INVESTMENT SPIKES AND UNCERTAINTY IN THE PETROLEUM REFINING INDUSTRY

Authors


  • *An earlier version of the paper was presented at the 25th North American Conference of the International Association for Energy Economics (IAEE) in Denver in 2005. We thank Kevin Forbes, Shu Lin, Dan Sutter, the Editor and an anonymous referee for helpful comments. We have also benefited from conversations with Dennis O'Brien, Sid Gale, and Stephen Patterson. The authors alone are responsible for any remaining errors.

Abstract

This paper investigates the effect of uncertainty on the investment decisions of petroleum refineries in the U.S. We construct uncertainty measures from the commodity futures market and use data on actual capacity changes to measure investment episodes. Since capacity changes in U.S. refineries occur infrequently, we empirically model the investment process using hazard models. An increase in uncertainty decreases the probability that a refinery might adjust its capacity. The results are robust to various investment thresholds. Our findings lend support to theories that emphasize the role of irreversibility in investment decisions.

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