EM187937 DOI: 10.

2118/187937-PA Date: 19-September-17 Stage: Page: 90 Total Pages: 13

The Net-Present-Value Paradox:

Criticized by Many, Applied by All
Bart J. A. Willigers, AstraZeneca; Benjamin Jones, CRU International Limited;
and Reidar B. Bratvold, University of Stavanger

Summary
The exploration and production (E&P) industry is facing a net-present-value (NPV) paradox. Despite the fact that the NPV method is
widely criticized by practitioners and academics alike, the NPV method remains the cornerstone of E&P project valuation. We posit
that this contradiction, which we labeled the NPV paradox, is likely to be caused by a combination of limitations of the method, a lack
of theoretical understanding, and ambiguity regarding the implementation of the NPV method.
Even though the NPV method has been described in numerous papers and textbooks, rigorous and succinct guidance on how to
determine risk premiums for systematic risk is not available. We demonstrate that risk-adjusted discount rates are very sensitive to the
choice of the length of the periods over which returns are determined (daily, weekly, or monthly), length of the time horizons consid-
ered (such as 10 or 25 years), and start date (such as 1965 or 1990). We discuss the fundamental implications and rationale of choices
and their effects on the variables that underpin the risk-adjusted discount rate: risk-free rate, company b, market-risk premium, and the
cost of debt.
Although not entirely satisfactory, we argue for a moderate downward revision of discount rates for projects with timelines exceed-
ing 20 years. This recommendation is dependent on recent advancements in public finance and the reality that the exposure to system-
atic risk in the long run is significantly less in many real-life E&P projects than the capital-assessment-pricing model (CAPM) implies.
The inflated discount rate that is currently used, combined with the extended investment horizons that are common in the upstream sec-
tor, will for example result in an underweighting of decommissioning and future legacy costs.
In addition to a set of widely recognized shortcomings of the NPV model, there are also lesser well-known issues. For example, the
failure of CAPM to capture bankruptcy risk has a bearing on the project-risk premium. Also, the application of the NPV model implies
a set of probabilistic assumptions around market risks that are likely to be invalidated when evaluating a set of market scenarios or
using a series of probability-weighted market scenarios.

Introduction
The determination of the expected returns of investment projects is an important strategic-planning function within the E&P industry.
The most common tool used to inform such judgments is by far the NPV model.
The first use of NPV analysis to value projects is generally ascribed to Dean (1951), who referred to “discounting the stream of capi-
tal earnings to take account of the diminishing value of distant earnings.” The E&P industry had become aware of the NPV method by
the 1960s, as evidenced by several publications (Reynolds 1959; Woody and Capshaw 1960). In the next 50 years, the approach became
widely adopted across the corporate sector (Arnold and Hatzopolous 2000; Ryan and Ryan 2002). Arnold and Hatzopolous (2000)
stated: “only a small minority [of companies] do not make use of discounted cash flow,” but they also noted “however, managers con-
tinue to use simpler rules-of-thumb.”1 Dissatisfaction in the NPV approach can also be inferred from a survey by Carr and Tomkins
(1998): “100% of the US sample [of companies] used NPVs but only 50% used NPVs for ‘strategic’ decisions.”
One reason that the NPV method has not been fully embraced by decision makers might well be related to the limitations of the
NPV methodology and the practical issues associated with its implementation. Although the NPV methodology is explained in most, or
perhaps even all, corporate finance textbooks (Damodaran 2001; Brealey et al. 2011) and countless “self-help-finance” websites, many
of the inherent limitations of the method are generally omitted and the practical issues faced when implementing the method are not rig-
orously discussed.
As with any theoretical model, there are a number of issues with the assumptions that underpin the NPV method. Four areas of con-
cern that can be recognized are assumptions around market dynamics, mathematical procedures used, assumptions around project dy-
namics, and determination of model parameters. Some issues of the NPV method are well-known by the E&P community and have
been extensively investigated. For instance, potential problematic assumptions that relate to market dynamics include all investors are
well-diversified, firms are price takers,2 and borrowing/lending at the risk-free rate is perfectly elastic. The mathematical assumptions
in the standard NPV method are not strictly valid. Those assumptions include, for example, a normal distribution of the asset’s return,
the stationary nature of market volatility, and constant project leverage. Many investment projects have flexibility around future
choices. The NPV method does not acknowledge and quantify this flexibility associated with a project, and NPV will consequently
underestimate the project value (Schwartz and Trigeorgis 2004).
This paper focuses on the less-well-documented underlying implications of the NPV model, and alternative perspectives to valuation
are discussed. In addition, we explore the ambiguity that exists in the determination of risk-adjusted discount rate by use of
market data.
The need for increased understanding of the NPV method is illustrated by a question posed by McNamee and Celona (2008) in their
influential book on decision analysis: “[Given] there is no intrinsic relationship between time and risk, why try to evaluate risk by a dis-
count rate?” This paper aims to answer this question by explaining the underlying theoretical assumptions of the NPV method. We aim
to provide the reader with a better appreciation of the merits and limitations of the NPV technique.

