Joint Costs in Oil-Gas Production M. A. Adelman The Journal of Industrial Economics, Volume. 10, Issue Supplement: The Supply & Price of Natural Gas (1962), 25-36. Stable URL: bhtp:flinks,jstor-org/sici?sici~0022-1821%281962%29 10%3C25%3 A JCIOPHIE2.0. CO%3BI-C ‘Your use of the ISTOR archive indicates your acceptance of ISTOR’s Terms and Conditions of Use, available at up: srw jstor org/aboutterms.html. ISTOR's Terms and Conditions of Use provides, in part, at unless you have obtained prior permission, you may aot download an entite issue of a journal or multiple copies of articles, and ‘you may use content in the ISTOR archive only for your personal, non-commercial use Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the sereen or pfinted page of such transmission. ‘The Journal of Industrial Economics ‘published by Blackwell Publishers. Please contact the publisher for further permissions regarding the use ofthis work. Publisher contact information may be obfaines at Ip: fovotororg/journalsfblack ta The Journal of Industrial Economics ©1962 Blackwell Publishers ISTOR and the JSTOR logo are trademarks of JSTOR, and are Registered in the U.S, Patent and Trademark Otic. For more information on ISTOR contact jstor-nfo@umnich edu, (©2003 JSTOR hup:therwwjstor.orgy Mon May 5 16:36:04 2003JOINT COSTS IN OIL-GAS PRODUCTION JOINT COSTS IN GENERAL Jour costs in oil and gas production are universally recognized, but ‘widely misunderstood. Outside of the Soviet Union,! gas at the well- head is usually called ‘essentially a by-product’, or ‘2 mere by- product’, ‘sold for what it will bring? instead of in some more propet or rational manner, etc. As usual, slogans are a poor substitute for ideas. Economic theory has since Marshall’s day becn able at least to state the problem accurately. Whenever one canuot produce one product without at the same time producing another, the two are called joint products, or are said to be in joint supply. Gasotine was once useless and a fire hazard to boot, hence a ‘waste product’; Iater it would fetch something, so it became a ‘by-product’; still later it became the ‘main product’ or ‘cash crop’ of the refinery. Through- out, it was sold at the best price that could be had, i.c. ‘sold for what it would bring’. Joint costs are incurred when products cannot be separately pro- diiced; hence they are not the same as common costs, e.g. where the sarne factory makes both refrigerators and washing-machines. In such, a factory itis altogether feasible to make all of one product or all of the other; or to double the output of one without affecting the output of the other. Given common {not joint) costs, it may well be feasible to compute the separate unit costs of the two or more products. This is basically a task for the accountant; the economist has no reason to object. But in the presence of joint supply there és no auch thing as the cost of either product separately, because neither product can exist separately. To make laborious computations purporting to divide costs is ‘nonsense on stilt’, and has no more meaning than the famous cxample of predicting the banana crop by ite correlation with expenditures on the Royal Navy. There is no need to put up with rough estimates rather than precise ones. It is not a bit difficile ‘or complex ot arduous to calculate a separate cost of a product in joint supply; it is @ perfectly casy exercise in self-deception, Where the proportions in which the joint products can be pro duced are fixed, then in effect there is only a single product and a single cost. But when the proportions are variable, then while neither product has a unit cost, ar average cost, both have a marginal cost, which can and should be compared with the price in order to see whether profit can be increased by changing the output. Marginal costs, although familiar and constantly used in some 2 See below, pp. 94 ff, expecially p96 ce 2526 THE SUPPLY AND PRICE OF NATURAL GAS branches of the petroleum industry, chiefly refining, have been rather badly misunderstood when applied to oil and gas production. One can sec even in well-informed places the statement that gas was once available at marginal or incrernental cost but today it ‘must’ or ‘should? be priced to cover its ‘full or ‘true’ cost; or that it is ‘shock- ing’ that gas is being sold at ‘unfair’ tow prices because the buyer gets so much more thermal value (more BTU?s) per dollar than from crude, or residual fuel oit, or light