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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 appraoch. 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 sow that, in theory, the net present alue ofa 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 ofaditional 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.

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Bibliographic Info

Paper provided by Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford in its series OxCarre Working Papers with number 064.

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Date of creation: 2011
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Handle: RePEc:oxf:oxcrwp:064

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Related research

Keywords: Oil production; Real Options; Capacity Expansion; Stochastic Optimization;

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References

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  1. Olivier Aj Bardou & Sandrine Bouthemy & Gilles Pag\`es, 2007. "Optimal quantization for the pricing of swing options," Papers 0705.2110, arXiv.org.
  2. Davis, Graham A., 1996. "Real options: Managerial flexibility and strategy in resource allocation : Lenos Trigeorgis The MIT Press, Cambridge, MA, 1996, xiii + 427 pp. (hardcover), ISBN 0-262-20102-X," Resources Policy, Elsevier, vol. 22(3), pages 218-220, September.
  3. Noureddine Krichene, 2005. "A Simultaneous Equation Model for World Crude Oil and Natural Gas Markets," IMF Working Papers 05/32, International Monetary Fund.
  4. Octavio A. F. Tourinho., 1979. "The Option Value of Reserves of Natural Resources," Research Program in Finance Working Papers 94, University of California at Berkeley.
  5. L. C. G. Rogers, 2002. "Monte Carlo valuation of American options," Mathematical Finance, Wiley Blackwell, vol. 12(3), pages 271-286.
  6. Paddock, James L & Siegel, Daniel R & Smith, James L, 1988. "Option Valuation of Claims on Real Assets: The Case of Offshore Petroleum Leases," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 479-508, August.
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Cited by:
  1. Nikolay Aleksandrov & Raphael Espinoza & Lajos Gyurko, 2012. "Optimal Oil Production and the World Supply of Oil," OxCarre Working Papers 092, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.

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