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The impact of spatial price differences on oil sands investments

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  • Galay, Gregory

Abstract

In this article, a two-factor real options model is developed to examine the impact spatial price differences have on the value of an oil sands project and the incentive to invest. Large, volatile price differences between locations can emerge when demand to ship exceeds capacity limits. This may have a significant impact on production, investment, and policy in exporting regions. Here, we assume the price difference between two locations follows a stationary process implying crude oil markets are integrated as oil prices in different locations move together. The investment decision is formulated as a linear complementarity problem that is solved numerically using a fully implicit finite difference method. Results show the value of an oil sands project and the incentive to invest in a new project will increase when the mean price difference decreases. Surprisingly, the standard deviation of the price difference has very little impact on project value or the incentive to invest.

Suggested Citation

  • Galay, Gregory, 2018. "The impact of spatial price differences on oil sands investments," Energy Economics, Elsevier, vol. 69(C), pages 170-184.
    • Handle: RePEc:eee:eneeco:v:69:y:2018:i:c:p:170-184
    DOI: 10.1016/j.eneco.2017.11.008
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    Cited by:

    1. Gregory Galay & Henry Thille, 2021. "Pipeline capacity and the dynamics of Alberta crude oil price spreads," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 54(3), pages 1072-1102, November.
    2. Jia-Yue Huang & Yun-Fei Cao & Hui-Ling Zhou & Hong Cao & Bao-Jun Tang & Nan Wang, 2018. "Optimal Investment Timing and Scale Choice of Overseas Oil Projects: A Real Option Approach," Energies, MDPI, vol. 11(11), pages 1-22, October.
    3. Jerzy Rembeza & Kamila Radlińska, 2020. "Price Linkages Between Tea Markets: A Case Study for Colombo, Kolkata and Mombasa Auctions," European Research Studies Journal, European Research Studies Journal, vol. 0(2), pages 134-150.

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    More about this item

    Keywords

    Real options analysis; Natural resource; Project valuation; Spatial price differences; Numerical methods;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • Q32 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Exhaustible Resources and Economic Development

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