fitet oil, not to mention the superior qualities of gas, such as cleanliness. These attitudes, deep- seated and sincerely held, are merely an obstacle to thought. There is no inherent reason why gas should not be sold for much less, or for much more, than ol, To understand why, we must examine the nature of marginal or incremental costs more closely. ‘A simple example may help. Let us suppose that we can build a one-story building, with a certain area of useful space, for a given sum. If instead, we should build a two-story building, the marginal coxt is not simply the labor, materials, etc., needed for the second floor. There must also be substantial redesigning of the Grst floor — heavier foundations, less useful space because of the need for stair ‘ways, heating and plumbing systems, etc. Hence the marginal cost is the difference between (a} the total cost of building two stories and (8) the total cost of building one. This difference, divided by the net increment to the product floor space— in this case the resultant of an increment and adecrement —is the marginat cost per unit, Tt may be higher or lower than the unit cast (average cost} of one floor. The production of the additional product can ouly be undertaken if certain changes are made in the methods of producing the original product, This is another way of saying that the costs of the two products are not independent, but are joint. The notion, unfortunately widespread among non-economists (and sometimes spread by economists) that incremental cost is somehow ‘only a part of total unit cost’, or, worse still, involves only out-of pocket expenses, is altogether wrong. Marginal cost is not a type or a part of cost; itis a difference between two totals of cost, each total representing a different effort and a different result. Marginal cost is the total cost of the difference; dividing by the number of additional units yields the marginal cost per unit. Depending on the time period chosen, margiaal cost may include investment cost, ar only ‘operating cost; that depends on the problem. Let us now imagine an old-time refinery which has no cracking unit and relies only on a fractional distillation, From every barret of crude it produces a certain fixed amount of gasoline, middle distil- lates and residual. Then the only refining cost is the cost per barrel ofJOINT Costs IN OlL-Gas PRODUCTION 27 crude charge, or per barrel of aggregate product output. Bach refined product is sold for what it will bring, but there is only one net profit margin, on the whole barrel. Thete is no refining cost or profit for the individual products, Some may sell for much more than. the value of che crude, some for much less, A higher price for one of the products tends to lower the price of the others. If middle distil- lates were in great demand, and the price rose, it would pay to refine ‘more crude ait; but since one cauld not produce more middle distil- tates without ar the same time producing more gasoline and residual, their supply would increase and price fall. But these fixed proportions in refining would to some extent be mitigated by variable proportions in producing. Where gasoline is in greatest demand, and its price the highest of any product, crudes with the most gasoline content are the most valuable. Hence the familiar gravity differentials on crude oil prices. But at other times and places other products would be more valuable. Depending on relative prices, exploration would be favored which seemed to have better prospects of tighter (or heavier) fractions; development would be pushed most on discoveries of lighter (or heavier) oii, etc. In short, there is room for variation in the kind of crude reserves which can be found, developed and extracted, and this variability gives us the possibility of reckoning incremental costs, however roughly. In principle (practice is, of course, nowhere as precise), if a deposit with t5 gallons of gasoline and 27 gallons of other products can he developed for 50 cents per harrel, while a barrel with 20 gallons of gasoline and 22 of other products can be developed elsewhere for t dollar then the cost of the incremental 5 gallons of gasoline is 50 cents plus the value of the 5 gallons of other products. If this incremental cost is tess than the expected price of gasoline, it is worth incurring. ‘The cracking process in refining has been a breakout from fixed to variable proportions. The computation of incremental cost in oil refining