Near-well effects can have a strong impact on many subsurface flow processes. In oil production, because dissolved gas is released from the oil phase when the pressure falls below the bubble point, the detailed pressure field in the immediate vicinity of a production well strongly impacts gas (and thus oil) production. This effect is complicated by the interplay of fine-scale heterogeneity and two-phase flow physics, and can be difficult to capture in coarse-grid simulations. In this article, we develop and apply a new upscaling (coarse-graining) procedure to capture such near-well subgrid effects in coarse-scale flow simulation models. The method entails the use of preprocessing computations over near-well domains [referred to as local well models (LWM)] for the determination of upscaled single-phase and two-phase near-well parameters. These parameters are computed by minimizing the mismatch between fine and coarse-scale flows over the LWM. Minimization is accomplished using a gradient-based optimization procedure, with gradients calculated through solution of adjoint equations. The boundary conditions applied on the LWM can impact the upscaled parameters, but these boundary conditions depend on the global flow and are not, therefore, known a priori. In order to circumvent this difficulty, an adaptive local-global procedure is applied. This entails performing a global coarse-scale simulation with initial estimates for well-block parameters. The resulting pressure and saturation fields are then used to define local boundary conditions for the near-well computations. The overall procedure is applied to several example problems and is shown to provide results in close agreement with reference fine-scale computations. Significant improvement in accuracy over existing near-well upscaling treatments is demonstrated, particularly for a heavy oil case with oil viscosity of similar to 10(4) cp.