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Energies 2016, 9(10), 848; doi:10.3390/en9100848

Revenue Risk of U.S. Tight-Oil Firms

1
Basque Centre for Climate Change, Sede Building 1, 1st floor, Scientific Campus of the University of the Basque Country, 48940 Leioa, Spain
2
Department of Financial Economics II, University of the Basque Country, Av. Lehendakari Aguirre 83, 48015 Bilbao, Spain
*
Author to whom correspondence should be addressed.
Academic Editor: Bin Chen
Received: 30 July 2016 / Revised: 5 September 2016 / Accepted: 11 October 2016 / Published: 21 October 2016
(This article belongs to the Special Issue Energy Economics 2016)
View Full-Text   |   Download PDF [3215 KB, uploaded 21 October 2016]   |  

Abstract

American U.S. crude oil prices have dropped significantly of late down to a low of less than $30 a barrel in early 2016. At the same time price volatility has increased and crude in storage has reached record amounts in the U.S. America. Low oil prices in particular pose quite a challenge for the survival of U.S. America’s tight-oil industry. In this paper we assess the current profitability and future prospects of this industry. The question could be broadly stated as: should producers stop operation immediately or continue in the hope that prices will rise in the medium term? Our assessment is based on a stochastic volatility model with three risk factors, namely the oil spot price, the long-term oil price, and the spot price volatility; we allow for these sources of risk to be correlated and display mean reversion. We then use information from spot and futures West Texas Intermediate (WTI) oil prices to estimate this model. Our aim is to show how the development of the oil price in the future may affect the prospective revenues of firms and hence their operation decisions at present. With the numerical estimates of the model’s parameters we can compute the value of an operating tight-oil field over a certain time horizon. Thus, the present value (PV) of the prospective revenues up to ten years from now is $37.07/bbl in the base case. Consequently, provided that the cost of producing a barrel of oil is less than $37.07 production from an operating field would make economic sense. Obviously this is just a point estimate. We further perform a Monte Carlo (MC) simulation to derive the risk profile of this activity and calculate two standard measures of risk, namely the value at risk (VaR) and the expected shortfall (ES) (for a given confidence level). In this sense, the PV of the prospective revenues will fall below $22.22/bbl in the worst 5% of the cases; and the average value across these worst scenarios is $19.77/bbl. Last we undertake two sensitivity analyses with respect to the spot price and the long-term price. The former is shown to have a stronger impact on the field’s value than the latter. This bodes well with the usual time profile of tight oil production: intense depletion initially, followed by steep decline thereafter. View Full-Text
Keywords: tight oil; oil price; stochastic process; futures prices; Monte Carlo (MC) simulation; risk profile; value at risk (VaR); expected shortfall (ES) tight oil; oil price; stochastic process; futures prices; Monte Carlo (MC) simulation; risk profile; value at risk (VaR); expected shortfall (ES)
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This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. (CC BY 4.0).

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MDPI and ACS Style

Abadie, L.M.; Chamorro, J.M. Revenue Risk of U.S. Tight-Oil Firms. Energies 2016, 9, 848.

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