has been elaborated to an impressive degree, not only for gasoline as against middle distillates, but for finely graduated qualities of gasoline, and for various methods of achieving a given quality. Were it possible to achieve 42 gallons of any desired product to the barrel of crude, technology would have liberated us altogether from joint products. But there are still limits to the transformation, and as one approaches those limits, the cost of going from middle distillates into gasoline, or of adding another octane unit, etc., rises shan hoe we hey Soule cose Seeing fst Ts prousn would ge ok ae increasing cmt st ler, uni incremental cnt appyoached or equaled the price ofpuning. *28 ‘THE SUPPLY AND PRICE OF NATORAL GAS steeply; in this sense, too, products are produced at increasing cost. ‘And the changing stock will be ‘squeezed’ to the point where the cost of another unit (another ounce, another octane number) is about equal to its expected market price. JOINT COSTS OF OFL-045 PRODUCTION Let us now directly consider joint costs as between oil and gas. We must acknowledge at the outset how rough and misleading ace these two general headings. What we have is really a spectrum of pacafins (CoHonia) with increasing molecular weights, from the gases methane and ethane (Ci and Ca) through the liquefiable hydrocarbons (LPG) propane and butane (Cs and Cz), and natural gasoline (the pentanes plus), whereupon we are in the highly com- plex domain of crude oif itself, which includes paraffinic and other varieties, There is an almost infinite variation in the mix of what may actually be found in any given deposit. The customary dlistine- tion — crude oil, natural gas and natural gas liquids — is a rather summary one, But itis not actually incorrect, and since the existing statistics conform to this usage, so will we.! But the statistics also distinguish among three types of gas deposits: gas dissolved in cil, like the carbon dioxide in a bottle of beer; gas in contact with or ‘associated? with an oil deposit, usually as a gas cap up-dip, in such a way that the production of gas affects the production of oil; and ‘non-associated’, usually called ‘dry’ gas, which does not occur in conjunction with oil.# Actually, ‘dry’ is a misnomer, since it is often accompanied by condensate (which is for transport and refining purposes equivalent toa light ctude) or by LPG and natural gasoline. ‘The reader will note how we will need to disregard some of these facts in order to handle the figures, and must judge to what extent we have oversimplified the reality. AVERAGE AND MARGINAL COSTS IN NON-ASSOCIATED AND OTHER GAS As noted earlier, the idea of allocating total costs to arrive at a supposed average cost for cach of two or more joint products — “neglect of natal genie 2nd LPG soo ile The pce and eet tse supply) of EPG has tenced fo rae sclauive 0 aarors) qualia, Palmates ofthe mouse Sieger and batanes (sa ay head te oSted ore ue pseseion ‘aby debe SoS of svg tae Ute Seat Fe nd ashes tebtly ance ral ety Se owt py and Benard Cateye Louie Arora Choe Socey, Lie t hms Se a psp ate RiGiaidee ea TERS Suet tsar nent bans API Boas a RUE R Frio MH ae) ’ Tse inicln Royle Tide — American Gas Amacain, Pad Rtv of cade i Mee us Eg ed Met Ga ec eed ts ABER ieeeJOWNT Costs IN OML-GAs PRODUCTION 29 rather than estimating marginal costs — is fallacious; while the idea of allocation by the respective sales receipts of the products is purely siccular reasoning.! Allocation by the so-called BTU method, ie. the relative heat content of oil and gas, is based on a physical fact, and docs not involve the circular absurdity of allocating by relative sales receipts, or any variant thereof? This may make it a useful fiction, but it lacks analytical support. The joininess of cost is very different as between non-2ssociated gas and ‘casinghcad’ gas (associated and dissolved). Dissolved gas is rigidly, and associated gas is largely, in fixed proportions at every stage through actual extraction, The producer has no aption but to find, develop and bring them up together; discretion only begins when he decides whether to gather the gas or to vent and burn it. Only to the limited extent that exploration can be varied somewhat, or a gas cap left untouched or reinjected for pressure maintenance to be sold after much of the crude is produced, can we speak of variable proportions. Otherwise, there is no marginal cost of ‘casinghead’ gas apart from cil, or oil apart