Real Options in Offshore Oil Field Development Projects

The average size of discovered petroleum reserves on the Norwegian continental shelf has declined steadily over the last years. As a consequence, the fields have become economically more marginal, and new and flexible development strategies are required. This paper describes a stochastic dynamic programming model for project evaluation under uncertainty, where emphasis is put on flexibility and its value. Both market risk and reservoir uncertainty are handled by the model, as well as different flexibility types. The complexity of the problem is a challenge and calls for simple descriptions of the main variables in order to obtain a manageable model size. Results from a case study reveal significant value of flexibility, and clearly illustrate the shortcoming of today’s common evaluation methods. Particularly capacity flexibility should not be neglected in future development projects where uncertainty surrounding the reservoir properties is substantial.