Regulations in the Energy Industry by André Dorsman & Özgür Arslan-Ayaydin & James Thewissen

Author:André Dorsman & Özgür Arslan-Ayaydin & James Thewissen
Language: eng
Format: epub
ISBN: 9783030322960
Publisher: Springer International Publishing

2.2 Influence of Uncertainty on Investments

In the perfect scenario—where everyone has perfect information and no uncertainty, firms can easily decide on how much to invest. Yet, in real-world situations, it is often difficult to determine the exact level of investments that firms want to undergo, which is usually followed by over/under investments (Pindyck and Rubinfeld 1991; Dixit and Pindyck 1994). In our imperfect world, the influence of uncertainty level on investments has always been the main priority for scholars, but still there is no common agreement on the relation between investment and uncertainty. Standard models of investments suggest that this relationship is negative (Dixit and Pindyck 1994). However, according to among others Smit and Trigeorgis (2004), this relationship could be positive, in case a company (especially in gas and oil sectors) stops awaiting future benefits options of its investment when it expects high levels of price volatilities (Kulatilaka and Perotti 1998; Sarkar 2000). Simultaneously, according to Grenadier (2002) and Akdoğu and MacKay (2008), the value of the waiting option would be affected by factors such as imperfect competition and strategic investment. Scholars deliver two types of price uncertainty: temporal and permanent. For the temporary periods of uncertainty, oil and gas companies could consider oil price volatilities as a transition phenomenon Mohn and Misund (2009). This transit phenomenon with high peaks of oil price volatility is considered to be followed by a period of decreasing volatility. This by any means follows the standard investment irreversibility theory. According to this theory, the relationship between investment and uncertainty (oil price volatility in our case) is negative, as was concluded by Favero et al. (1992) and Osmundsen et al. (2006). However, the approach on strategic investments and compound options highlights a positive relation between uncertainty and investments. Scholars did present findings for sample periods of 20 years ago Mohn and Misund (2009), but the current situation could have changed the relation between uncertainty and investments.

Mohn and Misund (2009) delivered their result from a strategic investment approach view, but did not specify the concrete link between this approach and oil pricing. They were referring to Smit and Trigeorgis (2004) that the strategic investment approach dominates the oil and gas companies’ investment incentives. During period of uncertainty, firms can wait for new information, thus declining any possible returns from early investments (strategic or not). Henriques and Sadorsky (2011) showed that increases in uncertainty raise the option value of waiting such that investments are postponed. However, things are changing with strategic investments that cannot be postponed forever for the sake of better information. Dedicating attention to this topic is needed, since oil prices significantly affect investment incentives of oil and gas companies. Henriques and Sadorsky (2011) state that the correlation between oil and gas prices ranges from 26% in general up to 70%. In addition, the 2008–2009 global crisis and subsequent oil price drops may shed new insights into the relation between uncertainty levels and investments. After having discussed capital structure and uncertainty factors, we now look more deeply into these and develop our hypotheses.

Download

Copyright Disclaimer:
This site does not store any files on its server. We only index and link to content provided by other sites. Please contact the content providers to delete copyright contents if any and email us, we'll remove relevant links or contents immediately.