from ‘casinghead’ gas; doubling the out. put of one doubles the output of the other, etc. The only price that can affect output is the price of gas-plus-oil. ‘The actual ratio of associated and dissolved gas discoveries to oil discoveries in 1946-59 fluctuated around a mean of 1.5 to 2.0 thousand enbie feet of gas for every barrel of oil (sce below, Table 5), and no movement is dis- cernible either way. At respective prices af eg. 20 cents per mef and 43.00 per barrel, a 10 per cent increase in the price of gas would mean an increase of less than 2 per cent in the price of oil gas. Hence we would not expect, and do not find, any perceptible + Sone have, sevetielen, recommended ths procure, Thuy Joel B Disa, ‘Naural Gas ist, Conervaon, and Pricing Fajr and Praacdl of te Aoetcah Bamana Actin 8 May 98), BP asa sera 47s Wile x hard fo fod dawian method fr allocate eiplration pent, test ace several veacnably taluthetry methods" Having onftuedpresnn wich eevinee; he rear ta tet ‘Stony ofl cape Med ahr, bee he FG, Tuner Of Cy Docket ‘Seog hr, tn doe adugeare allocating by vata of rxpetve le ae hia are reading of hs dacsraene~ oi ‘ean very eatehiiypeepared tows shat the alain Sth anjel ot ecu {vu car realy be so separated) but ely Seca the end fel would e fo eld ptostn fmf turn deed ho “ome or ata "enema he meaning of hae terra aac revened aed ey wlio aay cae be iva * Sao Steer public tly eqs destined fl the mua red Staten pltitytegelatin sera ces tal sometinsnt them deh of cueular tenvoning. For teary Bly years fom Smyth a, Amey 16g WS. 406 (eine esl mane as bad ieleal Pee Commision Hope Neauai Gas eppany, 490° US. gor Cgtah special at, colycequatio purported to allow rotons Yar valuc wAbch Oe neting batt capliSlon of be Reo seat any ied prot rar sutgmatially stsbdasng, Poday, jon cous il be alsa Eegrding“o elgive sae teil so coat Apres wl hen “prove that the rave fs coca oe cn obs th Una Seas opreme out a ot “tate to pam on cal eating as'an rument of regulates. Petags they ww So beter thes ge igh na mare tam ta due sce east have30. HE SUPPLY AND PRIGE OF NATURAL GAS relation between the ptice of gas and the discoveries of ‘casinghead’ as. The matginal cost of ‘casinghead? gas is approximately zero (aside from the cast of disposal and from the aid or sometimes hindrance in ail production) up to the point where the producer contemplates putting in a gathering system. As a recent interesting if mistitled paper has shown,! marginal costs may, under certain conditions, exist even when’ proportions are rigidly fixed. Walters’s theory cannot be directly applied to petroleum production or refining, as i¢ has been in transportation, although it seems essentially correct, and deserves to be kept in mind. ‘T's of no practical importance’ has been a famous last utterance among theoreticians and businessmen alike, Walters's article will give some comfort to those who would allocate joint costs according to the ratio of the thermal content of oil and gas— the BTU method ~since he shows that, under the conditions of his problem, calculating costs on the basis of relative physical quantities would come nearer to MEC than would zero? But this seems an accidental improvement, We turn now to non-associated, sometimes called ‘dry’ gas. Here the whole cost of development can be considered as marginal cost; but itis not 2 clear-cut marginal gas cost, for natural gas Liquids are often a joint product which we must largely neglect. Development, as we have stressed throughout, is not a clearly defined phenomenon; it shades off into exploration, and there is no rigorous way of drawing the line. As the activity of searching, evaluating and dritling takes on more and more of an exploratary character, costs become more and more joint in that the operator does not know what, if anything, he will get in return for his outlays, and must gamble on the probability of some expected mixture of gas, oil and other hydrocarbons. Marginal cost of gas in the development of a dry gas 1A. A. Wales, “The Allacaton of Joint Cavs with Demands as Probability Distibs- sigs Aeron ng rai, vol 31960) pp. tbe Wales ot concerned with ‘Mlocadan’ at all Yor he does ot catcclace separate aurage cone, cely margin cout. ‘The tespective desnands forthe two (or mare) produets may be soitle known in advance thatthe hem may seed fo reckon wh the probability that ether ane ar the othec may turn aut tbe the ose for wnove sake ai icrement of capacity # needed. Pvery eon. Lescy