A Comparative Study of Using Risk Adjusted Discount Rate and Historical-Based Monte Carlo Simulation to Evaluate Risk/Uncertainty in Oil and Gas Investment

This paper presents a comparative analysis of the use of two methods, Risk Adjusted Discount Rate (RADR) and Monte Carlo Simulation, in evaluating the risks and uncertainties in an oil and gas investment proposal. Basically, RADR method is the same as the usual discounted cash flow. But the discount rate already considers any risk/uncertainty that a project will face. Thus, some percentage, based on trusted publisher, will be added to the discount rate. While using monte carlo simulation, an economic model, with base discount rate, will be evaluated by creating hundreds of possible iterations that continually change the major economic assumption based on historical data such as production, capital expenditure, operating expenditure, oil and gas price. The purpose of this paper is to compare the use of two methods, RADR and Historical-Based Monte Carlo Simulation in evaluating risk/uncertainty in oil and gas investment proposal. There are four real oil and gas projects which will be evaluated: Project 1 (Gas Development Project), Project 2 (Shallow Water Development Project), Project 3 (Offshore Development Project), and Project 4 (EOR Development Project). The Net Present Value (NPV) of each project with those two methods will be evaluated and analyzed. The comparison study shows that NPV Calculation with Historical-Based Monte Carlo Simulation tend to have higher NPV. This is important to maintain the level of project attractiveness. Historical Based Monte Carlo Simulation method also shows the real risks and uncertainties because it is based on the historical data. Besides, this method gives real picture of what the project might face in the future instead of allowing static variables to be introduced into potential dynamic model. However, to make Historical-Based Monte Carlo Simulation robust, complete historical database is needed. While, Risk Adjusted Discount Rate method can simply be used by trusted publication.