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High-End Risk

Case Aims: To illustrate the risks associated with investment in high-end technology that is more expensive than conventional technology

Occasionally situations arise where there is a finite or limited capacity in an industrial sector which begins to create problems as demand rises rapidly and customers face spiralling prices. Under these circumstances innovation may become of interest even though bringing new capacity onstream through technological advances may be more expensive than the operating costs of existing producers. The risk facing the exploiters of the new technology is that if prices fall due to a decline in demand, high operating costs may vitiate profitability (Balakrishnan and Pathak 2014).

An example of this high-end alternative technology is provided by the development of fracking in the oil and gas industry (Hausman and Kellogg

2015) . This technique, involving the injection of a pressurised liquid, was first developed in the late 1940s to stimulate greater output from existing hard-rock wells. It was not until the 1980s that producers began experimenting with ways of opening up new wells from oil and gas deposits located in highly permeable rock formations. The new process involved the high-pressure injection of fracking fluid, consisting primarily of water, sand or other chemicals, to create cracks in deep-rock formations. The entrepreneurial innovation which dramatically expanded access to more difficult deposits was the development of horizontal drilling in place of the more conventional vertical drilling. Because they create a much larger contact area with the oil and gas deposit, horizontal wells are much more effective than vertical wells in producing from nearly horizontal beds.

Murtaugh (2016) noted that the drawback with fracking is that the breakeven production cost is in the region of $50 per barrel, whereas break-even for producers in the highly productive Middle East fields is in the region of $5-10/barrel. Hence for the first decade of the twenty-first century when oil prices at times exceeded $100/barrel, the profitability of companies engaged in fracking, especially in the USA, led to a major expansion in this area of the oil industry and numerous new wells were drilled. However as the downturn in the global economy caused demand for oil to decline in 2015, oil prices fell to below $50/barrel (Aguilera 2009; Kulkarni 2015; Murtaugh

2016) . Although the price drop affected total revenue of producers in the Middle East using conventional vertical drilling technology, the impact on the US fracking industry was much more dramatic, with many producers beginning to lose money. This outcome has resulted in some wells being shut down and plans for new drilling being severely curtailed.

 
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