An oil-drilling company knows that it costs $25,000 to sink a test well.
If oil is hit, the income for the drilling company will be $425,000. If only natural gas is hit, the income will be $125,000. If nothing is hit, there will be no income.
Before this question can be answered, you need to know the probability of hitting oil and of hitting gas. I think (from someone else asking the question), it was 1/20 and 1/40 which would be 1/800. Since there is a greater probability of not finding oil or gas, the best thing to do for the company is to abandon the current location and search for another location that has a higher probability of hitting oil or gas. Companies hire geologists to take core samples to tell them what is beneath the earth ie what minerals and in what concentration they are in the sample. As for when the companies take the risk of drilling a hole, depends on the risk they want to take. Some companies may decide 80% likelihood of finding oil or gas to be high enough of a probability to dig a test well. Other's may be more conservative and won't dig until they likelihood is 90% or higher. It depends on what the company's management considers to be low risk of finding nothing. 10%, 20% or lower than 10%?
Dec 4th, 2014
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