ig weighted wich the probability of ts aecureenee} and te sum fori aFatonal scheme of marginal carts even under fixed proportars. Thus gnc eae calculate the “nari expected cot (EC) of ten 3 Tew than, the peice, fs rational canduer to prove the eapaeity to stuaty ‘fas argument ec brite ot wate pation in wy pring, ‘where the pzobablity of Peak t being greater or feta Peak 4 decermines whieh, Fequires the est of nerersenal capacity. See fl 8. Houthatker, ‘blectety Ta ‘Tabory and Braces’, Lomo Journal val LL (1954), pha s-35, fp an snp ode, ay clleague Pail Av Sarzuelso has gereralized che Walters caey purging It of _Zomé sor mathematical errors af wll as foe ambiguity of the ete and some of the “en at noted i the foots Walters, op. cic, 427.JOR costs 1 OIL-aas PRODUCTION 3t field is, by and large, development cost itself; marginal cost of gas in exploration is the additional cost of getting more of one kind of hydrocarbons in one mixture in one place than in a different mixture in another place. Icis this dual character of marginal costs in petroleum production which has caused some confusion. Marginal costs as ‘additive? costs to a main project —a gathering system, a processing system, etc. — are obvious enough. Marginal costs as redesign costs, as in the example of a two-story building, are less easily seen when they ine volve differences in the main project itself, usually in its choice. The misunderstanding of marginal cost in production is largely because the petroleum industry has had no need for working out such can- cepts, and because few economists have bothered with this range of problems lying on the borderline between economics and engincer- ing.! This lack of contact has been unfortunate. ‘The search for oil and gas is a continuous process in time and a less than continuous spectram in space as among the various hydco- carbons found in return for any given effort. Too much stress has been laid upon the idea of a ‘search for gas in its own right’ as though that were some sharply different activity. To be sure, there was clear mn for decades, tong before World War IL, chiefly, Ay, in the Appalachian region and California.? Yet the ane was once a considerable oil province, and the latter still is, so that the search was always commingled with oil. Recently, as gas has become increasingly valuable, increasing emphasis has been put on finding it. The exploratory articles in the trade press have for some years spoken, of exploration for gas. The recent remark by a producer —‘Pd drill a well, but I'm afraid F'll find oil and not gas"? —was, of course, a deliberate exaggeration. But in its latest annual reviewsforecast issue, the Oil and Gas Journal stated that ‘Gulf Coast and West Texas wildcatters will have gas on the brain; gas has replaced oil as the prize in both regions’, as well as in others ‘The context, however, shows that it is misleading to talk of ‘the’ prize, It is rather the case that: ‘Gas is right up there on top with oil as an exploratory objective in North American basins.’® In the 1960 mid-year review, it was clearly a matter of exploratory GF Jn 8. Mey ei atic Jf ed v5 (96), 59s 2 Soditerytepont op pe 2 Peale We aly 1b va 23 «(eg of tiara re tin Aug of, when te rach was completed, sit AIR in it wed a ara pe a i rte 3 Ca Ce ing gpa ang wit chennai prot Sigh Day apts tog ota) See Es We ay ats gre 8S Mound ba on lac oss32 ‘THM SUPPLY AND PRICE OF NATORAL GAS emphasis, which might be on oil in an old gas province (Paradox Basin), or on either oil or gas in a particular stratigraphic layer (Gallup oit ... and the deeper Dakota gas sands’) ot gas or oil alone. Or: ‘There's no sign of a let-up ... in the Texas Gulf Coast and the East Texas development. The emphasis in both regions is on gas and condensate reserves."" A recent Peiralaum Week survey? notes that producers continue to place increasing emphasis on gas, so that “digging for oil and finding gas’ will be said in hope rather than disgust. In the offshore Louisiana region, ‘the hunt for natural gas is a principal spur to the current off-shore upsurge ... [because] the unrestricted flow from gas will provide a steady predictable income [according 1 the) manager of off-shore operations for the GA.T.C. group. Gas fields, moreover, require smaller drilling outlay since wells are opened moze widely apart... ? Since offshore Louisiana is expected to show roughly 11 mef of gas to every barrel of oil,* such that gas gross revenue at current price will about equal cil, with lower development and extraction expense, this manager's statement is not hard to credit. ‘A final example may help clarify the process and introduce an additional aspect. In September 1958, Phillips Petroleum Company broke the depth record with a well in Pecos County, Texas. ‘It was a calculated business risk... Phillips officials sought natural gas in the Ellenburger [a Cambro-Ordovician formation]. Based on success at the nearby Puckett field, the company put down three deep wells.’ The cost was reported as something over $1.5 million for one such well, roughly twice that for three wells.5 The total cast of this project was something in the neighborhood of $5 million, including lease purchase and other clements.6 This is, of course, only part of the (social) incrernental cost. Since the test was based on the results in the Puckett field (though it was not an outpost from Puckett), the costs are joint between the hoped-for gas deposit and the Puckett deposit. Puckett field exploration was in part also “nd July og of, po gba, Ste a. A Kora, “Gnston Valley Discovers wren -VGes ea Wid i, Maseh sp Sy Tope “par Peucton, Fine fo, Po TPE ah Tay a te 8 ‘i LY ike Tener Lnisane Ofiirs Are Hossto, avineteaphe, tag), oximaed that ove soe eso 9 iar Toqansa were fy cate eabie et of gua an Elle arctan Nyce ‘tlt fo"), be he expected the ulate "ato to be som hat lower, aly Tose GG sec er Choe asl elas» eropordon af aber 171 cow Ti aot GS Famel, September aoth, gst Newsletter and np. g15 395. The cont far the well cally wat 8a lan "Bile pete So bay low pre lesues (B38,00 fr two hal sctins) sod syed mee Toney on dete: dling, while the opeaton wo made he oaly ater dl {Ee pecared to spond mace on leash (Syagunfon for a and 9) acess) ond et om cidng Obese tat well went to Sey ot te cost Yet ma)JOINT COSTS IN OIL-Gas PRODUCTION 33 exploration for this new field. Conversely, the dry holes —for so, unfortunately, they turned out to be—were in part the cost of delineating the area originated by the Puckett discoveries. But these were joint costs in another sense. The news item speaks of the drilling as though it were purely a search for gas. But this is not correct. The tract was sufficiently close to good oil territory, and the structure sufficiently similar, to make it worth considering as a possible source of oil, An oil company official explained the geology of the region in some detail, summing up: ‘The likelihood of an oil-bearing structure was perhaps ax high as, that of a gas producer ... Of course, we would be very happy to fhave a gas field of the caliber of Puckett Field [about 34 trillion cubic fect], but we probably would not have gone to the cffort and expense that we did if we had felt that it was restricted toa gas play.t ‘This is a good example of the continuous nature of the choices being made day to day by the petroleum industry, and it is 2 world away from the stereotypes of gas as a ‘mere by-product’ versus a simple ‘search for gas in its own right’. Dapth and Marginal Gas Cost cis often said that ‘the deeper the hole, the lighter the oil, and the higher the gas: oil ratio’, whether in the sense of more ‘casinghead” gas per barrel extracted or in the sense of greater probability of gas being found, whether associated or non-associated. This is something ‘more than casual generalizing from some limited post-war experi- nee, since some good reasons are offered: first, that greater heat and pressure farther underground act as a natural ‘cracker’, breaking down the heavier paraffins into lighter ones, so that there is an upward movement all along the scale, with the net result being less heavy oil at one end and more gas at the other end; second, the greater compression causes more gas to exist per cubic foot of permeable sands Such a relationship is a perfect example of variable proportions. It would, of course, mean a strong connection between the marginal cost of gas and the price of gas. For the petroleum producer would be on notice that as he went deeper, at-a considerably higher real cost, hhe would probably get more gas and less cil for his maney. Hence we might be able to work out a fairly smooth gradation, and plot an + Personal leter, James E. Finley, of Continental Oil Company, tothe writer, Me ney was icwolved fa the study ofthe fed, and asd his company as t being. CGantinensal was tot one af the high Bidder, ane wna not sovoleed nether othe te am indebted to Mr Finley for