The high capital requirements, long payout horizons, and significant correlated risks that characterize many unconventional development programs may require new approaches to the way a company evaluates these investments within their portfolio of opportunities. Uncertainties, including unproven technologies or technical applications, changing economic conditions, and unpredictable regulatory environments can expose a company to unacceptable levels of risk over the life of a project. To reduce exposure to these risks or better align the scale of a project to available capital, many firms pursue partnerships or focus their efforts on a particular stage of a given project life cycle. A company may focus on early assessment work, without the resources or organizational depth to fully exploit a development project through completion. Other companies may focus on production efficiency improvements or cost reduction, buying into more mature, producing assets. An active market provides opportunities for both companies to participate in the specific phase of the value chain that best complements their existing portfolio and skill sets.
Despite this, many companies fail to adequately assess the value of options generated by their unconventional development programs, resulting in lost opportunities, suboptimal capital allocation, and lower valuations. Projects may take on a life of their own, even though they are a poor fit with the objectives, existing investments, and acceptable risk levels inherent in a company's portfolio. An ongoing, holistic evaluation of a particular unconventional resource project, with consideration of the full value chain and exit options can greatly increase the value leveraged from these projects and ensure an optimal fit within the company's asset portfolio.
This paper outlines a practical approach to applying option analysis and capital allocation techniques to unconventional resource investments. A simplified model of a Bakken shale development program, including assessment, pilot testing, facility options, and multiple development phases is used to demonstrate the way in which a simplified, but structured analytical framework can assist in better quantifying option value potential throughout the life of a project. Investment and divestment options, included at each phase of the development, provide a way to assess the optimal participation or level of investment given a company's objectives and existing portfolio. While methods related to real options and value chain analyses have been addressed in a number of prior works, these methods are generally underutilized, either due to the complexity of the analysis, difficulties in managing and updating data sets, or lack of alignment with existing capital allocation and portfolio management (decision) processes. By combining stochastic assessments, time shifting optionality, and consideration of a company's goals and constraints, the process described in this paper facilitates effective analysis of a company's portfolio of real options.