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How and Why Petroleum Leases Are Held by Production: Analysis of a Compound Option

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  • James L. Smith

Abstract

Most oil and gas leases allow the operator to extend possession by establishing production in paying quantities. We show how this option to “hold by production” (HBP) stimulates the drilling of many uneconomic wells but also creates incentives to delay other economic wells. We provide a simple method to value the HBP provision as a compound option and estimate that it has increased the value of typical shale gas leases in the major U.S. basins by 25% to 250% in recent years. We also identify subbasins where drilling appears likely to have been suppressed rather than stimulated.

Suggested Citation

  • James L. Smith, 2018. "How and Why Petroleum Leases Are Held by Production: Analysis of a Compound Option," Land Economics, University of Wisconsin Press, vol. 94(1), pages 52-72.
    • Handle: RePEc:uwp:landec:v:94:y:2018:i:1:p:52-72
    Note: DOI: 10.3368/le.94.1.52
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    Cited by:

    1. Mason, Charles F. & Wilmot, Neil A., 2020. "Jumps in the convenience yield of crude oil," Resource and Energy Economics, Elsevier, vol. 60(C).
    2. Xu, Minhong & Xu, Yilan, 2020. "Fraccidents: The impact of fracking on road traffic deaths," Journal of Environmental Economics and Management, Elsevier, vol. 101(C).

    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • Q33 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Resource Booms (Dutch Disease)

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