Exploration of hydrocarbon resources is a costly investment, yet with great odds of ending up with dry holes, companies increasingly take on this uncertain venture. Most firms decide which opportunity to drill based on the capacity for value creation. However, valuations in practice commonly use a mixture of decision analysis and discounting principles that are inherently inconsistent and potentially obscure the value–maximizing decisions. For example, the interrelated uncertainties, risks, and risk-adjustments are usually disparately represented by experts and aggregated with capital asset pricing models. We discuss the shortcomings in current valuation practice and implement a coherent method of risk–neutral valuation that, while more detailed, excels in valuation of uncertain investments.
|Publication status||In preparation - 14 Mar 2017|