U.S. light tight oil supply flexibility - A multivariate dynamic model for production and rig activity

Abstract

I examine U.S. light tight oil (LTO) production theoretically and empirically. The theoretical model combines endogenous rig activity and stylized reservoir pressure mechanics with the Hotelling model for exhaustible resources. The empirical section presents a vector error correction model for U.S. LTO production. A one percent increase in the West Texas Intermediate (WTI) oil price results in up to a 0.7 percent increase in LTO supply and a 1.5 percent increase in rig activity. A positive shock to LTO supply has a negative but insignificant effect on the WTI oil price. The results indicate a structural break in March 2020, with LTO being less responsive to the WTI after the outbreak of Covid-19.