The Timing Of Investment In Deepwater Heavy-oil Opportunities With Uncertainty In Oil Price And Production Technology

Many offshore heavy oil discoveries in deep waters can be considered valuable assets if new technologies are available to transform geological successes into economic successes through projects of development and production. But, there are some latent questions: i) how to forecast future technology advances in order to produce this heavy hydrocarbon?; ii) how companies can estimate development cost for the next five to ten years?; iii) with which degree of certainty will new technologies be available to reduce present production costs for these oil types? This paper proposes the application of the theory of option pricing for valuation and decision-making in opportunities to invest in projects to produce heavy oil in a deep water environment. The first uncertain variable is oil price, which evolves over time as a Geometric Brownian Motion. The second uncertain variable is the impact of advances of production technology on production cost that evolves as a Poisson process. The assumptions in oil price modeling are based on continuous fluctuations over time. In case of production technology, we assume that advances take place in a discrete way through jumps that can represent gains, which may enable the firm to produce with greater efficiency reducing costs. This timing model is applied for valuation and decision-making of a typical heavy-oil project located in Campos basin in Brazil (15 oAP1, 2900 m water-depth). This production includes 7 production and 7 injection wells. Preliminary results show that the investment-rule is far from that of traditional NPV (that is, invest as long as NPV>0), especially in case of increasing oil pricing volatility and size and arrival of technological innovations. Copyright 2006, Society of Petroleum Engineers.533223333Costa Lima, G.A., (2004) A Proposal of Using Real Options and Preference Theory in Projects of Production and Exploration of Petroleum, , PhD. Dissertation, State University of Campinas, CampinasCosta Lima, G.A., Suslick, S.B., Quantification of investment moment in mineral assets using real options theory (2001) Ouro Preto Mining School Journal, 54 (2), pp. 149-154. , Ouro PretoDias, M.A.G., Valuation of exploration & production assets: An overview of real options models (2004) Journal of Petroleum Science and Engineering, 44Dias, M.A., Rocha, K., Petroleum concessions with extendible options using mean reversion with jumps to model oil prices (1999) 3rd International Conference on Real Options, pp. 1-27. , The Netherlands, 1999, June 6-8Dixit, A., Pindyck, R., (1994) In Vestment under Uncertainty, , Princeton University Press, FebruaryDoraszelski, U., Innovations, improvements, and the optimal adoption of new technologies (2004) Journal of Economic Dynamics & Control, (28), pp. 1461-1480Farzin, Y.H., Huisman, K.J.M., Kort, P.M., Optimal timing of technology adoption (1998) Journal of Economic Dynamics and Control, (22), pp. 779-799Grenadier, S., Weiss, A., Investment in technological innovations: An option pricing approach (1997) Journal of Financial Economics, 44, pp. 397-416Kaplan, R.S., Must CIM be justified by faith alone? (1986) Harvard Business Review, 64, pp. 87-93Meyers, S., Majd, S., (1983) Calculating the Abandonment Value Using Option Pricing Theory, , Cambridge: MIT pressMurto, P., Timing of investment under technological and revenue related uncertainties (2003) Systems Analysis Laboratory Research Report, E11. , Helsinki University of TechnologyPaddock, J.L., Siegel, D.R., Smith, J.L., Option valuation of claims on real assets: The case of offshore petroleum leases (1988) Quarterly Journal of Economics, pp. 479-508. , AugustPindyck, R., Volatility in natural gas and oil markets (2004) Journal of Energy and Development, , NovemberStermole, F.J., Stermole, J.M., (1993) Economic Evaluation and Investment Decision Methods. 8th Ed., 479p. , Golden, Colorado:Investment Evaluations CorporationSuslick, S.B., Schiozer, D.J., Nepomuceno, F., Furtado, R., Forecasting the development of heavy-oil reserves in ultra-deep waters using technological risk models (2003) SPE Hydrocarbon Economics and Evaluation Symposium, , Dallas-USA. SPE Hydrocarbon Economics And Evaluation Symposium held in Dallas, Texas, U.S.A., 5-8 April 2003.. Richardson, Texas: SPE - Society of Petroleum Engineers, 2003Tourinho, O.A., (1979) The Valuation of Reserves of Natural Resources: An Option Pricing Approach, , PhD. Dissertation, Berkeley: University of Californi