Pricing option contracts on the strategic petroleum reserve

Abstract

In this article we examine the pricing of option contracts on the strategic petroleum reserve (SPR) and consider how these can be used by both the government and refiners. We analyze the interaction between the call and put option contracts, taking into account the underlying game, in the infinite Markov decision process with discounting, explaining the relationship between the valuation of options on the SPR by refiners and the valuation of financial options on a marker crude in financial markets. We conclude that the values of both call and put options on the SPR increase with oil prices and decrease with total inventory. Furthermore, our analysis shows that a more active management of the SPR creates higher social welfare (although refiners profit less from inventories) and larger volatility in inventory profits, decreasing private investment in petroleum stocks.