A numerical scheme and real options modelling for evaluation of a hypothetical oil field under uncertainties

Abstract

This paper uses real options for evaluation of a hypothetical oil field under uncertainties. We have supposed that this oil field is located in Saudi Arabia. Our evaluation includes uncertainties of oil price and exchange rate. The analysis is done both for the fixed exchange rate regime and for the floating exchange rate regime. The proposed approach enables us to take the advantage of real option valuation to overcome the shortcoming of the discounted cash flow (DCF) method which neglects uncertainties. This paper uses an explicit finite difference method (FDM) to approximate the solution of the resulting equation. The numerical experiments show that the impact of the exchange rate, oil price volatility and the correlation coefficient between returns of oil price and exchange rate on the value of an oil extracting project is significant. In addition, the behaviour of the project value is studied as a function of exchange regime. [Received: May 6, 2019; Accepted: September 17, 2019]