STRATEGIES OF INVESTMENT IN THE CANADIAN OIL SANDS UNDER PRICE
UNCERTAINTY: A DYNAMIC PROGRAMMING APPROACH
Déborah BOUCHONNEAU, IFP, University of Montpellier, +33147525351, deborah.bouchonneau@ifp.fr
Frédéric LANTZ, IFP, +33147526868, frederic.lantz@ifp.fr
Overview
Our concern is the economic analysis of the development of non conventional crude oil in Canada (oil
sands) under price uncertainty. The oil sands resources have a large development potential in terms of reserves
size: according to the AEUB estimates (2003), 1700 billion of bitumen barrels are initially in place in Canada,
and about 300 billion of barrels could be ultimately recoverable with anticipated technical evolutions (Gruson
and al., 2005). However, due to technological complexity, the exploitation of Canadian oil sands implies higher
capital and operating costs compared to conventional crude oil. After a period of significant development, the
non conventional oil supply was negatively impacted by the crude oil price collapse during the period 20082009, associated with increasing capital and environmental costs. As a result, several planned start-up projects or
expansions were suspended, such as mining, in situ or upgrading projects in the province of Alberta in Canada.
Despite an improving economic context (increasing crude oil price and weaker cost inflation pressure), non
conventional actors still face a high degree of uncertainty. Production income and operating costs (of which a
significant proportion are energy costs) are strongly impacted by crude oil price level and volatility, whereas
production costs might significantly increase under new environmental regulations. In this perspective,
investment behaviour of the non conventional oil sector remains cautious and may be accentuated by risk
aversion and a short economic visibility.
Methods
The aim of this article is to model the development of the non conventional Canadian crude oil under
uncertainty, by taking into account various crude oil price scenarii and increasing environmental cost. A dynamic
modeling approach was chosen here to determine the optimal exploitation path of the non conventional Canadian
crude oil. The developed algorithm allowed us to evaluate optimal investment and extraction strategies in the
non conventional path for different sets of reserves and invested capital under price uncertainty.
As the resolution of a dynamic model is performed recursively, the first step consisted in determining the
final date of the model. This problem was analytically solved using transversality conditions presented in the
exhaustible resource theory. Lehvari and Liviatan (1977) analysed the impact of a non linear marginal cost on
optimal extraction strategies, and proved that the final date of extraction is reached when marginal revenue
equals marginal cost. Using more general mathematical hypotheses than the ones used by Hotelling (1931), they
showed that the resource might not be completely exhausted at the final date.
The empirical estimation of the final date was then performed from an economic analysis of the non
conventional path (Canadian Statistical Handbook, 2009). A cost analysis highlighted a non linear marginal cost
of oil sands extraction, decreasing during a first period due to technical and organizational improvements and
then increasing in the recent years, due to energy cost inflation and environmental considerations.
The second step consisted in introducing price uncertainty in the dynamic model. Theoretical developments
performed by Pindyck (1980) proved that volatility on the market resource price might affect the optimal
extraction path of this resource, depending on the marginal cost function. Probabilized crude oil price scenarii
resulting from an econometric analysis were introduced in the dynamic model to reflect the price uncertainty,
varying over the time periods.
Finally, the addressed demand of non conventional crude oil was calibrated from the linear programming
refinery model developed by the IFP, adjusted to the North American zone. The IFP refinery model determines
an optimal crude oil supply, in minimizing the cost function of the North American refinery sector, from a
balance between crude supply cost (transportation cost included) and treatment costs depending on the quality of
the processed crude, under capacity and petroleum products demand constraints. The resulting long-term
equilibrium non conventional crude oil demand of the North American market was then introduced in the
dynamic programming model.
Results
Our preliminary simulations highlighted a negative impact of price uncertainty over the optimal extraction
path, but sensitive to demand scenarii and marginal cost parameterization. Under sustained petroleum products
demand scenarii, the Canadian non conventional crude oil takes advantage of limited transportation costs to
reach the Northern US markets, and represent an increasing part of the global refineries crude oil demand over
time (from 3.8% in 2005 to 6.8% in 2030).
Conclusion
The refinery linear programming model can be used to calibrate the long-term equilibrium crude oil demand, but
the large size of the model prevents us from introducing probabilized price scenarii. The introduction of crude oil
price uncertainty is more easily tractable with a dynamic programming approach. In reducing the problem by
using limited discrete variables describing both the possible states in terms of reserve and capital, and the action
variables (production and investment) modifying the states, distinct optimal investment and production strategies
can be highlighted, depending on the crude oil price levels and their associated probabilities over the periods, the
form of the marginal cost of extraction, and other key parameters such as the non conventional crude oil demand
to be satisfied.
References
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World Oil Supply : Tar Sands, Oil Shales and Non-conventional Liquid Fuels from Coal and Gas, technical
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Lantz F., Gruson, J.F., Saint-Antonin V., Development of a model of the world refining for the POLES model:
the OURSE model, IFP report 58 808, report for the JCR-Sevilla, 2005
Levhari D., Liviatan N., Notes on Hotelling’s economics of exhaustible resources, Revue canadienne
d’économique, 10, pp. 177-192, 1977
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