Abstract
What encourages irreversible investment? How sensitive is investment to uncertainty? The research presented here analyzes these questions in the context of the US oil industry with implications across numerous settings. First, macroeconomic and oil industry-wide shocks are identified and quantified in a structural vector autoregression model of the oil industry and regressed on industry measures of realized investment projects and expenditures. Responses vary across projects, with oil demand shocks generally the most dominant. Second, examining all operating US petroleum refineries from 1999-2020 I identify the firm- and sector-specific factors correlated with increases in operable capacity. In particular, I examine the role of uncertainty, identified using market uncertainty indexes, market expectations, and price margins, and find the investment-uncertainty relationship to be strongly correlated with the size of the refinery. The smaller the firm, the greater the sensitivity of its investment decisions to prices and thus to uncertainty measures. Larger firms increase operable capacity to increase production efficiency and economies of scale. Third, the dampening effect of energy transition policies and politics on oil sector investment underlines the fundamental role of investment in industries characterized by high capital outlays and long planning horizons and its sensitivity to policy interventions and political uncertainty. Under low elasticities and lack of substitutes, policy interventions prove ineffective while the prospect or threat of sector decline induces sector decline via reduced investment. Overall, these results indicate that while irreversible investment weathers many shocks, firm characteristics and policy frameworks prove the most salient determinants.