Port capacity investment size and timing under uncertainty and congestion

Abstract

ABSTRACTWell-planned port capacity investments are required to accommodate growing maritime trade, especially in developing countries. Such investments prove to be expensive, irreversible and subject to uncertainty. Under these conditions, the application of real options is better suited than the traditionally used NPV approach, given that specific port and market characteristics are taken into account. In this paper, we consider the investment in a new container port. The port is operated by one single actor who also owns the port and absence of competing ports in the neighbourhood is assumed. Two decisions have to be made: the size of the port and when to build it. Our real options model evaluating the option of flexible size and timing of the investment is based on a geometric Brownian motion. This approach has the advantage of analysing the impact of economic growth and uncertainty independently. Additionally, port users differ in aversion to congestion. Our model allows examining this impact on the optimal port investment. This paper shows that ports with more waiting-time averse customers are better off when investment is delayed to install a larger port. This result holds in both privately owned, profit-maximising ports and government-owned, social welfare-maximising ports.