How do you value flexibility in petroleum projects?

1 Types of flexibility

Flexibility in petroleum projects can be classified into two broad categories: operational and strategic. Operational flexibility refers to the options to adjust the production level, mix, timing, or location of the output. For example, you can shut in or restart a well, switch between oil and gas production, or use different transportation modes. Strategic flexibility refers to the options to modify the scale, scope, or structure of the project. For example, you can expand or contract the capacity, diversify or specialize the portfolio, or form or dissolve partnerships.

2 Methods to value flexibility

Flexibility can be valued using different methods, depending on the complexity and uncertainty of the project. The most common methods are: net present value (NPV), decision tree analysis (DTA), and real options analysis (ROA). NPV is the simplest method, but it assumes that the project is fixed and deterministic. It does not capture the value of flexibility, and may underestimate or overestimate the project value. DTA is a more advanced method, but it still assumes that the project is discrete and sequential. It can capture the value of flexibility, but it may be impractical or inaccurate for large or continuous projects. ROA is the most sophisticated method, but it also the most difficult and controversial. It assumes that the project is dynamic and stochastic, and treats flexibility as a financial option. It can capture the value of flexibility, but it requires a lot of data and assumptions, and may be subject to model risk and market imperfections.

3 Factors influencing optimal use of flexibility

Flexibility is not always beneficial or available. It depends on several factors, such as the project characteristics, the market conditions, and the managerial preferences. Some of the key factors are: volatility, irreversibility, timing, and learning. Volatility is the degree of uncertainty and variability in the project outcomes. It increases the value of flexibility, as it creates more opportunities and risks to respond to. Irreversibility is the degree of commitment and sunk cost in the project. It decreases the value of flexibility, as it reduces the ability and incentive to change course. Timing is the degree of urgency and delay in the project execution. It affects the value of flexibility, as it determines the trade-off between waiting for more information and acting on current expectations. Learning is the degree of improvement and feedback in the project performance. It enhances the value of flexibility, as it allows for better adaptation and optimization.

Flexibility is a vital aspect of petroleum projects, as it enables you to cope with uncertainty and capture value. By understanding the types, methods, and factors of flexibility, you can make more informed and effective decisions in your projects.

4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?