much more chan this particular nformstion,Eve ‘THE SUPPLY AND PRICE OF NATURAL. Gas approximate relation between higher costs and higher gas finds, and calculate the incremental cost of gas. And the price of gas would become increasingly important in influencing exploration as it went to greater depths. Unfortunately, no such simple and regular relation appears to exist, and indeed it is not proved that any relation exists. Itis a fact ‘of common notoriety that the world’s great gas fields are found at all depths, As Table I at p. 34 shows, gas discovery wells in 1959 differed significantly from oil, but only by tending much more to- ward the middle of the distribution than to either extreme. Gas condensate wells, however, are clearly deeper than oil. et ry ot oo Nima Parcel a 4 as 5 6 Bee bp Bt Bom Fh Be & % "et H & ot t eee yom By s000 a so, degrees of heed = 8, Poor Septh tases {in sous af fet)2'4, arias B, was-asos Gas o-a7a; D, ars-so.a; B 50°74, F, Jgston G, toourtgs i, ease Suara: Oi end Gas Jena Apel ast, 1960, p. 298. Perhaps there is an analogy to be drawn between depth-gas relationship and the formation-depth relationship (see below, tables at pp. 98 and 115). That is, one would expect the older formations to be generally deeper, and thisis true more often than not. Yet it is often untrue: the great producing area of south and offshore Louisiana consists predominantly of geologically young Pliocene: Pleistocene sands, and yet the wells are among the deepest in the world. Similarly, it may be that there is really a significant relation- ship between depth and gas occurrence, but that itis a weak relation- ship, or works only under certain conditions. An economist has nothing to contribute, obviously, except to paint out the economicJORNT COSTS IN aIL-Gas PRODUCTION 35, importance of knowing more, Greater knowledge of the depth-gas relation would enable us to discover them at a lower real cost. It may be that research is still hampered by lack of interest and funds which are an outdated remnant of the time when gas was atl un- wanted waste product. Conclusion We have tried to establish three basic propositions. First, petro- eum exploration and development are increasing-cost industries. Second, much associated and dissolved gas is available at an inde- Price, Cost Now Gos Reserves. Developed Feo, 6. Changes io supply and demand curves for natural gas terminate or very low marginal exploration and development cost, since it is joint in fixed proportions with oil. Third, because of vari- able proportions, marginal exploration cast exists as an increasing fametion for some small proportion of associated gas, and for the great bulk of non-associated gas. In Fig. 6, the line $:S1 shows the marginal cast (including in cost a normal or minimum return on all possible outpats of the product). If all natural gas were in fixed proportions with oil, there would be no marginal cost for gas and the relation between ising price and36 ‘THE SUPPLY AND PRICE OF NATURAL GAS increased supply would be weak, especially in the lower ranges of price. But for non-associated gas, arising price draws out an increas- ing supply as exploration and development are increasingly drawn toit. Neglecting, for the moment, the other § lines, and the MR line, if we imagine the demand curve shifting in the course of time from Dy to Da (as happened in the United States and is happening else~ where), as it shifts it traces out the supply curee. The shifting of the demand curve means that in a freely competitive market increasing amounis are being demanded at any given price, or that higher prices will be paid for the same quantity. ‘The varying S lines represent a shift over time in the conditions of cost, as distinguished from conditions at one time. For reasons to be shown later, we are not able to measure any shifts in the recent past, and will treat the supply function as being approximately stable during the period of our statistics. The demand curve has shifted so dramatically along the supply curve during this period that we Delieve it swamps any slower changes that might have been taking place in the supply curve itself. But this the reader must judge. If, therefore, a supply function exists in theory, we shail now make ‘an attempt. to approximate its actual shape. Two sets of facts are needed; the prices of newly developed gas reserves, and the outputs of new reserves, ie, the gross increment. to the total stock of proved reserves.