Exploration economics: taking opportunities and the risk of double-counting risk

Babak Jafarizadeh () and Reidar B. Bratvold ()
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Babak Jafarizadeh: Heriot-Watt University
Reidar B. Bratvold: University of Stavanger

Mineral Economics, 2019, vol. 32, issue 3, No 5, 323-335

Abstract: Abstract When investing in projects with uncertain outcomes, most companies use a discount rate that reflects their perception of risk and reward. This rate is used in decision tree models that once again represent opportunities and risks, usually with little attention to what was already included in the discount rates. Besides, capital asset pricing models lead to discount rates as “average measures” that do not often represent individual project’s risk. Such inconsistent treatments of risk could distort valuation and ultimately destroy shareholder value. In this paper, we use twelve years of monthly return data for major upstream petroleum companies in the U.S. market, and suggest an industry-wide beta, stripped of the blurring effects of corporate debt and embedded real options. In addition, for each project we separately account for systematic and project-specific risks. This provides a more consistent guideline for valuation of exploration and development projects, particularly in the petroleum and mineral industries.

Keywords: Exploration economics; Real options analysis; Decision analysis; CAPM (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s13563-019-00188-1

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