Abstract
Indonesia has many potential undeveloped reserves and currently still depends on petroleum resources to support its economy. In Indonesia case, the Discounted Cash Flow (DCF) is much more widely applied than
Real Option for valuation of the petroleum project. Generally, ROV was chosen to accommodate flexibility management in adapting and revising future decisions in response to changing circumstances. The ROV technique makes efficient use of market information and minimizes reliance on subjective and arbitrary data inputs, as observed in the illustrations in Paddock, Siegel and Smith (1988).
Two approaches can be used to value petroleum reserve using ROV i.e.:
– Internal approach that uses the output of DCF result.
– External approach that uses market data i.e. historical actual reserve transaction price.
ROV still requires the use of an existing DCF model when we want to value the petroleum project under our company. Since the field under our internal control, there will be much technical and financial information about the field, and we can use that information to make economics projection for that field.
However, if we want to value the petroleum project beyond our control for instance, in the acquisition program, external approach is required to see how market expects the value of the petroleum reserve at this moment. In this case, ROV can make efficient use of market information and minimizes reliance on subjective judgments and arbitrary assumptions provided by an analyst, as the illustrations in Paddock, Siegel and Smith (1998) demonstrates.
In internal approach, we identify the underlying asset as the net present value of developed petroleum reserves. The NPV exhibits a log normal probability distribution, so the volatility of the underlying asset is based on the logarithm of the future cash flows.
In external/market approach, the underlying asset is valued based on the historical actual reserve transaction data from Adelman and Watkins’ study in 2003. This paper tests for co-integration between the estimated oil reserve price and WTI spot price. The output of the Error Correction Model will be an input for ROV in term of underlying asset parameter.