Real Options Theory for Real Asset Portfolios: the Oil Exploration Case

This paper discusses a portfolio theory for real assets with main focus on petroleum exploration and development assets. Exploratory assets are prospects with chances to find out development assets (oilfields in this case). By the real options point of view, exploratory assets are compound options. In opposition to financial assets portfolio theory, the paper shows that positive correlation between exploratory assets is a desirable feature because it increases both the (endogenous) learning option value and the synergy gain with development assets. In the first case due to the learning sequential nature, with the option to limit losses if occur bad news and creating the option to develop if occur good news. In the second case because a higher (positive) correlation increases the probability of multiple success and so the synergy gain by sharing the development infrastructure. The analysis of the simplest portfolio, i.e., with only two exploratory assets, provides important insights about learning, synergy and option to defer exploration. The optimal intertemporal distribution of projects shall use the concept of option to defer. A necessary condition for the immediate exercise of an exploratory option (wildcat drilling investment) is the existence of at least one scenario where the development option is deep-in-the-money. For all projects in which deferring is optimal, we need an idea of both the probability of later exercise and the expected time of exercise, conditional to option exercise occurrence. This portfolio planning is necessary for resource management purposes and is performed by real-world (and not risk-neutral) stochastic processes simulation. A multiple asset portfolio of exploratory prospects example is analyzed, highlighting the learning processes modeled as information revelation processes, with discussion of their properties. JEL classification: G31; G12;