The Cozzolino Rent as an Efficient Tool of Bargaining for the Terms of Shared Financing of a Project with a Probabilistic Outcome

An analysis is presented of equilibrium bargaining solutions to the problem of the working interest distribution in a risky project amongst co-investors whose preferences are described by the Cozzolino formula. Atypical project could be an oil or gas exploration venture. It is shown that any Pareto-efficient distribution of the project cash flows can be achieved by dividing the working interest among the partners proportionally to individual risk tolerance values, which is equivalent to the maximization of a synergetic valuation measure that we propose to call the Cozzolino Rent. This Cozzolino Rent then can be re-distributed among the partners according to their bargaining power. Applications of the proposed approach to the group financing of ventures of various complexity are presented including projects with simple binary outcome and complex projects that require managing several inter-related risky assets as real options.

1. Al-Harthy M. H. Utility Efficient Frontier: An Application in the Oil and Gas Industry. Natural Resources Research, 2007, vol. 16, no. 4, pp. 305-312. doi: 10.1007/sl1053-007-9056-3

2. Mutavdzic M., Maybee B. An Extension of Portfolio Theory in Selecting Projects to Construct a Preferred Portfolio of Petroleum Assets. Journal ofPetroleum Science andEngineering, 2015, vol. 133, pp. 518-528. doi: 10.1016/j.petrol.2015.06.018

3. Pratt J. W. Risk Aversion in the Small and in the Large. Econometrica, 1964, vol. 32 (1/2), pp. 122-136. doi: 10.2307/1913738

4. Cozzolino J. M. Controlling Risk in Capital Budgeting: A Practical Use of Utility Theory forMeasurementandControlofPetroleumExplorationRisk. 7fte.£ng/neer/ng Economist, 1979, vol. 25, no. 3, pp. 161-186. doi: 10.1080/00137917908902848

5. Lerche I. AReview of Economic Risking Methods Commonly Used inHydrocarbon Exploration. Journal of Petroleum Exploration and Production Technolog, 2019, vol. 9, pp. 1579-1591. doi: 10.1007/sl3202-018-0602-9

6. Lerche I., МасКау J. Optimum Working Interest in Hydrocarbon Exploration Projects: The High Gain Situation Revisited for Cost, Wealth and Fear Factors. Energy Exploration & Exploitation, 2003, vol. 21, pp. 381-390. Available at: https://www.jstor.org/stable/43754052 (accessed 05.07.2024)

7. Kovalev S., Blam I. The Cozzolino Criterion as a Tool of Oil and Gas Exploration Projects Evaluation Adjusted for Risk Aversion. World of Economics and Management, 2023, vol. 23(2), pp. 52-69. (InRuss.) https://doi.org/10.25205/2542-0429-2023-23-2-52-69

8. Gaudet G. Natural Resource Economics under the Rule of Hotelling. Canadian Journal of Economics, 2007, vol. 40(4), pp. 1033-59. doi: 10.1111/j.l365-2966.2007.00441.x

9. Nash J. The Bargaining Problem. Econometrica, 1950, vol. 18 (2), pp. 155-162. doi:10.2307/1907266

10. Kalai E., Smorodinsky, M. Other Solutions to Nash’s Bargaining Problem. Econometrica, 1975, vol. 43 (3), pp. 513-518. doi:10.2307/1914280

11. Hart S. Shapley Value. In Eatwell, J.; Milgate, M.; Newman, P. (eds.). The New Palgrave: Game Theory. Norton, 1989. pp. 210-216. doi:10.1007/978-l-349-20181-5_25

12. Smith J. L., Thompson R. Rational Plunging and the Option Value of Sequential Investment: the Case of Petroleum Exploration. 'The Quarterly Review of Economics andFinance, 2009, vol. 49, pp. 1009-1033. Available at: https://ideas.repec.Org/a/eee/quaeco/v49y2009i3pl009-1033.html#cites (accessed 05.07.2024)

13. Dias M. A. G. Valuation of exploration and production assets: an overview of real options models. Journal of Petroleum Science and Engineering, 2004, vol. 44(1-2), pp. 93-114. doi:10.1016/j.petrol.2004.02.008