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Optimal Oil Extraction as a multiple Real Option


  • Nikolay Aleksandrov
  • Raphael Espinoza


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.

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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    References listed on IDEAS

    1. Olivier Aj Bardou & Sandrine Bouthemy & Gilles Pag`es, 2007. "Optimal quantization for the pricing of swing options," Papers 0705.2110,
    2. 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.
    3. James L. Paddock & Daniel R. Siegel & James L. Smith, 1988. "Option Valuation of Claims on Real Assets: The Case of Offshore Petroleum Leases," The Quarterly Journal of Economics, Oxford University Press, vol. 103(3), pages 479-508.
    4. 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.
    5. Noureddine Krichene, 2005. "A Simultaneous Equations Model for World Crude Oil and Natural Gas Markets," IMF Working Papers 05/32, International Monetary Fund.
    6. L. C. G. Rogers, 2002. "Monte Carlo valuation of American options," Mathematical Finance, Wiley Blackwell, vol. 12(3), pages 271-286.
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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.

    More about this item


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

    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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