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Implications of Output Price Risk and Operating Leverage for the Evaluation of Petroleum Development Projects

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  • Gordon Salahor

Abstract

This paper is the first in a series that describes how Modem Asset Pricing (MAP) may be used for project evaluation in the upstream petroleum industry. It shows how MAP methods can be used to value a project, if it i's possible to split its cash-flows into two components: one for revenue and one for cost. Two design choices for a "now or never " natural gas field development are used as examples of what can be gained by this type of approach to project evaluation. The first choice involves a tradeoff between capital and operating costs, while the second involves a tradeoff between costs and potential production rate. The results show that the use of standard DCF methods can induce systematic, and possibly misleading, biases into the analyses that lie behind project design and selection.

Suggested Citation

  • Gordon Salahor, 1998. "Implications of Output Price Risk and Operating Leverage for the Evaluation of Petroleum Development Projects," The Energy Journal, , vol. 19(1), pages 13-46, January.
    • Handle: RePEc:sae:enejou:v:19:y:1998:i:1:p:13-46
    DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-2
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    References listed on IDEAS

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    1. Lessard, Donald R., 1979. "Evaluating foreign projects : an adjusted present value approach," Working papers 1062-79., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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