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Optimal Oil Extraction as a Multiple Real Option

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  • Nikolay Aleksandrov
  • Raphael Espinoza

Abstract

We study optimal oil extraction strategy and the value of an oil field using a multiple real option approach. Extracting a barrel of oil is similar to exercising a call option and optimal strategies lead to deferring production when oil prices are low and when volatility is high. We show that, in theory, the net present value of a country’s oil reserves is increased significantly (by 100 percent, in the most extreme case) if production decisions are made conditional on oil prices. We also show that the marginal value of additional capacity is higher for countries with bigger resources and longer production horizons. We apply the model to Brazil and the U.A.E. in order to pin down two points of the global supply curve.

Suggested Citation

  • Nikolay Aleksandrov & Raphael Espinoza, 2011. "Optimal Oil Extraction as a Multiple Real Option," OxCarre Working Papers 064, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    • Handle: RePEc:oxf:oxcrwp:064
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    File URL: https://ora.ox.ac.uk/objects/uuid:6ee71357-df1a-42d6-9170-2852dab85b61
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    References listed on IDEAS

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    Cited by:

    1. Aleksandrov, Nikolay & Espinoza, Raphael & Gyurkó, Lajos, 2013. "Optimal oil production and the world supply of oil," Journal of Economic Dynamics and Control, Elsevier, vol. 37(7), pages 1248-1263.
    2. Fabio Bertoni & Stefano Lugo, 2013. "Testing the Strategic Asset Allocation of Stabilization Sovereign Wealth Funds," International Finance, Wiley Blackwell, vol. 16(1), pages 95-119, February.
    3. Mr. Nikolay Aleksandrov & Mr. lajos Gyurko & Mr. Raphael A Espinoza, 2012. "Optimal Oil Production and the World Supply of Oil," IMF Working Papers 2012/294, International Monetary Fund.

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    More about this item

    Keywords

    Oil production ; Real Options ; Capacity Expansion ; Stochastic Optimization;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • Q30 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - General
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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