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Impact of Oil-Price Model Parameters and Uncertainty on Project Economics

Smit, Nea

Engineering Honours Degree, 2006

University of Adelaide

Executive Summary

This thesis is part of a 4th Year Honours Project undertaken at the Australian School of Petroleum, University of Adelaide. It provides information on some of the various models used to forecast spot oil prices and assesses the impact of these model parameters on the economics of a generalized project.

It has been known for some time that the oil price is a key factor in any project’s economics. Despite this, care taken to choose an appropriate model to predict oil prices is limited. Often people select a single estimate, or a narrow range, in which to analyze their project economics on without proper thought of the consequence this will have on their analysis. Even if an individual was to use an accepted oil price model there is uncertainty as to whether the model type, or its parameters, can be projected into the future. For this reason, the intention of this project is to analyze the extent that model parameters have on the overall project economics.

This study reviews the historical oil prices, past and present trends and theory behind common stochastic price processes in the first two chapters. The insights gained from these chapters were then applied to produce several oil price models and techniques for estimating the parameters within them in the third chapter. A simple integrated model system, as described in the fourth chapter, was then developed such that the impact of the model choice and parameters could be adequately assessed. By generalizing the process it was hoped that the outcomes could be, at a basic level, be applied universally.

It can be concluded from this report that oil price models and parameters do have impact on the economics of a project. Conventional methods significantly underestimate the uncertainty in the oil price, and thus the uncertainty in the economic measurements. While the actual method of parameters estimation usually does not have much influence on the economic parameters, care must be taken as in certain situations the parameters used can significantly change the economics. It was found that the assumption that the model is based on historical data and the time of the project were crucial to the outcome of the project.

Australian School of Petroleum



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