THE REAL COSTS OF US STRATEGIC PETROLEUM RESERVES MARKET VALUATION by Carol A Dahl, Colorado School of Mines, USA and Jennifer Considine, University of Dundee, Scotland for 34th USAEE/IAEE North American Conference Tulsa, OK, October 23-26, 2016

Mineral and Energy Economics Program and Colorado School of Mines Dr. Carol A. Dahl Professor Emeritus Mineral and Energy Economics Program and Senior Fellow Colorado School of Mines and

Dr. Jennifer I. Considine Honorary Lecturer and Member of CEPMLP Global Academic Team Center for Energy Petroleum and Mineral Law Policy University of Dundee King Abdullah Petroleum Studies and Research Center

What is SPR SPR still in the News Part of Research Agenda Measuring Cost Benefits of U.S. SPR Presented in Perth and Bergen actual/optimal Survey of SPR Modeling Edward Elgar: Handbook of Energy Politics Global co-author Yang Bai, School of Business, Nanjing Normal University, China

Methodology simple discounted cash flow (DCF)/net present value (NPV) sample model simple real options valuation have some initial results real options valuation/Monte Carlo simulations (ROV) sample model results don't take numbers seriously yet

U.S. SPR

SPR Still In the News Opening Plenary Session modernization of SPR from crude to products international legal obligations PIGGY Bank questions about deliverability

Evaluating SPR: Costs   our interest

Benefits – Avoiding Net Loss in Consumer Surplus 10 Benefits – Avoiding Net Loss in Consumer Surplus SUS (1-)SUS+ROW P SUS+ROW P1 P0 DUS+ROW DUS QUd1 QUd0 QW1 QW0 Q

Externality Cost 11 e is GDP-price elasticity, P0 price with no disruption P2 post-drawdown of SPR GDP2 is observed gross economy GDP0 is potential value

Minimize Total Costs of SPR 12 our interest subject to a variety of constraints can't exceed capacity maximum fill and drawdown rates

Valuing Projects That is traditional decision tree analysis enhanced to include state of the art technologies including multiple criteria, artificial intelligence, game theory etc. etc. To cite only one source. including multiple criteria, artificial intelligence, game theory

DCF 2016-2030 r = risk adjusted interest rate DCF/NPV appropriate when no operating flexibility. no delays/expansions/new products abandonments/shut-ins project is independent of future investments. no “Strategic Options”

DCF: Project Assumptions Futures curve for LOOP storage costs and WTI Project Discount Rate Operating Expenses Taxes Rates Market Center Margin Capital Costs

Sample DCF Results Yellow Changeable Assumptions

Sample DCF Results Jennifer: I think this is probably the wrong version of results as there is no tax in 2016. I will copy right ones in later. 7000

Call Options-Underlying Asset

Value of Call Option K=100 P=probability prices goes up (1-P) = probability price down

Value Real Options (RCt) With Strike Price the Cost of Capital DCFt up RCt DCFt down

The Black-Scholes Option Pricing Model Geometric stochastic difference equation where: C = the option price S = the stock price K= exercise price τ = the time to expiration r=risk free interest rate σ=volatility of underlying asset N(di) = the cumulative normal probability distribution

Simple Real Options Valuation As European Call Option

Real Options Value with Monte Carlo Simulations Solved with @Risk These include: Futures prices for crude oil Percent of crude oil required for strategic purposes Slippage errors Strategic drawdowns Project discount rate

Distribution of Variables for Monte Carlo Simulations

Normal Distributions For Oil Prices Change By Year Around Forward Curve

Probability Distribution For SPR Storage Facility

Value of SPR As Storage Facility Sample Output

Sum Up Valuing SPR using the market Sample (DCF)/(NPV) Simple Call Options Real Options Valuation/Monte Carlo (ROV) Don't take any numbers seriously yet For copy of paper Leave me card – valuing SPR on back Any info on inputs much appreciated Valuing any inventory facility Excess oil capacity for NOC