Some Implications of Applying the Theory of the Economics of Exhaustible Resources to Oil and Gas Pricing

Abstract

ABSTRACT The theory of the economics of exhaustible resources is reviewed and discussed in terms of its applicability to the complex structure of the international petroleum industry. Particular attention is given to the implications of uncertainty in reserves estimations for corporate, public, and financial institutions which have the responsibilities of oil and gas pricing and depletion policy formulation. A modification of the model of the economics of exhaustible resources under a freely competitive market structure is analysed to determine the effect of uncertainty in reserves estimations on the optimal net price and on depletion profiles. The uncertainty in the resultant time until economic exhaustion and the discounted present value is found to be directly proportional to the uncertainty in the reserves estimations. These results should be carefully considered in the difficult conflicts between short-term profit maximisation and long-term social objectives in the formulation of public and private pricing and depletion policies.