Why are the values of large capital projects routinely overestimated?

Abstract

The values of resources projects are routinely overestimated and poorly understood when projects are sanctioned. The challenge with this is that shareholder funds can be squandered on projects that are less attractive than they are perceived to be. This extended abstract addresses how this happens. Behavioural biases at the organisational, portfolio, and project level lead to the benefits of projects being overestimated. Forecasts of capital expenditure and project timing are routinely optimistic. The author will survey the recent track record of the oil and gas industry in estimating project costs, showing that project costs and timelines are positively skewed; that is, costs and timelines have a greater tendency to be in excess of original estimates. Project valuations are often presented as simple base case and anchored high/low cases. A poor understanding of the full spectrum of value outcomes can remove the chance for the project design to be enhanced and the benefits of flexibility are routinely ignored. Small biases in commodity prices and demand projections can significantly improve the appearance of a project, particularly when these metrics move together. Too much comfort is placed in the FEED processes. There is a way to consider value to enable better decisions to be made when sanctioning resources projects. This approach combines tools and techniques from decision analysis, corporate finance and valuation, portfolio management, data analytics, and behavioural economics to provide tailored insights. The author will work through a case study on how to present value differently.