The Option Value of Acquiring Information in an Oilfield Production Enhancement Project

Margaret Armstrong, William Bailey and Benoît Couët

Journal of Applied Corporate Finance, 2005, vol. 17, issue 2, 99-104

Abstract: In many industrial applications, the option to acquire information instead of simply waiting for conditions to improve can add considerable value to projects. As one example, most oil wells require periodic “workovers” to maintain production at satisfactory levels, and acquiring up‐to‐date information on the reservoir using a production logging tool (PLT) generally improves the efficiency of such workovers. This article presents a case study of oil production enhancement in which Bayesian analysis is incorporated into a real options framework to determine whether the additional cost of acquiring information is justified. This case is different from most applications of real options in that there are two main sources of uncertainty: the oil price and the reservoir. Bayesian analysis was used to update the reservoir model, using the PLT data together with prior knowledge about the reservoir. The updated reservoir model was then incorporated into a real options valuation framework.

Date: 2005
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