The Option Value of Refracturing Oil Wells: Implementation in a Binomial Lattice

Abstract

Summary The steep production decline of unconventional oil wells means that positive cash flows only last for a short while. The operator must then decide whether to continue, abandon, or hydraulically refracture the well. The decision of when to refracture the reservoir has an economic effect on the value of a well, especially with the uncertain oil prices of the future. In this paper, we develop a flexible Markov-decision process that assumes that the optimal refracture or abandonment time depends on the stochastic mean-reverting behavior of prices (described in a binomial lattice) and the then-current level of production. The Excel Visual Basic for Applications (VBA) implementation of the algorithm accompanies this paper.