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Abstract
Whenever the Government opens the tender process for new PSC blocks, it is the government’s expectation that the contractor begins immediate investment in exploration activities and start exploitation soon after confirming commercial reserves. Ultimately, it is the government’s intention to maximize the revenue derived from these tender blocks for the greater benefit of Indonesia.
In terms of investment decisions, the primary difference between traditional net present values (NPV) analysis and real options analysis is the timing of the investment. NPV analysis suggests that the investment opportunity is “now or never”. Simply, make the investment now and the NPV is positive. But most investments are not “now or never”, and in these cases an NPV greater than zero is not sufficient for immediate investment. The option pricing theory tells us that immediate investment is not optimal unless well head prices are higher than the threshold price.
The objective of this paper is to examine how Real Options Analysis can help both the government and the contractor in analyzing the potential of undeveloped reserves.
This paper extends a model by Paddock, Siegel, and Smith (1988) to value undeveloped reserves in the Indonesian PSC regime
This paper makes the conclusion that the Real Options (RO) can be applied to the Indonesian PSC regime to value undeveloped reserves in Indonesia. The RO is more likely to reveal the real picture with regard to the value of potential exploration and the subsequent value of undeveloped reserves in Indonesia than any other currently available technique. Consequently, it has the potential to develop into a better basis for the negotiation of contract terms between the contractor and the Government of Indonesia. This in turn will allow for greater stimulation in the development of undeveloped reserves in Indonesia.

ABSTRACT
The high costs and risks associated with many oil and gas exploration projects often cause companies to seek partners to share those costs and risks before embarking on major expenditure programs.
A previous study of farm out analysis for block X in Medco has been done using deterministic model (Kristiono, 2005). This further study was conducted to optimize farm-out analysis using probabilistic model. A risked economic evaluation of a two pay zone prospect i.e. Zone A and B in that block illustrates how probabilistic simulation modeling and deterministic valuation and risk analysis techniques combine to provide useful insight to economic evaluation of a farm out opportunity.
One of the significant advantages of probabilistic methods is their ability to quantify downside risk in more detail than deterministic calculations. Analysis of the negative values in the calculated EMV distributions from the probabilistic method can yield significant insight into the downside risk associated with a prospect.
This paper concluded that, there do appear to be farm-out terms that could be attractive to both parties i.e. Farminee pays between 60% and 70% of exploration well costs to earn a 50% working interest. However, If Medco is subject to capital constraints and under timer pressure to drill an obligation well it may accept farm-in terms with little or no promote to limit its financial exposure and down side risk.
Alternatively, the farminee may be prepared to accept less than optimal farm-in terms on this prospect in exchange for an interest in the upside potential of other possible prospects in the contract.

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.