The Option to Drill Again: Valuing a Sequence of Dependent Trials
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.
Real option, valuation, oil, exploration
SMU Cox School of Business Research Paper Series