Abandonment Decision-Making of Overseas Oilfield Project Coping with Low Oil Price

• Published in: Computational economics 2020-04, Vol.55 (4), p.1171-1184
• Main Authors: Zhou, Hui-Ling, Tang, Bao-Jun, Cao, Hong
• Format: Article
• Language: English
• Subjects: Abandonment; Behavioral/Experimental Economics; Computer Appl. in Social and Behavioral Sciences; Computing time; Coping; Corporate taxes; Decision making; Decision making models; Economic models; Economic Theory/Quantitative Economics/Mathematical Methods; Economics; Economics and Finance; Extraction; Finance; Flexibility; Foreign exchange rates; Income taxes; Intelligibility; Math Applications in Computer Science; Oil field equipment; Operations Research/Decision Theory; Petroleum; Political culture; Prices; Risk; Scrap; Shutdowns; Taxation; Value
• ISSN: 0927-7099; 1572-9974
• DOI: 10.1007/s10614-018-9837-2

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.