Oil investment in the North Sea

Investment in oil production on the UK continental shelf (UKCS) involves three separate but highly interrelated activities: exploration, development and extraction. The exploration and extraction decisions have recently been analysed by Pesaran and Favero. The aim of this paper is to provide a model of the investment decision on the UKCS, where the development process is explicitly modelled within an intertemporal optimization framework. The model highlights the importance of the lengthy time lags that exist between price and tax changes and changes in oil supplies from UKCS. The empirical results show significant improvements over the previous studies, demonstrate the importance of theoretical considerations in modelling the oil supply process and illustrate the pitfalls involved in relying on standard unrestricted distributed lag models in the econometric analysis of oil investment. © 1994