Date of Original Version

1-2008

Type

Working Paper

Rights Management

All Rights Reserved

Abstract or Description

Since natural gas reserves in North America and Europe are declining, energy companies there can no longer create value by just drilling more wells; they must create value by better managing their current production assets, and by better leveraging technology. In this paper, we analyze the real option to pause production from a well (better management) along with the real option to scale production technology (leverage technology), within a model incorporating price and geological uncertainty.We use our model to generate insights through numerical experiments, using actual financial and well data provided by Equitable Resources. We find, surprisingly, that the often neglected option to pause production adds up to 5% to the value of a well. Furthermore, we find that technology scaling options add up to 65% through enhanced extraction technology, and almost 5% through improved communication technology. That is, we show that profits can be increased by managing for value, and not just by drilling more wells. In addition, our work provides insights into the optimal tactical management of a well when adjusting to changes in price, production rate, and seasonal cost factors. Our results extend to other natural resource extraction projects, such as mining and oil extraction, and may extend to other production processes such as farming and forestry.

Comments

Tepper Working Paper 2007-E10

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