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Optimal Oil Production and the World Supply of Oil

Author

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  • Nikolay Aleksandrov
  • Raphael Espinoza
  • Lajos Gyurko

Abstract

We study the optimal oil extraction strategy and the value of an oil field using a multiple real option approach. The numerical method is flexible enough to solve a model with several state variables, to discuss the effect of risk aversion, and to take into account uncertainty in the size of reserves. Optimal extraction in the baseline model is found to be volatile. If the oil producer is risk averse, production is more stable, but spare capacity is much higher than what is typically observed. We show that decisions are very sensitive to expectations on the equilibrium oil price using a mean reverting model of the oil price where the equilibrium price is also a random variable. Oil production was cut during the 2008-09 crisis and we find that the cut in production was larger for OPEC, for countries facing a lower discount rate, as predicted by the model, and for countries whose governments' finances are more dependent on oil revenues. However, the net present value of a country's oil reserves would be increased significantly (by 100 percent, in the most extreme case) if production was cut completely when prices fall below the country's threshhold price. If several producers were to adopt such strategies, world oil prices would be higher but more stable.

Suggested Citation

  • 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.
  • Handle: RePEc:oxf:oxcrwp:092
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    References listed on IDEAS

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    Cited by:

    1. Araujo, Juliana D. & Li, Bin Grace & Poplawski-Ribeiro, Marcos & Zanna, Luis-Felipe, 2016. "Current account norms in natural resource rich and capital scarce economies," Journal of Development Economics, Elsevier, vol. 120(C), pages 144-156.
    2. Y. Charles Li & Hong Yang, 2016. "A mathematical model of demand-supply dynamics with collectability and saturation factors," Papers 1606.06720, arXiv.org.

    More about this item

    Keywords

    Oil production; Real Options; Capacity Expansion; Equilibrium Price of Oil; OPEC;

    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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