A Well-Based Cost Function and the Economics of Exhaustible Resources: The Case of Natural Gas

A cost function for natural gas production is estimated, using a pool of data from 29 wells. Statistically exact tests are performed for parameter stability across locations, formations, wells, and producing firms. Costs are determined to be inversely related to remaining recoverable reserves, and marginal costs of production are decreasing in all cases. Theoretical implications of these cost characteristics on optimal exhaustible resource extraction are analyzed. Although marginal cost is decreasing, production effects on the resource stock imply that an interior production path may be optimal. Conditions under which production optimally occurs at the capacity bound are delineated, and optimal interior production paths are characterized.