How valuable is the option to defer Uganda's crude oil production?

Abstract

Our study contributes to the limited literature on real options valuation of Africa's oil investments. We establish binomial lattices to assess the value of the option to defer crude oil production in Uganda. We assume that oil prices follow a Geometric Brownian Motion (GBM) stochastic process. In our base case, we find that deferring production by another year adds value of $0.9 billion to the oil project. The value of the option to defer production particularly increases at lower crude oil prices amidst higher crude oil price volatility. When the rate of net convenience yield is high and the oil price is high, the value of the option is lower. At low oil prices, increases in cost inflation result in rejection of the project. We conclude that the Uganda oil project is generally profitable, and that deferring oil production is justified except in the cases where the net convenience yield or cost inflation is high.