The two-factor price process in optimal sequential exploration

Research output: Contribution to conferencePaperpeer-review


In a group of exploration prospects with common geological features, drilling a well reveals information about chances of success in others. In addition, oil prices vary during the exploration campaign and with them so do the economics of wells and the optimal decision to drill. With these dependencies and price dynamics, where do we drill first and what comes next given success or failure in previous wells? The solution to this valuation problem should compare the value of learning (drilling wells that provide information) with the uncertain value of earning (drilling wells that have large payoffs, yet uncertain). We calculate a joint distribution for geological outcomes by applying information-theoretic methods and construct a two-dimensional binomial sequence to represent a twofactor stochastic price process. We then propose a Markov decision process that solves the optimal exploration problem. An Excel® VBA software implementation of this algorithm also accompanies this paper.
Original languageEnglish
Number of pages15
Publication statusPublished - Jun 2019
Event23rd Annual International Real Options Conference 2019 - London, United Kingdom
Duration: 27 Jun 201929 Jun 2019


Conference23rd Annual International Real Options Conference 2019
Country/TerritoryUnited Kingdom
Internet address


  • Petroleum Exploration
  • Sequential Decision Making
  • Markov Decision Process
  • Two-Factor Oil Price Process
  • Valuation


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