Exploration Activity, Long-Run Decisions, and the Risk Premium in Energy Futures

Abstract

We present evidence that the capital stock of firms in oil and gas exploration as well as oil inventories are each positively related to the slope of the futures curve, and negatively predict returns on holding crude oil futures contracts. We build an equilibrium model of resource extraction, exploration, and storage with these features. Capital lowers extraction costs as firms drill in increasingly expensive fields, while inventory helps smooth fluctuations in demand and extraction. The model sheds light on the role of declining well quality on the recent positive trend of real oil prices, and the peaking of consumption.