The Impact of Stochastic Extraction Cost on the Value of an Exhaustible Resource: An Application to the Alberta Oil Sands

43 Pages Posted: 2 Jul 2013

See all articles by Abdullah Almansour

Abdullah Almansour

King Fahd University of Petroleum & Minerals (KFUPM)

Margaret C. Insley

University of Waterloo - Department of Economics

Date Written: June 30, 2013

Abstract

The optimal management of a non-renewable resource extraction project is studied when input and output prices follow correlated stochastic processes. The decision problem is specified by two Bellman equations describing the project when it is currently operating or mothballed. Solutions are determined numerically using the Least Squares Monte Carlo methodology. The analysis is applied to an oil sands project which uses natural gas during extracting and upgrading. The paper takes into account the co-movement between crude oil and natural gas prices and proposes two price models: one incorporates a long-run link between the two while the other has no such link. Incorporating a long-run relationship between oil and natural gas prices has a significant effect on the value of the project and its optimal operation and reduces the sensitivity of the project to the natural gas price process.

Keywords: non-renewable resource extraction, oil sands, stochastic costs, Least Squares Monte Carlo, co-integration of natural gas and oil prices, real options

JEL Classification: Q30, Q40, G13, D81

Suggested Citation

Almansour, Abdullah and Insley, Margaret C., The Impact of Stochastic Extraction Cost on the Value of an Exhaustible Resource: An Application to the Alberta Oil Sands (June 30, 2013). Available at SSRN: https://ssrn.com/abstract=2287596 or http://dx.doi.org/10.2139/ssrn.2287596

Abdullah Almansour

King Fahd University of Petroleum & Minerals (KFUPM) ( email )

Dhahran, 31261
Saudi Arabia

Margaret C. Insley (Contact Author)

University of Waterloo - Department of Economics ( email )

200 University Avenue, West
Waterloo, Ontario N2L 3G1
Canada
+1 519-888-4567, ext. 38918 (Phone)

HOME PAGE: http://economics.uwaterloo.ca/margaret-insley

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