Application of Real Options Theory to Tackle Investment Uncertainty in Commodity Industries

The last decades' progress of science and technology are continually changing the world as we know it. With the fast pace of movement of commodities, people, and ideas, uncertainty had become the only certain aspect of our lives. Yet, instead of merely accepting this fact, many have tried to leverage uncertainty to improve decision making. Real options theory (ROT) is an economically valuable tool for making better investment decisions. Its flexibility allows corporate decision makers to take real life scenarios to decide on the best course forward, including to make, delay, or else abandon some investment choice available, factoring uncertainty to the value of each option. Despite its promise to improve decision making, policymakers and business leaders fundamentally misunderstand, mischaracterize, and ultimately underutilize ROT.

The project first developed a basic mathematical model for pricing real options. During the project, the ROT methodology was then applied to a concrete case, showcasing its value and impact.The Capstone team applied their theory on a case study of political uncertainty in Argentina (2018) and deferring an investment for a year entailed a ~$9mm higher NPV. The project used real options valuation to better assess potential investments and assemble efficient portfolios. Finally, the rationale for working with real options theory, the versatility in modeling scenarios and managing risks, was captured in a slide deck to help spread this approach to more corporate decision makers.