Institutional Effects on an in Situ Natural Resource Market: Forced Pooling in a Petroleum Reserves Market

Abstract

It has been pointed out by several authors in recent articles that economists should pay closer attention to institutional factors in natural resource markets. And, moreover, that this is particularly important in natural resource economics because social, cultural, and legal institutions are more pervasive and significant than in many other areas of the economy. Robert A. Gordon's [11] Presidential address to the AEA was devoted to the importance of institutions in understanding and analyzing market behavior. V. Kerry Smith [26] noted that empirical appraisals of resource scarcity must be supported by geological, market, and technical specifics for each resource. Bromley [6] and Randall [24] both stress the importance of legal institutions in resources markets. This paper is concerned with legal institutions in oil and gas development and their effect on the scarcity or abundance of reserves. Markets for oil and gas exploration and development are well known to be highly constrained by property law and state and federal regulation [7; 17]. It is commonplace in many states to have regulations concerning spacing of wells, maximum allowable production rates, and compulsory unitization. The oil and gas mineral lease used nationwide is a unique set of property rights especially developed for and defined with respect to petroleum resources. The state and federal government cooperated for 50 years in limiting production nationwide through the demand prorating system. Within this general set of institutions, there is variation from state to state. An extremely interesting variation is forced pooling. This is a law found in Oklahoma as well as in many other major petroleum producing states. However, due to the generality of the statutory language each state apparently has implemented forced pooling in significantly different ways. This paper is an empirical study of the