Abandonment Decision-Making of Overseas Oilfield Project Coping with Low Oil Price

The role of the abandonment option in strategic capital allocation: a review of selected literature

“…The real options literature includes a substantial amount of research where probabilistic methods are used. 9 The binomial model suggested by Cox et al (1979) and applied by many authors (e.g., Xiaoran, 2020;Rambaud & Perez, 2016;Ulrich, 2013) and other more sophisticated lattices (e.g., Song et al, 2017, Zhou & Cao, 2020, in addition to the Monte Carlo simulation (e.g., Amédèe-Manesme et al, 2013;Kryzia et al, 2020;Maier, 2021), have been largely applied to model capital investment problems in different business sectors and industries. Nevertheless, continuous-time models, where state variables follow some type of diffusion process, have also been widely applied since the early days of the ROA, and the following processes are the ones most frequently used to model the state variable(s): (i) geometric Brownian motion (gBm); (ii) Poisson or jump process; (iii) gBm with jumps; (iv) Mean reversion.…”

“…The most recent contributions are the ones by Guedes & Santos (2016), Abadie & Chamorro (2017), Zhou & Cao (2020) and Maier (2001). Guedes & Santos (2016) use a set of sophisticated lattices to appraise the value of several options, including the abandonment option.…”

“…Later in the paper they also derive solutions to the mothball decision and the abandonment option, resorting to the Monte Carlo simulation. Zhou & Cao (2020) apply a trinomial lattice to assess the option to abandon an overseas oilfield project, in the presence of multiple sources of uncertainty -oil price, exchange rate, political environment and taxation policy. They use CCA and conclude that price oscillations and exchange rate movements have a strong impact on the option value whereas the other factors have a smaller impact.…”