An 'oil'igopoly theory of exploration

Abstract

This paper develops a theory of [`]oil'igopoly exploration of an exhaustible resource. Strategic exploration and production are jointly derived in a three period subgame perfect equilibrium. While the [`]oil'igopoly theory of exploration shares many features with non-strategic models of exploration and production, there is one important difference. The [`]oil'igopoly theory of exploration predicts that firms who exhaust their proved reserves before they can convert their unproved reserves into proved reserves have an incentive to over-explore, relative to the Nash equilibrium level of exploration. A simple empirical prediction is that firms holding smaller proved reserves should be observed doing more exploration. This prediction is consistent with country-level production and reserve data in the post-World War II era.