Exciting Valuation of an Oil Field
What are the key details in valuing an oil field with exciting possibilities?
a) How do we compute the risk-neutral probabilities of potential oil price changes?
b) What is the total value of the oil field considering extraction costs and potential revenue?
c) How do we derive the fair one year forward price of one barrel of oil?
Insightful Answers:
a) The risk-neutral probabilities of the two possible states of the oil price in one year are approximately 0.9677 for an increase and 0.0323 for a decrease.
b) The value of the oil field is $200,000 million.
c) The fair one year forward price of one barrel of oil is $132.11.
In the fascinating world of valuing an oil field with extraordinary potential, there are key details that play a crucial role in determining its worth.
Risk-Neutral Probabilities and Valuation
a) To compute the risk-neutral probabilities, we need to consider the possible states of the oil price in one year. The price can either increase or decrease by 15%. The risk-free interest rate is 2%. By performing the necessary calculations, we arrive at the risk-neutral probabilities of 0.9677 for an increase and 0.0323 for a decrease.
Total Value of the Oil Field
b) The value of the oil field is determined by considering extraction costs and potential revenue. By analyzing the extraction costs of $90 per barrel for the first 2500 barrels, $75 per barrel for the next 2500 barrels, and $100 per barrel for the last 2500 barrels, we calculate the total extraction cost to be $662,500. Subtracting this cost from the revenue generated by selling the oil, which amounts to $862,500 million for the full oil field, we find the total value to be $200,000 million.
Fair One Year Forward Price
c) The fair one year forward price of one barrel of oil is derived by using the risk-neutral probabilities and the expected future price. By calculating the weighted average of potential future prices considering these probabilities, we arrive at the fair one year forward price of $132.11 for one barrel of oil.