Abstract
The abandonment option of an operating oil project refers to the right to shut down or transfer the project. As a kind of American real option, it minimizes the impact of bad operating conditions, thus increases the initial project value. Meanwhile, as a put option, it maximizes the management flexibility in unfavorable environment, especially in the current low oil prices. This article uses the trinomial tree, rather than the binomial tree widely practiced in finance, to value the option. Its lattice structure shows flexibility and intelligibility, and improves computational efficiency and accuracy. In this article, the abandonment option value incorporates uncertainties of oil price, exchange rate, political environment and taxation policy. The risk-neutral based decisions are relatively objective for oil companies. The case study indicates that the relative relationship between the abandonment option value and the project scrap value or selling price is the key to the decision-making results. A novel conclusion from the risk-neutral prospective is that, the project is more likely to be sold at higher risk scenario or with higher profit requirement. Moreover, export duty and mineral extraction tax have a greater impact on the abandonment timing than corporate income tax. This decision-making model can be introduced with modifications to other investments with increasing risk of falling asset price.
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Data source: The oil-price and exchange-rate series come from World Bank, IMF and EIA. The political environment series come from the political index in ICRG (2016)
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Acknowledgements
We gratefully acknowledge the financial support from the National Natural Science Foundation of China (Grant Nos. 71573013, 71521002, 71642004), Special Items Fund for Cultivation and Development of Beijing Creative Base (Grant No. Z171100002217023), Key Project of Beijing Social Science Foundation Research Base (Grant No. 15DJA084), National Key R&D Program (Grant No. 2016YFA0602603) and Special Items Fund of Beijing Municipal Commission of Education.
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Zhou, HL., Tang, BJ. & Cao, H. Abandonment Decision-Making of Overseas Oilfield Project Coping with Low Oil Price. Comput Econ 55, 1171–1184 (2020). https://doi.org/10.1007/s10614-018-9837-2
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DOI: https://doi.org/10.1007/s10614-018-9837-2