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 • Tell FriendsPrinter Friendly

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 shows co-integration among oil reserve and WTI spot prices using the two-stage Engle-Grager methodology and results in an ECM equation for forecasting current oil reserve price.

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

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