Switching from oil to gas production in a depleting field

Kristian Støre, Stein-Erik Fleten, Verena Hagspiel and Cláudia Nunes

European Journal of Operational Research, 2018, vol. 271, issue 2, 710-719

Abstract: We derive an optimal decision rule with regards to making an irreversible switch from oil to gas production. The approach can be used by petroleum field operators to maximize the value creation from a petroleum field with diminishing oil production and remaining gas reserves. Assuming that both the oil and gas prices follow a geometric Brownian motion we derive an analytical solution for the exercise threshold. We also propose an explicit solution for the option value that is new to the literature. Numerical examples are used to demonstrate the threshold and option value for a generic petroleum field. Both the threshold and option value solutions are relevant for application to other real options cases with similar features (e.g. other types of switching options or a perpetual spread option).

Keywords: OR in energy; Switching option; Petroleum; Investment under uncertainty (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:271:y:2018:i:2:p:710-719

DOI: 10.1016/j.ejor.2018.05.043

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