--> Abstract: Option Pricing, A Significant Advance in Economic Analysis: Applications to Exploration, Development and Operations, by J. C. Burns; #90987 (1993).

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BURNS, JAMES C., Bow Valley Industries Ltd., Calgary, Alberta, Canada

ABSTRACT: Option Pricing, A Significant Advance in Economic Analysis: Applications to Exploration, Development and Operations

A technique for valuing option contracts was not perfected until the early 1970s. Since that time, the application of option pricing theory has spread from valuing financial option contracts to valuing a variety of securities with option-like characteristics and, in recent years, to valuing contingent claims on real assets. This final application refers to valuing opportunities to develop, exploit or abandon real (as opposed to paper) assets where decisions can be deferred.

A major deterrent to the application of option pricing theory outside of the field of finance has been the complex mathematics necessary to explain the theoretical background. It should be noted that the mathematics are no more complex than are utilized routinely by reservoir engineers and that personal computers presently have the power to handle analytical approximations which are simple and accurate.

A large number of applications of option pricing have been considered in recent papers. The value of holding a strategic undeveloped asset such as heavy oil reserves in western Canada, the value of the option to vary production rates or temporarily shut-in production from producing gas fields, determining the value of exploratory land given the probability distribution of reserve quantities underlying the land, determining the optimum point in time to develop established reserves in response to observed product prices, estimating the impact and value of government subsidies and evaluating the impact of fluctuating interest rates on timing of investment decisions have all been evaluated by various authors.

This paper provides an overview of option pricing applications and the resulting implications for exploration and development practitioners with a minimum of theoretical detail. The results provided by option pricing methods are often at odds with, and more accurate than, those determined by discounted cash flow methods and are often intuitively appealing to explorationists.

AAPG Search and Discovery Article #90987©1993 AAPG Annual Convention, New Orleans, Louisiana, April 25-28, 1993.