Abstract
Oil firms that apply the technique of CO2-enhanced oil recovery inject CO2 into oil reservoirs to increase oil production. The long-term CO2 sales contracts commonly used in the industry often include a special price adjustment clause—the CO2 price is pegged to the oil price faced by the buyer. This is quite different from typical price adjustment clauses in other long-term contracts, which peg the contract price to input costs faced by the supplier. Using a stylized model, we identify plausible conditions under which the pegging practice adopted in the CO2 market is optimal. Numerical simulations calibrated to an active CO2-enhanced oil recovery project suggest that the optimal pegging rate is sensitive to the anticipated oil price level, but not to the oil price variance around that level. The optimal pegging rate is sensitive also to a given oil project’s CO2 “utilization efficiency” – the amount of CO2 required to produce an additional barrel of oil – which is both highly variable across projects and uncertain up front.
Published Version
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