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Investment in Information in Petroleum, Real Options and Revelation

A firm owns the investment rights over one undeveloped oilfield with technical uncertainties on the size and quality of the reserve. In addition, the long run expected oil price follows a stochastic process. The firm needs to select the best alternative of investment in information with different costs and different revelation powers. The modeling of technical uncertainty uses the practical concept of revelation distribution, which works directly with the possible new expectations after the information revelation caused by an investment in information. Expectations drive the valuation of the development option exercise. With a partial revelation of uncertainty of a technical parameter, is necessary to know only the initial uncertainty (prior distribution) and the expected percentage of variance reduction induced by the investment in information. After the information revelation, the development threshold decision depends on the value of the project normalized by the development cost. This normalized threshold is the same for any technical scenario revealed by the new information when the oil price follows a geometric Brownian motion. In addition, there is a time to expiration of the rights for the option to develop, so that the normalized threshold is a free boundary obtained from the optimal stochastic control theory. The model includes a penalty factor for the lack of information, which causes sub-optimal development, and this factor is introduced into the dynamic real options model. The model outputs are the real options value with and without the technical uncertainty, with and without the information, and the dynamic net value of information.