Modeling the Expansion of Oil Production in South Texas and Mexico

ABSTRACT

This study develops a dynamic output adjustment model that characterizes the expansion of U.S. oil production firms into Mexico. Using a Cobb-Douglas framework that differentiates U.S. and Mexican plants, we derive the comparative, static, risk-free, dual-country production levels for the multinational operations in each of the two countries when there are no capital constraints and perfect information. Given capital and labor constraints on Mexican production, the article uses an optimal control framework to derive the optimal production levels over time during a fixed adjustment period. This provides a pragmatic strategy for planning a growth path for investment in foreign operations.

KEYWORDS:

• Dual plant
• international production
• Mexico
• oil drilling
• optimal control
• Texas

Notes

¹ The price of $80 per barrel is consistent with the predictions of the oil industry. At its April 8, 2015, investor meeting, Conoco Phillips (2015) stated that it expected a more volatile price, and provided a WTI price range that centered around $80 per barrel throughout 2016 and 2017.

² For simplicity, we assume all inputs affect output within a given period, which seems reasonable for the annual frequency that the model represents.

³ The estimate of average cost above $50 per barrel also explains the fact that the U.S. shale oil boom did not develop until after 2007.

⁴ The planning horizon can be chosen arbitrarily. In its 2015 annual presentation, Conoco Phillips gives its projected capital expansion, output expansion, and forecasted price growth for the next three years, which goes through the end of the year 2017. Thus, a time horizon of eight years from the beginning of 2010 to the end of 2017 covers post-2009 EF expansion period through the region’s top operators’ three-year planning horizon forward from the year 2015.