The Management of Flexibility in the Upstream Petroleum Industry

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.

Rescaling-contraction with a lower cost technology when revenue declines

“…The models of Bjerksund and Ekern (1990) for oil development value include the analytical American perpetuity real call option. Laughton (1998) shows that both oil price and reserve volume uncertainties enhance the prospect value but distinctively influence the exercise of the various decisions. McCormack and Sick (2001) discuss the use of real options in valuing undeveloped reserves.…”

Optimal Petroleum Taxation Subject to Mobility and Information Constraints

“…Partial cash flow discounting represents an active research agenda, see e.g. Laughton and Jacoby (1993) Laughton (1998aLaughton ( , 1998b, Emhjellen (1999), and Emhjellen and Osmundsen (2001). The same applies to real option theory, see e.g.…”

Comparative statics for real options on oil: What stylized facts?

“…The single-beta version of this extension is used in the real options literature. Among authors recommending to use the CAPM to find µ are Trigeorgis (1996), Salahor (1998), Laughton (1998) On the other hand, Dixit and Pindyck (1994, p. 178) state that "when the σ of the P asset increases, µ must increase." From (7), this seems to rely on an assumption that ρ pm is positive and invariant to changes in σ p .…”