INTRODUCTION

This chapter examines the contracting problems encountered in efforts to unitize the production of crude oil in the United States. Since the first discovery of petroleum in the United States in 1859, oil production has been plagued by serious common pool losses. These losses arise as numerous firms compete for migratory oil lodged in subsurface reservoirs. Under the common law rule of capture, private property rights to oil are assigned only upon extraction. This follows similar practices in allocating property rights to other naturally occurring resources, such as fish, wildlife, and even frontier federal land. For each of the firms on a reservoir, a strategy of dense-well drilling and rapid production allows it to drain oil from its neighbors and to take advantage of the low extraction costs that exist early in field development. In new, flush oil fields, subsurface pressures are sufficient to expel the oil without costly pumping or injection of water or natural gas into the reservoir to drive oil to the surface.

Under these conditions, when there are multiple firms on a reservoir, each firm has incentive to drill competitively and drain to increase its share of oil field rents, even though these individual actions lead to aggregate common pool losses. Rents are dissipated as capital costs are driven up with the drilling of excessive numbers of wells (more than geologic conditions require or price and interest rate projections warrant) and with the construction of surface storage, where the oil can be held safe from drainage by other firms.