Total capital requirements for large E&P projects are seldom committed at the start of a project. Project development typically occurs in a stepwise fashion. Investments in a subsequent project stage are committed if, and only if, the project is deemed to be profitable point forward.
Such fashion of sequential decision making and Bayesian updating of the project’s outlook at each investment stage generally translates into a significant amount of value of flexibility.
During project development the amount of technical uncertainty generally decreases, however market uncertainty is much more persistent.
Market uncertainty is also much more difficult to model because prices continue to fluctuate during project development. Quantification of the value of flexibility that relates to market uncertainty requires the application of stochastic price models (“random walk of commodity prices”).
Recently developed real options techniques, such as Least Square Monte Carlo, allow for much more accurate project valuation than has been possible hitherto. The method allows for the valuation of some assets, such a gas storage facilities, that cannot be accurately valued using standard DCF methods.
Also, certain contracts that have a large amount of flexibility embedded in them can only be valued using real option valuation techniques.
Benefits:
- Competing by superior asset valuation
- Highly accurate asset valuation
- Guidance as to when to exercise project options
Real option analysis executed by Palantir consultants has given our clients a competitive edge over their competitors and resulted in strategic revisions in a variety of E&P projects.