Using Real Options Analysis For PSC Contract Term Negotiation (32nd IPA Conference, May 2008)

May 12, 2008 • Tell FriendsPrinter Friendly

ABSTRACT

When Government opens the tender for some new PSC blocks, the government expect contractor to invest immediately for exploration activity and develop soon after getting a confirmation of commercial reserve. By the end Government expect the maximize revenue from those tender blocks for the benefit of Indonesia

In term of investment decision, a different between traditional net present values (NPV) analysis and real options analysis is the timing of investment. NPV analysis suggest that if the investment opportunity is “now or never”, invest now of NPV is positive. But most investments are not “now or never”, and in these cases an NPV greater than zero is not sufficient for immediate investment, option pricing theory tells us that, immediate investment is not optimal unless well head prices are higher than threshold price.

The objective of this paper is to examine how Real Options Analysis can help both government and contractor in analyzing the potential undeveloped reserves.

This paper extends a model by Paddock, Siegel and Smith (1988) to value undeveloped reserve in Indonesian PSC regime

This paper concludes that ROV can be applied to the Indonesian PSC regime to value undeveloped reserve in Indonesia. 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 development of the undeveloped reserves in Indonesia can be stimulated.

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