Publication | Explore Real Options

A Probabilistic Approach to Valuing Different Equity Interest in Multi Pay Exploration Prospects (31st IPA Conference, May 2007)

May 12, 2007 adminDomestic, Publication

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.

Applying Real Option Valuation to Stimulate Growth of Oil and Gas Reserve Development in Indonesia (2nd Indonesia Business Management Conference, Jan 2007)

January 12, 2007 adminDomestic, Publication

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.

Econometric Model for forecasting petroleum Reserve price and its application of Real Option Valuation in Indonesia (29th IAEE Conference, Berlin – Germany, Jun 2006)

June 12, 2006 adminOverseas, Publication

Abstract
Innovation in derivative markets permits active trading, speculating and hedging, linking markets for physical petroleum products with financial markets. These markets continuously value petroleum delivered today and in the future, thereby providing a market price for inventories. Underground petroleum reserves are also an inventory defined by exploration surveys and development drilling. As a result, observable market information can be used to value these reserves.
Besides the discounted cash flow (DCF) approach, real option valuation (ROV) has been applied over the last two decades to value petroleum property. 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). The combining of both DCF and ROV approaches results in a better judgment from the internal and external perspective in valuation of petroleum property, especially for undeveloped reserves.
In Indonesian cases, the DCF approach is much more widely applied than ROV in the valuation of petroleum property. On the other hand, Indonesia has many potential undeveloped reserves and currently still depends on petroleum resources to support its economy. The need for the ROV approach in valuing petroleum property is essential for stimulating growth of petroleum resource development in Indonesia.
This paper extends a model by Pickels and Smith (1993) to value petroleum property and comes up with a valuation procedure for Indonesian PSC field.
Adelman and Watkins (2005) conducted a study to estimate the oil and gas reserve price based on the actual reserve transactions in the US, using the period 1982 – 2003. This paper tests for co-integration between the estimated oil reserve price and WTI spot price. The Error Correction Model (ECM) resulting from this test would be used to forecast the reserve price in 2004 and 2005.
The forecast reserve price resulting from ECM can be used as an input parameter for the underlying asset price in the ROV. Other input parameters, such as volatility, pay out rate, risk free rate etc would be adjusted in the Indonesian PSC regime.
This paper concludes that ROV can be applied to the Indonesian PSC regime and accompanying DCF approach to value the petroleum property in Indonesia. ROV judges petroleum property on the basis of objective market data and is less dependent on subjective judgments and arbitrary assumptions provided by an analyst. In that sense, ROV is more likely to reveal a true picture of the worth of exploration potential and the value of undeveloped reserves in Indonesia than any other currently available technique. As such, it has the potential to form a proper basis for the negotiation of contract terms between the contractor and the Government of Indonesia, as a result of which production of the undeveloped reserves in Indonesia could be stimulated

Building Competitiveness to attract Oil & Gas Investment In Indonesia – A Local Player Perspective (30th IPA Conference, Aug 2005)

August 12, 2005 adminDomestic, Publication

A LOCAL PLAYER PERSPECTIVE ON INDONESIAN OIL INDUSTRY
ISSUES AND CHALLENGE
Currently, the oil industry is experiencing a boom due to high oil prices. Although this situation is not sustainable, there is no sign of slow down in demand. It was indicated that the oil price will remain well over $20.00/bbl.
Recent reports indicate that oil and gas demand has risen from 47 mmbd in 1970 to 82 mmbd today sign of slowdown. Non OPEC production is expected to decline because due to limited resources, while reserves in some regions may have been exaggerated by both companies and countries.
While demand has been growing at an annual rate of 1.5% over the last 5 years, production capacity has grown at only 0.2%. It’s likely to be needed to enable OPEC to meet future demand, around $400 billion for oil and $200 billion for gas.
Indonesia as a member of OPEC is also encouraged to increase their production especially since Indonesia has already been a net importer. A change in incentive policy related to oil and gas investment is required since there are some exodus foreign investment from Indonesia especially for US and Europe investors.
On the other side, China has entered Indonesia and may effect the reduced invest of the western oil investor. From the local player’s perspective, the situation created a high competition.
Indonesian government needs to consider how to provide incentives to local players in competing with other country in energy business considering that in future, Government needs local oil companies to secure oil supply for the domestic demand.
In building competitiveness to attract oil & gas investment in Indonesia, Government should restructure the current PSC by providing some incentive for to utilizing local resources even though the government take would potentially be reduced.

Econometric model for forecasting Indonesian Crude Price and its Application in cross hedging strategy on futures contract (6th IAEE European Conference, Zurich – Switzerland, Sep 2004)

September 12, 2004 adminOverseas, Publication

Abstract
The volatility of the world oil market since the OPEC oil price shocks of the 1970’s has resulted in oil export dependent countries like Indonesia facing a considerable degree of macroeconomic risk. Declining oil revenues resulted in large public sector deficits and a worsening balance of payments situation.
Indonesia’s dependence on oil is such that even minor if oil price declines have had a substantial cumulative adverse impact on Indonesia’s macroeconomic performance. The need of the forecasting model in predicting the Indonesian crude price is greatly required to give guidance for government budget planning and also for hedging scheme.
Error correction model developed by Engle-Grager can be used to forecast price change as long as two variables which is non stationery are cointegrated in the same order. One of the advantage of this model is it can accommodate the short and long information in one model. The availability of error correction term (cointegration vector) in the model can correct any deviation happened into equilibrium in the long term.
Developing countries like Indonesia have sought to achieve export revenue stabilization through International Commodity Agreements with importing nations. An alternative approach to stabilizing export revenues is to use market based risk management tools such as futures hedging. Through futures hedging cannot insulate exporters from a long term secular decline in commodity prices; they are effective in managing short term price risk. Using futures market for hedging is a notion that is just now beginning to gain acceptability among developing countries. The New York Mercantile Exchange (NYMEX) estimates that developing countries are increasingly holding a higher percentage of the total open interest in crude oil futures. Since the gulf war, countries like Mexico, Brazil, and Chile are regular users of the oil derivatives market. (Satyanarayan, 1997)
The objective of this paper is to find the error correction model for forecasting changes in Indonesian Crude and WTI spot price, also to assess the risk management prospect for hedging Indonesian crude by developing scenario model of hedging and use it to evaluate the cost and benefits of different hedging strategies.
This paper shows that there is effective risk reducing strategies available to Indonesian policy markets that would have reduced the variance of Indonesian oil revenues over time. While these strategies may necessitate foregoing unexpected gains, they would have prevented unanticipated short term losses. We provide estimates of the cost and benefit of different hedging strategies that may aid in policy formulation.
Cointegration is found among Indonesian Crude and WTI spot price using the two stage Engle-Grager methodology and a series of error correction models are estimated. Using 72 months of “out of sample” data, the null hypothesis of no forecasting ability is rejected at a 2% level of significance for the ECM model found.
This paper also tests for cointegration between the spot and future price of WTI. It is purposed to estimate the closing price of WTI Futures contract so that we can know what position that will be held in the futures contract.
By using these two prediction model, we can make a simulation of cross hedging strategies on futures market. The result of simulation has an effect of increasing the mean, reducing the variance and positively skewing the distribution of gross profit over a naïve strategy.