Oil companies drill far more on the better-governed side of a national border, so where oil is found depends on institutions as well as geology.
In plain language
The question
Why have some regions, such as sub-Saharan Africa, found relatively little oil? Geology is the obvious answer. This paper asks whether institutions also decide where companies look. National borders make a natural experiment: they were not drawn with the oil beneath them in mind, but the rules of the game change the moment you cross one. Using the location of oil and gas exploration wells worldwide, the paper compares drilling on either side of borders that have not changed since 1965, in 88 countries over 1966 to 2010.
What we find
- Better governance attracts more drilling. At the border, the paper estimates more than twice as much drilling on the side with better institutional quality. A gap of one standard deviation in the Freedom House Political Rights Index translates into 85 percent more wells.
- The amounts are large. Within 10 km of the borders, about 2,000 wells sit on the worse-governed side. On the paper’s back-of-the-envelope calculation, 85 percent more would mean about 1,700 extra wells, which could yield 4.25 million barrels a day, about 4.9 percent of world production in 2013.
- It holds across countries and companies. The pattern appears in developing and high-income countries alike, and for the supermajors, national oil companies and the rest of the exploration industry. The supermajors are particularly sensitive to institutional quality in developing countries.
The result survives restricting the sample to borders stable since 1946, dropping borders between states with recorded military conflicts, and looking at Africa alone, where boundaries were arguably imposed from outside.
Why it matters for policy
Promising geology may not be enough to attract exploration. To the extent that governments can improve their institutional environment, they may speed up discovery and add to their country’s natural capital. Regions such as sub-Saharan Africa may be under-explored relative to their geology, which can help explain why they have found relatively little oil per square kilometre. And because the oil a country has found partly reflects its institutions, some natural capital is itself an economic outcome, like human and physical capital. That is a caution for research that treats oil wealth as a given cause of political and economic outcomes.
Abstract
We provide evidence that institutions have a strong influence over where oil and gas exploration takes place. We utilise a global data set on the location of exploration wells and national borders. This allows for a regression discontinuity design with the identifying assumption that the position of borders was determined independently of geology. In order to break potential simultaneity between borders, institutions, and activities in the oil sector, we focus on drilling that occurred after the formation of borders and institutions. Our sample covers 88 countries over the 1966–2010 period. At borders, we estimate more than twice as much drilling on the side with better institutional quality. Subsample analyses reveal effects of institutions on exploration drilling in both developing and high income countries, as well as across three types of operating companies. We find that the supermajor international oil companies are particularly sensitive to institutional quality in developing countries. Our findings are consistent with the view that institutions shape both exploration companies' incentives to invest in drilling and host countries' supply of drilling opportunities.
Cite as
James Cust and Torfinn Harding (2020). "Institutions and the Location of Oil Exploration." Journal of the European Economic Association. https://doi.org/10.1093/jeea/jvz028