nonrenewable Resources and Conservation: Government Policy, Q42: Alternative Energy Sources, Q35: Hydrocarbon Resources, G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill, D24: Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity, D21: Firm Behavior: Theory

Keywords: Oil prices, Volatility, Oil Leases, Oilwell abandonment decision

DOI: 10.5547/ISSN0195-6574-EJ-Vol7-No4-2

Published in Volume 7, Number 4 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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