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The Management of Flexibility in the Upstream Petroleum Industry

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  • David Laughton

Abstract

This paper is the third in a series that describes how Modern Asset Pricing (MAP) may be used for project evaluation in the upstream petroleum industry. It demonstrates how MAP can be applied to projects where policies for the management of future flexibility must be considered within the context of the valuation. We illustrate this use of MAP by looking specifically at flexibility in the timing of the exploration, delineation, and development of an oil prospect, and the timing of the abandonment of the subsequent developed field. We use examples to show how the value and management of flexibility depends on the amount of oil price and reserve size uncertainty. We find that prospect value increases with both types of uncertainty. We also find that all actions, from exploration to abandonment, occur later with greater oil price uncertainty. Conversely, we find that exploration and delineation occur sooner with greater reserve uncertainty. The reasons for these results are given.

Suggested Citation

  • David Laughton, 1998. "The Management of Flexibility in the Upstream Petroleum Industry," The Energy Journal, , vol. 19(1), pages 83-114, January.
    • Handle: RePEc:sae:enejou:v:19:y:1998:i:1:p:83-114
    DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-4
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    References listed on IDEAS

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    1. Paul G. Bradley, 1998. "On the Use of Modern Asset Pricing for Comparing Alternative Royalty Systems for Petroleum Development Projects," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 47-81.
    2. Malcolm P. Baker & E. Scott Mayfield & John E. Parsons, 1998. "Alternative Models of Uncertain Commodity Prices for Use with Modern Asset Pricing Methods," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 115-148.
    3. Gordon Salahor, 1998. "Implications of Output Price Risk and Operating Leverage for the Evaluation of Petroleum Development Projects," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 13-46.
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