#Real options valuation books how to#
In other words, the managers should apply the notion of options, as conceived in financial markets, to their own business situation.Ī simple financial model showed the company’s managers how to price blocks at their option value over five years, incorporating uncertainty about the size of the reserve and oil prices and leaving room for a flexible response to the outcome.
Left with unwanted blocks that were consuming cash (albeit very little) and that had limited investment appeal, the company decided to sell them to other companies that would buy them, cheaply, for reasons of geography or strategic fit.Īt one point in the divestment program, it was suggested to the company’s managers that, instead of calculating what the blocks would be worth if the company started developing them immediately, it should value its opportunity as an option to develop if, at some point in the future, recoverable reserves could be increased through the use of new drilling and production technologies. Where the blocks proved uneconomic-as most did, usually because development costs were too high in relation to expected revenues-development was shelved. Where net-present-value (NPV) analysis suggested that the economics were positive, the company drilled and developed the blocks.
Over 30 years of operation, one North Sea oil company accumulated a portfolio of license blocks-five-year rights to explore and produce oil and gas.
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