PROBLEM #1

CALCULATE THE ECONOMIC VALUE

OF THIS EXPLORATION PROSPECT

(X) (R) (C) (P) Exploration Reserve Development Reserve Cost Size Cost Price (million) (million bbl) (per/bbl) (per/bbl)

$50 0 (pr=½) $5 $4 (pr=½) 50 (pr=¼) $8 (pr=½) 100 (pr=¼)

Expected economic value (prior to exploration) = ___________.

CALCULATE THE ECONOMIC VALUE

OF THIS EXPLORATION PROSPECT

(X) (R) (C) (P) Exploration Reserve Development Reserve Cost Size Cost Price (million) (million bbl) (per/bbl) (per/bbl)

$50 0 (pr=½) $5 $4 (pr=½) 50 (pr=¼) $8 (pr=½) 100 (pr=¼) Note: E(R) = ½0 + ¼50 + ¼100 = 37.5 million bbl E(P) = ½$4 + ½$8 = $6/bbl Thus: E() = ($6-$5)37.5 - $50 = -$12.5 million

$6.25

$25

$100

- $50

- $50

$100

- $50

$250

$100

- $50

-$100

- $50

- $50

$250

-$50

-$150

- $50

Develop

Develop

Develop

Develop

Stop

Stop

Stop

Stop

pr($8) = 1/2

pr($4) = 1/2

pr($8) = 1/2

pr($4) = 1/2

pr(R=50) = 1/4

pr(R=0) = 1/2

pr(R=100) = 1/4

Explore

The Exploration Prospect Contains a Development Option

OCS SALE 123: OPTION VALUE CORRELATIONSBASED ON EVALUATION OF 18 TRACTS

YOUR YOUR OPTION HIGH YOUR AVG HIGH AVGcorrelations: NPV EV VALUE BID BID BID XBID XBID

YOUR NPV 1.00YOUR EV 0.96 1.00

OV 0.30 0.41 1.00HIGH BID 0.25 0.36 0.42 1.00

YOUR BID -0.41 -0.23 0.53 0.27 1.00AVG BID 0.01 0.16 0.53 0.86 0.72 1.00

HIGH XBID 0.21 0.32 0.35 0.99 0.23 0.86 1.00AVG XBID 0.07 0.21 0.47 0.95 0.51 0.97 0.94 1.00

N BIDS 0.15 0.15 0.08 0.60 0.14 0.45 0.65 0.60

Analogy Between Stock Call Option

& Oil Field Development Project

Stock Call Option Oil Field Development Project Current stock price Current value of developed reserve

Variance of stock price Variance of reserve price

Exercise price Development cost

Time to expiration Relinquishment requirement

Riskless rate of interest Riskless rate of interest

Dividend Convenience yield