The impact of spatial price differences on oil sands investments

In this article, a two-factor real options model is developed to examine the impact spatial price differences have on the value of an oil sands project and the incentive to invest. Large, volatile price differences between locations can emerge when demand to ship exceeds capacity limits. This may have a significant impact on production, investment, and policy in exporting regions. Here, we assume the price difference between two locations follows a stationary process implying crude oil markets are integrated as oil prices in different locations move together. The investment decision is formulated as a linear complementarity problem that is solved numerically using a fully implicit finite difference method. Results show the value of an oil sands project and the incentive to invest in a new project will increase when the mean price difference decreases. Surprisingly, the standard deviation of the price difference has very little impact on project value or the incentive to invest. (C) 2017 Elsevier B.V. All rights reserved.