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“Real Options Method” vs “Discounted Cash Flow Method” to Analyze Upstream Oil & Gas Projects

 

FEATURED PAPER

By Yerry Patumona Silitonga

Jakarta, Indonesia

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ABSTRACT

Upstream oil and gas project is an example of multiyear investment that has many uncertainties in the whole of project life time (started from exploration, field development and production). Regarding those uncertainties, the executive management is often driven to make a new decision or strategy which may be totally different from previous taken decision.

The Discounted Cash Flow (DCF) method is a most widely used quantitative method to appraise oil and gas field value. Unfortunately DCF method doesn’t produce a complete figure of strategy which may address uncertainties appropriately.

In contrary, Real Option method is a method that already captured those uncertainties through probability and volatility metrics. Real Option provides a complete figure of strategy for the whole life time, therefore Real Option method delivers more flexibility to the executive management in decision making process.

Keywords: upstream oil and gas, uncertainties, DCF, flexibility, strategy, decision making process, real option.

1.  Introduction

1.1   Exploration & Production (E&P) Business

In commonly business practice, upstream oil and gas should be started by exploration phase. Exploration phase consist of main activities include regional study, play concept, petroleum system, seismic 2D, seismic 3D, hydrocarbon resources estimate and drill exploratory well. The objective of exploration phase is discovery of hydrocarbon.

Discussing about petroleum system, we have to talk about subsurface parameters include source rock, reservoir rock, porosity, hydrocarbon migration, seal, trap. Theses parameters must be exist, as a prerequisite of hydrocarbon discovery. The absence of these parameters may elevate the risk of drilling activity in exploration and it’s possible in some circumstances to get dry hole (Pdry hole = 1 – Pg). Chance of success an exploration well to discover hydrocarbon is defined as probability of geological success (commonly called as Pg). Pg is product of occurrence five factors as follow:

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About the Author

pmwj36-Jul2015-Silitonga-PHOTO

Yerry Patumona Silitonga

Jakarta, Indonesia

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Yerry Patumona Silitonga
is a professional in the upstream oil, gas and geothermal sector. Yerry is currently an Assistant Manager Upstream Economic in Upstream Directorate, PT Pertamina (Persero). Yerry has 14 years of experience in petroleum project economics, geothermal project economics, upstream business development appraisal, upstream projects management, upstream commercial, upstream business portfolio, risk management, upstream asset divestment and strategic planning. He holds a Bachelor degree in Mechanical Engineering from University of Diponegoro (Undip) and a Master’s degree in Risk Management from the University of Indonesia (UI). He passed Financial Risk Manager (FRM) Part I Exam and has professional credentials including: Business Continuity Certified Expert (BCCE), Enterprise Risk Management Certified Professional (ERMCP), Certified in Risk Management (CRMTM) and Certified Cost Professional (CCP). He lives in Jakarta, Indonesia and can be contacted at [email protected].