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Uncertain time to completion in sequential oil project development

Building on earlier literature, we develop a framework for real options valuation of a sequential oil project. Investments at each sequential stage of oil project lifecycle are highly costly, lumpy and are sunk, for the most part, once expended. More so, each successive stage prior to the production stage typically does not lead to immediate cash flows but opens further investment opportunities. The capital intensity of oil investments, particularly at the development stage, makes them irreversible because the oil wells and operation facilities can only be used to produce oil. These complexities are exacerbated by the various uncertainties faced by these projects. Among these is the uncertainty about the oil price which influences the value of an oil project. Another is the uncertain time to completion of the preceding stages to production stage, particularly the development stage that requires large capital-intensive investments in facilities and infrastructure that take a long time to build. In particular, our framework applies Geometric Brownian Motion to model oil prices and incorporates an uncertain time to completion of the development phase. We obtain some closed form solutions for project values and threshold prices at which the firm should invest immediately. Finally, we undertake sensitivity analysis by varying some input parameters, such as oil price volatility and the expected duration of the development stage. Our case study is Uganda’s oil project in the Albertine Graben region. However, the framework is applicable to a broader range of real options involving lumpy, sequential and costly investments.