How to Value Proved but Undeveloped Petroleum Reserves.

The article focuses on valuing proved but undeveloped petroleum reserves (PUDs) by addressing the limitations of traditional valuation methods that often assign zero value to PUDs when production costs exceed prevailing forward prices. It introduces a stochastic model that generates future forward curves for crude oil and natural gas prices, capturing the option value of PUDs by probabilistically modeling hedging opportunities and financing conditions at the time of production. The model incorporates short-run and long-run price equilibria, seasonal adjustments, and correlations between crude oil and natural gas prices, enabling a more realistic valuation of PUDs under uncertain future price environments. Empirical results demonstrate that hedging significantly increases the expected net present value of PUDs compared to unhedged cases, even when prices are near or below production costs, highlighting the importance of modeling contingent hedging in PUD valuation. The approach is adaptable to other commodities with mean-reverting prices and liquid futures markets.