A Real Options Analysis of the Effects of Oil Price Uncertainty and Carbon Taxes on the Optimal Timing of Oil Field Decommissioning

Abstract

We use a real options model to examine the effects of three important sources of oil price uncertainty on the optimal timing of oil field decommissioning. These are (1) the degree of oil price volatility, (2) the level of the long-run equilibrium oil price, and (3) the speed of reversion of oil prices to their long-run equilibrium. We find that lower levels of equilibrium oil prices and speed of reversion to equilibrium prices have the effect of fostering early decommissioning. Oil price volatility however has the opposite effect. Our findings provide valuable insights into how policymakers may identify windows of opportunity for policy interventions leading to (1) an acceleration of the drive towards sustainable energy transition; and/or (2) the maximisation of economic recovery (MER) from oil and gas resources.With regards the former, we show that the imposition of carbon taxes fosters early decommissioning to a significant extent. In the most unfavourable oil price environment and under an aggressive tax regime for example, decommissioning may occur at a very early period in oil field operations, owing to over 45% of oil reserves being uneconomic to produce. The results highlight the effectiveness of carbon taxes as policy lever in jurisdictions that seek accelerated decarbonisation, climate change mitigation and energy transition goals.