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On the timing of non-renewable resource extraction with regime switching prices: an optimal stochastic control approach

Author

Listed:
  • Margaret Insley

    (Department of Economics, University of Waterloo)

Abstract
This paper develops a model of a profit maximizing firm with the option to exploit a non-renewable resource, choosing the timing and pace of development. The resource price is modelled as a regime switching process, which is calibrated to oil futures prices. A Hamilton-Jacobi-Bellman equation is specified that describes the profit maximization decision of the firm. The model is applied to a problem of optimal investment in a typical oils sands in situ operation, and solved for critical levels of oil prices that would motivate a firm to make the large scale investment needed for oil sands extraction, as well to operate, mothball or abandon the facility. The paper focuses on the impact of regime shifts on the optimal timing of investment and extraction compared with the case when the possibility of future regime shifts is ignored.

Suggested Citation

  • Margaret Insley, 2013. "On the timing of non-renewable resource extraction with regime switching prices: an optimal stochastic control approach," Working Papers 1302, University of Waterloo, Department of Economics, revised Aug 2013.
    • Handle: RePEc:wat:wpaper:1302
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    References listed on IDEAS

    as
    1. Chen, Shan & Insley, Margaret, 2012. "Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem," Journal of Economic Dynamics and Control, Elsevier, vol. 36(2), pages 201-219.
    2. Mason, Charles F., 2001. "Nonrenewable Resources with Switching Costs," Journal of Environmental Economics and Management, Elsevier, vol. 42(1), pages 65-81, July.
    3. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-638, June.
    4. Margaret Insley & Kimberly Rollins, 2005. "On Solving the Multirotational Timber Harvesting Problem with Stochastic Prices: A Linear Complementarity Formulation," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(3), pages 735-755.
    5. Andre Plourde, 2009. "Oil Sands Royalties and Taxes in Alberta: An Assessment of Key Developments since the mid-1990s," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 111-140.
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    8. Conrad,Jon M., 2010. "Resource Economics," Cambridge Books, Cambridge University Press, number 9780521874953, September.
    9. Abdullah Almansour & Margaret Insley, 2016. "The Impact of Stochastic Extraction Cost on the Value of an Exhaustible Resource: An Application to the Alberta Oil Sands," The Energy Journal, , vol. 37(2), pages 61-88, April.
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    11. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
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    14. Niu, Shilei & Insley, Margaret, 2016. "An options pricing approach to ramping rate restrictions at hydro power plants," Journal of Economic Dynamics and Control, Elsevier, vol. 63(C), pages 25-52.
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    Citations

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    Cited by:

    1. Ferrari, Giorgio & Yang, Shuzhen, 2016. "On an optimal extraction problem with regime switching," Center for Mathematical Economics Working Papers 562, Center for Mathematical Economics, Bielefeld University.
    2. Giorgio Ferrari & Shuzhen Yang, 2016. "On an Optimal Extraction Problem with Regime Switching," Papers 1602.06765, arXiv.org, revised Dec 2017.

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    More about this item

    JEL classification:

    • Q30 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - General
    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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