Since the beginning of the global oil crisis in the mid-2000s, oil and gas prices have been
more volatile than other commodity prices. Accordingly, it is increasingly important for the
independent E&P companies that are relatively vulnerable to market uncertainty to choose
appropriate additional reserves of oil and gas. This paper provides a real options framework
for analyzing the reserve replacement decisions of independent E&P companies, considering
uncertain revenues and irreversible costs. The model considers the extraction cost per unit
well associated with the remaining reserve level per well and instant production. Focusing
on the North American E&P companies, threshold levels of oil and gas prices are identified
for economic feasibility, above which it is optimal to undertake investment for reserve
additions. The results indicate that the relative gains from gas E&P projects are steadily
decreasing, primarily because of lowered gas prices triggered by recent gas development
booms in the North America. The policy implications from this finding support a more
conservative strategy and increased attempts in the field of gas development projects.