Modified-Decoupled Net Present Value: The Intersection of Valuation and Time scaling of Risk in Energy Sector

Abstract

Although the practical importance of investment analysis in long-term energy investments is well understood, choosing the proper method has always been a dilemma. In this regard, classic evaluation methods, with a history of almost a century, are mostly favored, but using them in the valuation of long-lasting energy projects has particular shortcomings, nevertheless. The drawbacks mainly stem from two structural problems: a) reflecting risk in rate of return instead of cash flow thus summing up risk and time value of money in a single parameter, b) generalizing the predefined rate of return to all project life time regardless of changing nature of risk. To overcome such drawbacks, a new easy-to-implement method termed Modified-Decoupled Net Present Value (M-DNPV) is proposed that intercepts coupling of risk and time value of money by deducting the risky portion of expected cash flows. To cover the dynamic nature of risk and as a buffer against uncertainty, it is suggested to attribute measured risks to investment lifespan using an "uncertainty coefficient”. Finally, the ability of the new method is shown through a complicated energy investment: an Iranian Petroleum Contract (IPC).

Keywords

• Energy investment
• Decoupled NPV
• Investment decision analysis
• Project valuation
• Iranian Petroleum Contract