A compound real options framework for optimal project portfolio allocation under uncertainty: The case of marginal field development under reservoir and price uncertainty

The decreasing average size of oil and gas (O&G) discoveries on the Norwegian continental shelf (NCS) has increased interest in mitigating the uncertainties involved in O&G investment decisions. Marginal fields, in particular, will not be able to support the same data gathering as larger fields, as the cost of appraisal wells may outweigh the potential revenues of the field. This lack of information increases subsurface uncertainty, making the investment decision more complex. Therefore, modeling this uncertainty and accounting for managerial flexibility is essential when evaluating O&G investments. Using existing infrastructure through tiebacks is one of the most cost-efficient solutions for developing smaller O&G discoveries. With spare capacities opening up on maturing production facilities, tiebacks from marginal fields to these facilities can be an appropriate investment option.

This paper presents a compound real options analysis (CROA) that allows us to evaluate a portfolio of two marginal fields under reservoir- and oil price uncertainty. The proposed methodology allows identification of additional value from managerial flexibility when investing in tiebacks to an existing host. The methodology is applied to a case where a decision-maker has to choose which field should be tied back first while knowing there is an option to develop the other field afterwards. Based on updates of crude spot prices and sizes of the reservoirs, the decision maker can evaluate whether to exercise the option to invest in either field or wait and reevaluate in consecutive years. We analyze what drives this choice and propose decision rules considering a portfolio view of O&G projects. The CROA approach is applied to a realistic case study resulting in improved decisions and, thereby, a return on investment of 25.4 % higher than the value resulting from the industry standard myopic valuation approach.