A methodology to evaluate an option to defer an oilfield development

The purpose of this paper is the valuation of an option to defer an oilfield development. A methodology is implemented to determine the suitable continuous-time stochastic processes for these risk factors: the crude oil price, the convenience yield and the risk-free interest rate. The analysis reveals that the convenience yield follows a mean-reverting process, that the oil price is better fitted by the Geometric Brownian Motion with jumps and that the risk-free interest rate can be considered constant. The valuation of the option to defer is based on the Monte-Carlo simulation adapting the Least-Square simulation method for valuing American type options. Results indicate that using multi-factor pricing models leads to rejecting the project contrary to the one-factor pricing model which leads to postponing investment for option maturity.