The Optimistic View to Uncertainty. Benefits of Real Option Valuation Methodology in Project Valuation; Example of its Application for a Rail Terminal Modification Project

Abstract

The two main factors that drive the shift to liquid cracking in the Middle East are the restricted availability of ethane and the fact that naphtha or mixed feed cracking provides us with a much more diverse product mix. This opens the path to a higher share of performance chemicals. Building petrochemical complexes based on liquid or mixed feed cracking requires very complicated downstream configurations at a high level of integration with refinery streams. The value created by such a project rests on the ability of the operator to solve complex optimization problems in a volatile market environment. Inevitably, the correctness of the investment decision rests on the ability of the management to determine the value of the project under conditions of uncertainty regarding the future market prices. This paper demonstrates how the approach that was developed originally for the option valuation, can be used to address the problem of project assessment under the conditions of uncertainty. A real-life example of an investment decision about a modification of a rail terminal is used to illustrate the problem and to present a solution to it. Building on this example further, the paper argues that the method of Real Option valuation can support a creation of a competitive advantage in the conditions of uncertainty.