Petroleum Prospect Valuation: The Option to Drill Again

Abstract

We examine the value of a petroleum exploration prospect that is to be exploited via a series of possibly dependent trials. The pattern and strength of dependence among trials is linked to a real option that affects the expected economic value of the prospect. We develop an exact, yet intuitive, expression for the expected value of such a prospect. We also show that two intuitive approaches to valuation provide strict upper and lower bounds for the actual value. Finally, the impact of dependence is shown to be monotonic: each increase in the degree of dependence among trials results in a further reduction in expected value of the prospect.

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