Managing Risks in Energy Capital Projects – The Value of Contractual Risk-Sharing in CCS-EOR

Agarwal, A.
PhD Thesis, Civil and Environmental Engineering, MIT, Report Nr. 0

This thesis addresses the question of how to maximize the value of energy capital projects in light of the various risks faced by these projects. The risks can be categorized as exogenous risks (not in control of involved entities) and endogenous risks (arising from sub-optimal decisions by involved entities). A dominant reason for poor project performance is the endogenous risks associated with weak incentives to deliver optimal project outcomes. A key objective of this research is to illustrate that risk-sharing through contracts is central to incentivize the involved entities to maximize overall project value.

The thesis presents a risk management framework for energy capital projects that accounts for both exogenous risks and endogenous risks to evaluate the optimal risk management strategies. This work focuses on a carbon capture and storage project (CCS) with enhanced oil recovery (EOR). CCS is projected to play a key role in reducing the global CO2 emissions. However, the actual deployment of CCS is likely to be lower than projected because of the various risks and uncertainties involved. The analysis of CCS-EOR projects presented in this thesis will help encourage the commercial deployment of CCS by identifying the optimal risk management strategies. This work analyzes the impact of the exogenous risks (market risks, geological uncertainty) on the value of the CCS-EOR project, and evaluates the optimal contingent decisions. Endogenous risks arise from the involvement of multiple entities in the CCS-EOR project; this thesis evaluates alternate CO2 delivery contracts in terms of incentives offered to the individual entities to make the optimal contingent decisions.

Key findings from this work illustrate that the final project value depends on both the evolution of exogenous risk factors and on the endogenous risks associated with response of the entities to change in the risk factors. The results demonstrate that contractual risk-sharing influences decision-making and thus affects project value. For example, weak risk-sharing such as in fixed price CO2-EOR contracts leads to a high likelihood of sub-optimal decision-making, and the resulting losses can be large enough to affect investment and project continuity decisions. This work aims to inform decision-makers in capital projects of the importance of considering strong contractual risk-sharing structures as part of the risk management process to maximize project value.

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