Between a Rock and a Steel Price: Steel Tariffs, Input Cost Uncertainty, and Oil Drilling Investment

Abstract

In this thesis, I develop a structural model of investment in oil drilling, extending the model developed in \citet{Kellogg2014} by including steel costs and independent variation in the market volatility of steel costs. The development of the extended model is motivated by recent tariff episodes, including the 2018 and 2025 Section 232 tariffs on steel and aluminum, creating level shocks that allow the principled study of how steel costs play a role in the drilling decision. I solve the firm's dynamic decision problem numerically and calibrate model parameters using data on well permits issued in Texas between 2010 and 2019. The fully calibrated model achieves a time series correlation of r = 0.675 to the observed drilling rates. The structural modeling approach allows for the exploration of counterfactual experiments. They show that a 25 percent steel cost increase over the sample reduces drilling by 2.8 percent. The combination of increasing steel costs by 25 percent and doubling steel cost uncertainty, reduces drilling by 3.1 percent, exceeding the sum of the individual effects and implying that investment is most impaired by cost increase when future costs are uncertain and vice versa. I also produce a counterfactual where I eliminate the level shift of costs due to the Section 232 tariffs and find that oil drilling would have been 3.7 percent higher during the post-tariff period. Finally, I find that the impact of the tariff is dependent on the level of the oil price. A 25 percent cost increase reduces drilling by 5.4 percent when oil prices are in the lowest quartile but only by 1.9 percent in the highest quartile, implying that the true economic cost of a tariff to the oil sector is a function of oil market prices when the tariff is imposed.