Final answer:
In the oil and gas industry, exploration costs are accounted for using mathematical models to estimate and compare the costs of various approaches and their potential economic benefits. These models consider the probability of discovery and the potential for both direct and external costs such as environmental impacts. The industry faces diminishing returns on new exploration and discovery, with costs influenced by the availability and efficiency of extraction machinery.
Step-by-step explanation:
Accounting for Exploration Costs in the Oil and Gas Industry
Exploration costs in the oil and gas industry are accounted for through various approaches, given the risky nature of finding new reserves and developing them into producing wells. Exploration is akin to searching for the proverbial 'needle in a haystack', where only about one in ten wells result in a discovery. The process is costly and the likelihood of finding new oil reserves at any random location is approximately 0.01%. These exploration activities are critical as they add to reserves and extend the timescale of production.
The analogy of not being able to produce oil that hasn't been discovered can be understood through everyday life examples, such as not being able to possess an iPhone model that hasn’t been designed yet. Similarly, as consumption cannot exceed discovery, there are mathematical models to estimate the costs of various exploration approaches. These costs are compared against the potential economic benefit, accounting for externalities such as environmental damage from oil spills.
The oil and gas industry often prioritizes 'low-hanging fruit' or easily accessible resource pools before moving on to more challenging and expensive resources. Cost considerations also include the limitations imposed by the available extraction machinery and the fact that deeper drilling may yield gas instead of oil. The historical peak in conventional oil discovery over 50 years ago suggests that new discoveries are becoming less frequent, which influences the cost-benefit analysis of exploration efforts.