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Optimal Oil Production and the World Supply of Oil

Author/Editor: Nikolay Aleksandrov | lajos Gyurko | Raphael A. Espinoza
Authorized for Distribution: December 17, 2012
Electronic Access: Free Full Text (PDF file size is 2,068KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: We study the optimal oil extraction strategy and the value of an oil field using a multiple real option approach. The numerical method is flexible enough to solve a model with several state variables, to discuss the effect of risk aversion, and to take into account uncertainty in the size of reserves. Optimal extraction in the baseline model is found to be volatile. If the oil producer is risk averse, production is more stable, but spare capacity is much higher than what is typically observed. We show that decisions are very sensitive to expectations on the equilibrium oil price using a mean reverting model of the oil price where the equilibrium price is also a random variable. Oil production was cut during the 2008–2009 crisis, and we find that the cut in production was larger for OPEC, for countries facing a lower discount rate, as predicted by the model, and for countries whose governments’ finances are less dependent on oil revenues. However, the net present value of a country’s oil reserves would be increased significantly (by 100 percent, in the most extreme case) if production was cut completely when prices fall below the country's threshold price. If several producers were to adopt such strategies, world oil prices would be higher but more stable.
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Series: Working Paper No. 12/294
    Published:   December 17, 2012        
    ISBN/ISSN:   9781616354831/1018-5941   Format:   Paper
    Stock No:   WPIEA2012294   Pages:   31
    Price:   US$18.00
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