Offshore Exploration Performance and Industry Change: The Case of the Gulf of Mexico
Authors: Attanasi E.D. , Drew L.J. 
Published: December 2007

This paper considers industry structure and the exploration performance (by size class of operator) of firms searching for oil and gas in the U.S. Gulf of Mexico. It also tracks the changes in industry structure that have occurred in response to a decline in the quality of remaining prospects in the area. Data presented indicate that because vertically integrated majors dominated in exploration in the early years of the Gulf of Mexico exploration history, they were able to discover 86% of the total hydrocarbons discovered through 1975. However, the data also show a dynamic relationship between the structure of the industry operating in an area and the quality of remaining prospects. The relative share of both credited discoveries and wildcat wells of nonmajor operators has increased as exploration in the gulf proceeded. For example, in state-owned waters from 1951 to 1955, major inns accounted for 85% of all wildcat wells drilled, whereas from 1971 to 1975 these firms accounted for only 30% of the wildcat wells. During these same two periods in the federal Gulf of Mexico, the majors' share of wildcats fell from 98% to 70%.

Introduction

U.S. crude-oil production in the conterminous 48 states peaked in 1970 and the production of natural gas attained its maximum in 1973. At the time, few were concerned with the consequences of the nation's growing dependence on imported oil. The supply disruptions of the 1970's helped focus attention on the structure of the domestic oil industry. Critics of the industry have charged the major integrated firms with restricting domestic oil and gas production by not concentrating their exploration efforts in the conterminous U.S. In addition, industry critics have been concerned with the wave of recent mergers and the possible anticompetitive effects of a concentration of domestic reserves. Because 80 to 90% of the wildcat wells drilled in the U.S. are usually drilled by independent operators, some critics have reasoned that the divestiture of the exploration and production units of the large integrated firms into regional units would increase domestic exploratory drilling and thereby increase supply. Other suggestions to increase the role of small firms in federal Outer Continental Shelf (OCS) development have already been implemented by permitting royalty bidding for selected tracts and prohibiting joint bidding by the larger firms. Several studies already have been performed in which financial rates of return (ROR) were compared across industries and across groups of firms (classified by size) that operated in the Gulf of Mexico. These studies have neglected physical measures of firm performance and the dynamic trends in the discovery process. This paper presents data on firm exploration performance and addresses petroleum industry changes that have occurred in the Gulf of Mexico. Analysis of these data shows a relationship between the nature or structure of the industry operating in an area and the quality of remaining prospects. This paper reviews past studies that compare returns to offshore operation by firm size. Then, the exploration performance of various size classes of firms operating in the Gulf of Mexico is discussed, as are changes in the structure of the petroleum firms operating there. In the concluding section the implications of the data are considered.

Previous Industry Studies

Economists often examine an industry's structure and reported earnings on equity to predict its performance in terms of economic efficiency. A study by R. Shriver Assocs. indicates that overall concentration (dominance of the industry by the top few firms) of the petroleum industry does not significantly exceed that of many U.S. manufacturing industries. It is frequently argued that, if firms are monopolizing an industry, long-run marginal costs will depart substantially from price and that earnings will be greater than the returns in competitive industries. Erickson and Spann showed that the overall profit rates for the eight largest petroleum firms were similar to rates reported by U.S. manufacturing firms. These studies consider all stages of the petroleum industry and do not focus on exploration behavior or performance. In one of the earliest studies of competitive conditions in the search for oil and gas, McKie concluded that competition was effective because there were no substantial artificial barriers to exploration in most areas for independent firms. McKie also pointed out that the independents' symbiotic relationship with the majors in joint or cooperative ventures worked to the advantage of both industry sectors.