Information Externalities, Free Riding, and Optimal Exploration in the UK Oil Industry

Abstract

Information spillovers between firms can reduce the incentive to invest in R&D if property rights do not prevent firms from free riding on competitors' innovations. Conversely, strong property rights over innovations can impede cumulative research and lead to ineffcient duplication of effort. These effects are particularly acute in natural resource exploration, where discoveries are spatially correlated. I quantify these effects using data from offshore oil exploration in the UK to estimate a dynamic structural model of the firm's exploration problem. Firms face a trade-off between drilling now and delaying exploration to learn from other firms' wells. Removing the incentive to free ride increases industry surplus by 27% and allowing perfect information flow between firms raises industry surplus by 5%. Counterfactual policy simulations highlight a trade off in property rights design: stronger property rights over exploration well data increase the rate of exploration, while weaker property rights increase the efficiency and speed of learning but reduce the rate of exploration. Spatial clustering of each firm's drilling licenses both reduces the incentive to free ride and increases the speed of learning.