Cost Forecasting in Organizations
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Date
2023
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Abstract
In this paper, the economic relationship between oil prices and operating expenses in the E&P sector is examined, along with the implications for capital budgeting and decision-making. We provide empirical evidence that the price and operating costs are positively correlated, and that failing to take this relationship into account has serious repercussions for the valuation of investment projects when using either the conventional Net Present Value (NPV) methodology or the Real Option approach. In the conventional NPV method, projects that are undervalued as a result of ignoring a price-cost correlation tend to be overvalued in Real Options Analysis, and vice versa. Purpose: The objective of the study was to demonstrate the influence of the relationship between oil prices and operating expenses on the assessment of oil prospects, and to highlight the potential consequences of neglecting or underestimating this correlation. Relevance: It presents the importance of ignoring or overlooking the relationship between the price of oil and operational expenditures, which might lead to the wrong decision when investing in a certain project. Key methodological aspects: This paper examines the impact when the pricecost correlation is ignored in the final investment and decision-making process. To investigate this, used the widespread traditional NPV approach and the Real Options Valuation approach. Data was taken from the local Operating company’s one of future projects. Summary of Key Findings: This paper shows that neglecting price-cost correlation has substantial effects, independent of the valuation methodology used (conventional NPV and/or real options approach). Ignoring the price-cost link leads to an overestimation of risk in NPV assessment, which leads to an underestimating of the investment project's value. When genuine option analysis is used, disregarding crosscorrelation results in more volatility and, as a result, exaggerated project values. iv Key conclusion: The final investigation shows that during the decision-making process, it’s important to use various instruments and not to ignore some economic processes that might impact the project's expected outcomes.
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Keywords
oil price, operating costs, financial distress, masters dissertation
Citation
Nurpeiis A./Cost Forecasting in Organizations