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Real options represent the decisions companies can make in the face of changing risks. In the energy and commodities industries, the real options are ubiquitous, including the extraction, processing and refining, storage and transportation of natural resources. These choices are influenced by constantly changing market and environmental conditions.

Because of these uncertainties, the energy industry has been at the center of the real options operational literature. Nicola Secomandi, professor of Rice Business, and Selvaprabu Nadajara, professor at the University of Illinois at the Chicago College of Business Administration, were recently invited by the European Journal of Operational Research to conduct a review of the operational literature on options real in terms of energy. Their review included 80 articles in 10 active journals in the field. The research was primarily conducted during Secomandi’s time at Carnegie Mellon University’s Tepper School of Business.

The review examined how often different types of energy and methods of studying related business processes have appeared in the operations literature. Almost a quarter of the articles considered natural gas, more often than any other type of energy. Storing natural gas has been the most studied process, while transporting and selling natural gas has been less discussed.

While only 10% of articles focused on electricity itself, mostly in the context of battery management, electricity was discussed alongside emissions and the environment in 22.5% of articles, almost as much. often than natural gas. About 11% of the articles were about electricity and natural gas.

About 21% of the articles were about crude oil and refined products. Exploration, development, and abandonment of crude oil deposits were common topics, while work on crude oil refining and gasoline logistics were rarer.

The review looked at the frequency of use of five categories: real option types, valuation methodologies, model formulations, price risk dynamics, and optimization schemes. Timing options, which irreversibly change the status of an asset when exercised, and switch options, which involve reversible changes, appeared with roughly equal frequency. Among assessment methodologies, risk-neutral assessment was used most often, appearing in nearly 78% of articles. Model formulations have been divided mainly between Markov decision processes, which assume decisions are made at specific times, and stochastic optimal control models, which assume decisions are made continuously. About 63% of papers discuss Markov decision processes, but at nearly 34%, stochastic optimal control models have not been entirely excluded from the literature. Nearly 75% of papers formulated models based on spot prices as opposed to futures prices, and more than 80% adopted normal distribution models, either alone or in combination with other models. Approximate solution approaches dominated in optimization diagrams, appearing in 71% of articles.

Although several energy sources and analysis tools have been discussed in the literature, the possibilities for future research remain wide. The transition to clean energy sources can add complexity to already complex operations. Its modeling and analysis may require more advanced models than existing ones.


This article originally appeared on Rice Business Wisdom and was based on research by Nicola Secomandi, Houston Endowment Professor of Management – Operations Management at Rice University’s Jones Graduate School of Business.