Interaction between Technology and Extraction Scaling Real Options in Natural Gas Production

This paper is the outcome of a research engagement studying questions of technology utilization and production management with managers at EQT Corp., an integrated natural gas production and distribution company. The question of how to best leverage the use of technology is fundamental to almost any industry; this is especially true for those companies operating in the volatile field of commodities production, as EQT Corp. does. We consider the interaction between two types of real options that arise in natural gas production: The option to scale the production level, through enhanced extraction and communication technologies, and the option to scale the extraction rate, by pausing production. We study this interaction by applying stochastic dynamic programming to actual operational and financial data. Our analysis brings to light data-driven managerial principles pertaining to the valuation and deployment of these three scaling options, the effect of price uncertainty on the option values, how to effectively simplify the optimal deployment policy, and whether these options, or subsets of them, are complements or substitutes. These principles are significant to natural gas production managers and, potentially, to managers of other natural resource production processes, such as the extraction of oil and mining.