Optimal oil production and the world supply of oil

Nikolay Aleksandrov, Raphael Espinoza () and Lajos Gyurkó

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 7, 1248-1263

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 2008–2009 crisis, and we find that the cut in production was larger for OPEC members, for countries facing a lower discount rate, and for countries whose governments' finances are less dependent on oil revenues. However, the net present value of a country's oil reserves would be increased significantly (by 100%, in the most extreme case) if production was cut completely when prices fall below the country's threshold price. If several producers were to adopt such strategies, world oil prices would be higher but more stable.

Keywords: Oil production; Real options; Capacity expansion; Equilibrium price of oil; OPEC (search for similar items in EconPapers)
JEL-codes: C61 Q30 Q43 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Working Paper: Optimal Oil Production and the World Supply of Oil (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:37:y:2013:i:7:p:1248-1263

DOI: 10.1016/j.jedc.2013.01.015

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