Abstract

This paper analyzes the problem faced by an oil company with investment rights over the tracks subject to relinquishment requirements, which limit the time the company can hold the tract before developing it. Some concepts of the modern Real Options Theory are described briefly, with focus on the tinting aspects: economic uncertainty and irreversibility incentive the learning by waiting, and delays the investment; technical uncertainty incentives the learning by doing, and generally speeds investment up. The technical uncertainty (existence, quality and volume of reserves) is dominant for the exploratory investment decisions, whereas the economic uncertainty (oil/reserves prices and costs) is dominant for the development decisions.

The arrival of technical information in the exploratory phase comes from two sources with opposite effects on the investment start up: information from the company itself exploration, and information from the neighbors tracts exploration. The second effect is one strategic aspect, and can be modeled by the Game Theory, usually as a non-cooperative game between the tracts owners, in the same geographical area. This non-cooperative game creates an another waiting effect: many companies can prefer to wait some of the neighbors investments (and get some "free" information) before start their own (and expensive) exploratory investment.

Some results for the development investment decisions are presented, using the Paddock, Siegel & Smith model, with the Barone-Adesi & Whaley analytic approximation, through an Excel spreadsheet. Also are presented some results from the interactions of two sources of economic uncertainty: the reserves value uncertainty and the development cost uncertainty. Although this effect can be small, the cost uncertainty lowers the total economic uncertainty (reducing the value of the option to defer) since the cost fluctuations are positively correlated with the oil/reserves prices, and the cost uncertainty is lower than price uncertainty. Some conclusions and suggestions are presented.

Introduction

Investment in exploration and production (E&P) is an activity with a high degree of irreversibility, and subject to large technical (endogenous) and economic/politic (exogenous) uncertainties. This article analyzes the investment timing of an oil company, beginning with the situation immediately after a leases bidding round, which companies acquire rights over tracts with some probabilities to discover hydrocarbons accumulations. These rights are not perpetual, there are a time to expiration (five years is typical) for the rights: if the company didn't find any oil/gas reserve or if did, but not compromise with a development investment plan, the tract goes back to the Government Agency and can be offered in another bid.

The E&P investment is a sequential process as is drawn in Fig. 1. In the beginning, the rights owner has only probabilities to find out some oil/gas accumulations. If the wildcat well investment results in a discovery, the owner has the right to invest in the appraisal phase, in order to reduce the technical uncertainty of the field, getting a delineated undeveloped reserve. This gives the right (option) to the owner to develop the field by a large development investment, obtaining a developed reserve (producing reserve).

Timing in this paper means when to invest in order to maximize the firm wealth. The solution of investment timing problem is performed backwards (in the spirit of the optimization tool named dynamic programming): first will be valueted the last phase (development) and last the first phase (exploration), because previous phase value depends of the subsequent phase value. The paper is organized as follows. First section is presented the option model that deals with economic uncertainty (which incentives the learning by waiting) for investment analysis at the development phase.

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