Abstract
<p>With the liberalization of energy prices and the opening of the energy sector to competitors in Mexico, an opportunity for new investment projects is now open. Due to the current conditions of international energy markets, such as volatility and low prices with no prospect of reversion, a need for valuation tools to better capture the risk and benefits of a project presents itself. We propose a methodology based on the volatility treatment of numerous underlying assets in a Real Options Analysis: using a TGARCH for the individual volatilities and copulas for the joint effect. The methodology is applied to a natural gas distribution project of Mexico’s State oil company Petróleos Mexicanos (PEMEX). An estimated net present value of the gas pipeline is provided, considering the real options perspective. The result of our empirical application validates the real option’s theory of a higher net present value estimation for the project when incorporating the effect of different sources of uncertainty and non-linear interdependence.</p>
Highlights
With the promulgation of the Mexican energy bill on December 20th, 2013 and the liberalization of energy prices in the country, the door to investment in energy projects was effectively opened in the country
We propose a methodology based on the volatility treatment of numerous underlying assets in a Real Options Analysis: using a TGARCH for the individual volatilities and copulas for the joint effect
Cash flows generated by projects in the energy business in Mexico clearly depend on the prices of the energetic itself but are intrinsically affected by changes in the United States Dollar (USD)-Mexican Peso (MXN) exchange rate, since prices of commodities are set on international markets and typically denominated in US dollars
Summary
With the promulgation of the Mexican energy bill on December 20th, 2013 and the liberalization of energy prices in the country, the door to investment in energy projects was effectively opened in the country. A relevant factor to consider in the valuation of energy investment projects is the presence of relatively low oil prices and high volatility in other energy prices. These considerations put a strain in investments and call for the development and application of new assessment tools that might lead to more accurate valuations, since small mistakes can mean investment in unprofitable projects or the foregoing of profitable and beneficial ones. It becomes evident that applying any evaluation tool that considers only one source of risk may lead to significant deviations from the real value of investment projects. We propose a methodology for the evaluation of projects based on real options with multiple underlying assets, and we apply the proposed methodology to the valuation of the natural gas distribution project “Los Ramones” of Petróleos Mexicanos (PEMEX hereafter), the Mexico State-owned oil company
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