Interesting. Curious why is the strike on PDP of $6.5b and not total proved of $11.2b? Given future development costs are on total proved? Same thing with reserve life...using PDP but reserve life of ~17 years based on proved + PUD i.e. proved RLI only 12.5 years?
Newby take: if oil price is log normal and stock price is 100% correlated with oil price (which I believe it is) - then your exposure to oil stocks should be probably somehow proportional to area under the curve to the right of current price. Means - the higher oil price the less exposure you should have. Never to zero but 100% is also rather exceptional (like in once-in-a lifetime case with negative prices).
Of course this curve is not static and changes over time. And thought must be given if it commands your total exposure or just %% of your new investment related to available cash pool. But still it’s worth further elaboration.
Michael, thank you for this post, it gives some fuel to thinking.
The Hotelling Rule presumes rational markets and no change in technology, and within those parameters both are valuable approaches. The Black-Scholes approach is to accept the market volatility as the best indicator and given volatility find the equivalence between risk of loss of capital and potential gain through development. In rational markets they should produce similar results. My preference for Black-Scholes is its simplicity in estimating value. The Hartwick rule is more of a policy guide. He proposes that a nation invest the benefits of resource development in permanent social infrastructure in paralled with the development so that when the finite resource is exhausted the society has an ongoing benefit from the capital built that offsets the decline in resource revenues. It is not really a valuation theory.
Interesting. Curious why is the strike on PDP of $6.5b and not total proved of $11.2b? Given future development costs are on total proved? Same thing with reserve life...using PDP but reserve life of ~17 years based on proved + PUD i.e. proved RLI only 12.5 years?
You are right - the analysis should have used $11.2 billion and 17.6 years or $6.5 billion and 7.3 years. I apologize for the sloppy error.
Newby take: if oil price is log normal and stock price is 100% correlated with oil price (which I believe it is) - then your exposure to oil stocks should be probably somehow proportional to area under the curve to the right of current price. Means - the higher oil price the less exposure you should have. Never to zero but 100% is also rather exceptional (like in once-in-a lifetime case with negative prices).
Of course this curve is not static and changes over time. And thought must be given if it commands your total exposure or just %% of your new investment related to available cash pool. But still it’s worth further elaboration.
Michael, thank you for this post, it gives some fuel to thinking.
Excellent application of the Black-Scholes model. Is this model preferable to Hotelling Rule and Hartwick Rule (Queens U.)?
The Hotelling Rule presumes rational markets and no change in technology, and within those parameters both are valuable approaches. The Black-Scholes approach is to accept the market volatility as the best indicator and given volatility find the equivalence between risk of loss of capital and potential gain through development. In rational markets they should produce similar results. My preference for Black-Scholes is its simplicity in estimating value. The Hartwick rule is more of a policy guide. He proposes that a nation invest the benefits of resource development in permanent social infrastructure in paralled with the development so that when the finite resource is exhausted the society has an ongoing benefit from the capital built that offsets the decline in resource revenues. It is not really a valuation theory.