Optimal divestment time in supply chain redesign under oligopoly: evidence from shale oil production plants

Abstract

AbstractThis paper investigates the optimal timing for the closure of production plants in the context of supply chain redesign. We consider producers operating under oligopoly and analyze their optimal decisions with the aid of real options. We contextualize this study in the energy supply chain, where revenue is heavily influenced by the Organization of the Petroleum Exporting Countries (OPEC). It is optimal to divest from a production if certain values pass below the liquidation cost. The optimal time to divest is, then, the optimal time to exercise a perpetual American put option on the total value of the project, where the strike price is the liquidation value and expenses. The OPEC oligpolistic power is modeled with the aid of a hidden market in a Hidden Markov Model, since the state of the Markov chain is not directly visible to the production manager. The reported results can be used by supply chain managers in decision making on production network redesign in the oligopolistic environment considering present value of plants and cash flows in the supply chain. The advantage of the modeling approach proposed is its analytical tractability, especially for project valuation and real‐option problems.