Valuation of decision flexibility and strategic value in coal gasification projects with the option-to-switch between different outputs

Abstract

Coal gasification has been promoted as a sophisticated clean energy technology alternative to coal burning these days. Aside from the usual technical difficulties, economic issues of such projects-especially valuation challenges-are important problems that practitioners usually struggle with. This is because of the major extent of managerial flexibility linked with specific characteristics of coal gasification projects, in particular, possibilities to mothball/restart manufacturing lines, or change between different outputs. The value of such flexibilities may be well assessed by real options valuations. The aim of this paper is to show that for the coal gasification technologies the real options valuation is more suitable than traditional discounted cash flow technique. This approach was applied to calculate an integrated plant that can produce either electricity or methanol. As the valuation approach the multiplicative stochastic process was used. As a consequence, binomial lattices of end-product (electricity and methanol) were developed. Then, in regard to them (reference instruments), two corresponding lattices of net cash flows (consecutive instruments) were created. In the end, two trees of switching option value were developed-one for electricity production as an initial mode, and the second for methanol production, delivering expanded net present (strategic) value.