Real Options Approach to Oil and Gas Investments

• Departmental Seminar
• Environmental and Resource Economics Workshop

Date and Location

Friday, May 29, 2015, 2:10 PM - 3:30 PM
ARE Conference Room, 2102 Social Sciences and Humanities

Abstract

In this paper, we are trying to understand the important factors in investment decisions of oil and gas companies to create new production capacity. We employ a real options approach to evaluate oil and gas companies’ investment decisions in an empirical setup. A unique measure of investment costs is obtained from energy industry data vendors. This novel dataset contains details of contract terms and pricing for offshore drilling equipment, which constitute the major share of investment costs in offshore oil field development. The investment database is combined with financial and macroeconomic data, which enables us to perform a panel data analysis of investments’ response to variations in investment costs and market variables such as the slope of futures curve, firms’ past earnings, cost of capital and implied oil price volatility. Our results show that the larger firms, facing less financial friction, are more forward looking while the smaller firms, who have less access to capital markets, are more dependent on their past earnings.