1
An emerging behaviorist literature, which draws on insights from wider social sciences including psychology and sociology, emphasizes the use of “rules of thumb” across a broad range
of economic and financial decisions (Altman 2015). This stands in contrast to classical economic theories dependent on fully optimizing consumer and producer behavior.
2
It is well-known that many energy markets are typically oligopolistic. In the UK, for example, approximately 90% of domestic gas and electricity is supplied by six firms (Ofgem 2016).
Copyright V
C 2017 Society of Petroleum Engineers

Original SPE manuscript received for review 14 February 2017. Revised manuscript received for review 28 April 2017. Paper (SPE 187937) peer approved 3 May 2017.

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The remainder of this paper consists of three sections. The first section concisely describes the NPV method and provides guidance
on the determination of the risk-adjusted discount rate. Several fundamental issues of the NPV method are discussed in the second sec-
tion. The third section provides concluding remarks.

NPV
The discounting-cash-flow method allows for the calculation of the present value of a future cash flow (CF). The sum of the present val-
ues of all future CFs, both incoming and outgoing, is the NPV. The CAPM is generally used to determine the cost of equity,3 which is
required to determine the discount rate applied in a discounting-cash-flow calculation.
The NPV, at time t, of an expected CF that occurs at time t þ s is given by
EðtÞ½CFðt þ sÞ
NPVðtÞ ¼ ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð1Þ
ð1 þ Ra Þtþs
where EðtÞ½CFðt þ sÞ is the expected CF in period t þ s in period t, and Ra is the risk-adjusted discount rate.
An NPV that represents the total value of CF that occurs across time periods S is given by
X
S
EðtÞ½CFðt þ sÞ
NPVðtÞ ¼ : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð2Þ
s¼0 ð1 þ Ra Þtþs

The NPV of a continuous CF can be calculated by

ðS
NPVðtÞ ¼ EðtÞ½CFðt þ sÞ  eRa tþs ds: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð3Þ
s¼0

The analyses presented in this paper are dependent on continuous discounting. The period t is generally set at zero and is thus omit-
ted from the NPV notation.
The value of the risk-adjusted discount rate has a very-large effect on the calculated NPV (Figs. 1 and 2). The effect of the choice
of discount rate on the NPV is illustrated by analyzing an annual USD 1 perpetual CF. The NPV of a perpetual CF given a discount rate
Ra is given by
CF
NPV ¼ : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð4Þ
Ra
The NPV of a perpetual CF is decreased by 95% if the discount rate is increased from 1 to 20% (Fig. 1).

120

100

80
NPV (USD)

60

40

20

0
0 5 10 15 20

Discount Rate (%)

Fig. 1—The NPV of a perpetual CF of USD 1/yr as a function of the annual discount rate.

The relationship between the present value of a future CF of USD 1 and the time of the CF is illustrated in Fig. 2 for five different
discount rates. It shows, for example, that the present value of a CF of USD 1 that occurs 20 years into the future equals approximately
USD 0.80 if the discount rate equals 1%, but the NPV drops to fewer than USD 0.05 if the discount rate equals 15%.

Weighted Average Cost of Capital. The risk-adjusted discount rate reflects the compensation demanded by investors for the risks4
that are associated with holding an asset (Damodaran 2001; Brealey et al. 2011). The higher the risk of an investment, the higher the
return that is required by investors (Sharpe 1964; Lintner 1965). The risk-adjusted discount rate equals the weighted average cost of
capital (WACC):
E D
WACC ¼ Re þ Rd ð1  TÞ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð5Þ
EþD EþD

3
See the Cost of Equity subsection.
4
In this paper, as is the case with broader corporate-finance practices, risk is used synonymously with uncertainty. In the field of economics and decision analysis, the terms “risk” and
“uncertainty” have distinct meanings.

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where E is the market value of equity, D is the market value of debt, Re is the cost of equity, Rd is the cost of debt, and T is the corporate
tax rate.

1.2
1%

1 5%

Present Value (USD)

7%
0.8
10%
0.6 15%

0.4

0.2

0
0 10 20 30 40
Time (years)

Fig. 2—The present value of USD 1 as a function of time. Present values have been determined for five discount rates.

Thus the appropriate reference point for the cost of capital reflects the particular financing mix, typically stocks and debt,5 used by a
corporation. The WACC represent the opportunity cost of capital. The next section, Cost of Equity, outlines the central model by which
the cost of equity and the cost of debt are assessed.

