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Revenue Risk of U.S. Tight-Oil Firms

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  • Luis Mª Abadie

    (Basque Centre for Climate Change, Sede Building 1, 1st floor, Scientific Campus of the University of the Basque Country, 48940 Leioa, Spain)

  • José M. Chamorro

    (Department of Financial Economics II, University of the Basque Country, Av. Lehendakari Aguirre 83, 48015 Bilbao, Spain)

Abstract

American U.S. crude oil prices have dropped significantly of late down to a low of less than $30 a barrel in early 2016. At the same time price volatility has increased and crude in storage has reached record amounts in the U.S. America. Low oil prices in particular pose quite a challenge for the survival of U.S. America’s tight-oil industry. In this paper we assess the current profitability and future prospects of this industry. The question could be broadly stated as: should producers stop operation immediately or continue in the hope that prices will rise in the medium term? Our assessment is based on a stochastic volatility model with three risk factors, namely the oil spot price, the long-term oil price, and the spot price volatility; we allow for these sources of risk to be correlated and display mean reversion. We then use information from spot and futures West Texas Intermediate (WTI) oil prices to estimate this model. Our aim is to show how the development of the oil price in the future may affect the prospective revenues of firms and hence their operation decisions at present. With the numerical estimates of the model’s parameters we can compute the value of an operating tight-oil field over a certain time horizon. Thus, the present value (PV) of the prospective revenues up to ten years from now is $37.07/bbl in the base case. Consequently, provided that the cost of producing a barrel of oil is less than $37.07 production from an operating field would make economic sense. Obviously this is just a point estimate. We further perform a Monte Carlo (MC) simulation to derive the risk profile of this activity and calculate two standard measures of risk, namely the value at risk (VaR) and the expected shortfall (ES) (for a given confidence level). In this sense, the PV of the prospective revenues will fall below $22.22/bbl in the worst 5% of the cases; and the average value across these worst scenarios is $19.77/bbl. Last we undertake two sensitivity analyses with respect to the spot price and the long-term price. The former is shown to have a stronger impact on the field’s value than the latter. This bodes well with the usual time profile of tight oil production: intense depletion initially, followed by steep decline thereafter.

Suggested Citation

  • Luis Mª Abadie & José M. Chamorro, 2016. "Revenue Risk of U.S. Tight-Oil Firms," Energies, MDPI, vol. 9(10), pages 1-18, October.
    • Handle: RePEc:gam:jeners:v:9:y:2016:i:10:p:848-:d:81045
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    References listed on IDEAS

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    1. Christiane Baumeister & Lutz Kilian, 2016. "Forty Years of Oil Price Fluctuations: Why the Price of Oil May Still Surprise Us," Journal of Economic Perspectives, American Economic Association, vol. 30(1), pages 139-160, Winter.
    2. Congressional Budget Office, 2014. "The Economic and Budgetary Effects of Producing Oil and Natural Gas From Shale," Reports 49815, Congressional Budget Office.
    3. Congressional Budget Office, 2014. "The Economic and Budgetary Effects of Producing Oil and Natural Gas From Shale," Reports 49815, Congressional Budget Office.
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    Cited by:

    1. Luis Mª Abadie & José M. Chamorro, 2017. "Valuation of Real Options in Crude Oil Production," Energies, MDPI, vol. 10(8), pages 1-21, August.
    2. Josué M. Polanco-Martínez & Luis M. Abadie, 2016. "Analyzing Crude Oil Spot Price Dynamics versus Long Term Future Prices: A Wavelet Analysis Approach," Energies, MDPI, vol. 9(12), pages 1-19, December.

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