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Original Articles

The real options content of oil producer stocks

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Pages 217-231 | Published online: 15 Nov 2010
 

Abstract

Oil producers may have options to expand or abandon their operations, the exercise of which depends on prevailing oil prices and production costs. These embedded options suggest that the equity of oil production firms may resemble options on oil. This article examines whether options of various strike prices and maturity dates replicate the daily changes in oil producers’ stock prices. We find that oil producer stocks resemble options contracts and that implied strike prices are related to production costs. Large integrated oil companies have implied strikes ranging from $10 to $35 per barrel, while higher production cost Canadian oil sands producers have implied strikes of $35–$60 per barrel. The results provide insights to investors interested in either understanding producers’ exposure to oil or designing a trading strategy to take advantage of the gamma provided by oil producer optionality.

Notes

1 Canadian Center for Energy Information, www.centerforenergy.com.

2 By 1-year option, we mean an option expiring in 1 year with an underlying futures contract that expires immediately thereafter.

3 Much of this higher expense was driven by the cost of leasing oil rigs, which has increased substantially in recent years.

4 Denbury Resources 2007, 10 K filing with the Securities & Exchange Commission (SEC).

5 It should be noted that a number of other companies also have exposure to oil sands either through joint partnerships or direct ownership of production assets, but in most cases the sands comprise only a fraction of those companies’ overall business. For example, Imperial Oil, Shell and Petro Canada all have oil sands interests, but the majority of their businesses centre around conventional oil and gas production and refining and marketing operations.

6 Most oil producers also produce some natural gas. To translate natural gas production into an energy equivalent number of barrels of oil, we can divide the number of cubic feet of natural gas by 6.

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