Evaluating the effect of the oil prices' uncertainty on the optimal timing of transition from oil to gas production using Real Option techniques

Abstract

Deciding whether or not to stop producing oil and start producing gas is a difficult decision. This due to the decision‟s irreversible nature and dependency on the many uncertain factors. With one of the main uncertainties being the oil price this thesis evaluate its effect on the optimal timing of transition from oil to gas production. To do this a Real Options model using Monte Carlo simulation was made in Excel. The model was built and fitted for a fictive case which was used as a basis for the evaluation. To model the oil price a Mean reverting Ornstein-Uhlenbeck-processes was chosen for its ability to include the main characteristics of the oil price. The analysis showed that the optimal timing was dependent on the oil price and its inherent uncertainty, and varying in terms with the nature of the oil price model.