Instructions: Write a brief essay, analyzing the situation using the tools of market supply and demand and cost analysis that we have developed in this course, drawing graphs as needed to illustrate your analysis. The goal is to carefully and rigorously explain the economics (not the technology, politics or other aspects) of the events that are discussed in the above article. Also analyze the situation that individual fracking firms face or are likely to face in coming years as a consequence of these developments. Comment on why it is reasonable to assume that the market for oil from fracking wells is roughly perfectly competitive. Assuming that this market is indeed perfectly competitive, comment on what has happened and what is likely to happen in the future, applying the theory from our discussion of supply and demand, and our discussion of perfect competition. Mention entry and/or exit as relevant. If further assumptions are needed for your analysis beyond those stated or implied in the above excerpt, state them in your essay. You must use graphs to illustrate your analysis of market and firm specific supply, demand, and cost. The goal is to rigorously analyze the situation, carefully explaining the meaning of any graphs using the theory we developed in this course. Extended re-statement of the article’s content or material from the text is not satisfactory; the goal is to present your own analysis.
Crude oil prices have fallen by about two thirds since 2014, and competitive market prices for oil are now about $40 per barrel. One major reason for the dramatic fall in prices is the huge increase in shale oil production in the United States, which in turn results from the boom in “hydraulic fracturing technology” which is commonly called “fracking.” Fracking is a technological innovation that allows oil to be extracted from shale oil deposits by injecting water and sand under pressure that fractures the shale rock and allows oil to be extracted. In 2002, only about 100,000 barrels of oil were pumped from fracking wells in the US. This increased to over 4 million barrels per day last year from fracking oil wells. During this same period the number of fracking wells has grown from about 20,000 wells to over 300,000 wells. The amazing increase in US oil production from fracking wells is a big cause of the worldwide glut of oil on the market, which is a major cause for the falling price of oil on the market. The other interesting fact is that fracking oil wells can be easily shut down if the price of oil goes too low, and can be quickly returned to operation when the price of oil goes up. The fracking wells are operated by a large number of small companies that have borrowed heavily to finance the wells. Many fracking well operators complain that they are now losing money each year. These businesses are having trouble paying off long-term loans that they had taken out to fund their operations. Most continue to operate, but many complain that they are operating at a loss. One operator said: “I have to keep operating to bring in cash to pay off my loans, even though my profits are negative.”