Uncertain Commodity Prices and Informed Sensitivity Analyses

From corporate budgeting to public planning, we hear that commodity prices are uncertain and that when they vary, key investment measures sway with them. However, claiming that commodity prices are outside a firm’s domain of control, corporate decision makers mostly neglect this uncertainty or at best reflect it in naïve sensitivity analyses. Yet, to avoid inferior decisions and loss of value, firms should make decisions that take in the understanding about key uncertain factors. In this paper, we show that the customary practice of analysis with arbitrary “high” and “low” prices is inconsistent with the general understanding about commodity price dynamics and the financial theory. To alleviate this, we suggest a consistent and project-specific sensitivity analysis method that supports valuations and decision making.