An Equlibrium Analysis of Exhaustible Resource Investments

Abstract

We develop a general equilibrium model of an exhaustible resource market where both the prices and extraction choices are determined endogenously. The model generates price dynamics that are roughly consistent with observed oil and gas forward and option prices as well as with the two-factor price processes that were calibrated in Schwartz and Smith (2000). However, the subtle differences between the endogenous price process determined within our general equilibrium model and the exogenous processes considered in earlier papers can generate significant differences in both financial and real option values.

Keywords: Exhaustible Resources, Energy