Cost of Equity. The CAPM allows for a determination of the cost of equity required by an asset that is reflective of its exposure to sys-
tematic risk6 (Sharpe 1964; Lintner 1965). Systematic risks, or market risks, are those sources of uncertainty that cannot be mitigated
by diversification. Examples of systematic risk include oil price, currency-exchange rate, and inflation rates. Investors do not require
compensation for “nonsystematic” or “private” risk. Those uncertainties are unique to projects and/or companies, such as subsurface
uncertainty and slippage of project-time schedules, and can, in theory at least, be eliminated through diversification.
The return of an asset, R, over a period is given by7
 
1 Vðt þ sÞ
R ¼ ln ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð6Þ
s VðtÞ
where s is the duration of a period and V is the asset value.
By calculating the rate of return over many equal-length periods, with historical data, the average rate of return R and the standard
deviation (SD) of the rate of return r can be determined.
CAPM combines these statistics for the asset and its relevant market to calculate cost of equity, Re , for the asset:

Re ¼ Rf þ bðRm  Rf Þ ¼ Rf þ Rp ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð7Þ

where Rf is the risk-free rate, ðRm  Rf Þ is the market-risk premium, Rp is the equity-risk premium, Rm is the expected return of the
market, and b is given by
ra
b¼q ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð8Þ
rm
where ra represents the SD of the return of the asset, rm is the SD of the return of the market, and q is the correlation between asset
return and market return.
The determination of a b of an unlisted company is more complex but can in principle be achieved by analyzing the b of listed
peer companies. Before use of b of peer companies, an adjustment is required to account for differences in the corporate-
financing structures.

Quantifying the Variables That Define a WACC. In this subsection, we describe how the variables Rf ; b; ðRm  Rf Þ, and Rd , which
are required in the calculation of a WACC, are determined. An erroneous choice of any of these variables will have a large effect on the
WACC and the NPV.
b. Fundamentally, b is a multiplier that sets the degree of systematic risk of an asset relative to the market. CAPM presumes that
the investor is “risk averse” and demands compensation in the face of uncertain returns. In particular, the covariance term, q; implies
that investors are willing to accept lower expected returns on stocks that reduce the variance in portfolio returns with valuations that run
counter to the business cycle.8

5
The assumption of two sources of capital is a slight simplification. Stocks often include common and preferred stock, and corporate debt often consists of a collection of bonds and other
sources of long-term debt.
6
This is shown formally in Appendix A. The reader is referred to the Systematic Risk, Nonsystematic Risk, and WACC subsection for additional details.
7
This result is obtained from Vðt þ sÞ ¼ VðtÞeRs .
8
For example, gold and precious metals are often thought of as safe-haven assets during periods of heightened macroeconomic risk. In the CAPM framework, it follows that the representa-
tive investor would be willing to accept lower “through cycle” returns because of this characteristic.

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Calculating the b requires the financial manager to define the market (typically a major stock index), a choice of the historical time
horizon from which data are taken, and a choice of the periodicity of return (daily, weekly, or monthly). These decisions have a material
effect on both the point estimate and confidence interval for the derived b. As such, great care is required when approaching its
determination.
To see this, we explore differences in the implied b for BG Group stock by use of different periods of return (daily, weekly, and
monthly), time horizons, and start dates (Fig. 3). On inspection, the results are highly sensitive to the choice of assumptions. The green
line in the far-right lower panel dependent on market data from 2014 and 2015 and monthly returns data [drawing on the Financial
Times Stock Exchange (FTSE) 100 Index] indicates a b of 1.78. Before the financial crisis, in 2006 and 2007, the b was much closer to
unity compared with subsequent years. Exploiting a 10-year sample, by contrast, indicated by the blue lines, results in a b of approxi-
mately 1.15 across the period.

Daily Returns Weekly Returns

2.5 2.5
10 years
2 5 years 2
2 years
1.5 1.5
β

β
1 1
10 years
0.5 0.5 5 years
2 years
0 0
2006 2008 2010 2012 2014 2006 2008 2010 2012 2014
Years Years

Monthly Returns
2.5
10 years
2 5 years
2 years
1.5
β

0.5

0
2006 2008 2010 2012 2014

Years

Fig. 3—A set of bs for BG Group stock calculated by use of market data of different periods of return (daily, weekly, and monthly)
and different time horizons, with both terms of duration and start/end dates. For example, the green line in the far right in the lower
panel indicates a b-value of 1.78. This b is calculated by use of market data from 2014 and 2015, and the data used represent
monthly returns. The bs are dependent on the BG Group stock and the FTSE 100.

For practitioners in the upstream sector, it may be desirable to adopt longer estimation periods, capturing a full business cycle, to
reflect the nature of the investment terms against which project returns will be benchmarked (perhaps 10–25 years, for example). How-
ever, it is important to recognize that effects of structural changes in the firm might not be captured when shorter estimation periods
are used.
It has long been recognized that the choice of the periodicity of returns has a major bearing on the derived b coefficients (Levhari
and Levy 1977). Shorter return periods (daily or weekly) result in more observations, which is an aide to the identification process in
the regression analysis. However, such measures are more susceptible to bias-arising illiquidities in the market, including nontrading
days or bid/ask bounce.9
Kothari et al. (1995) argued for the use of annual return data because they demonstrated a stronger relationship between bs and an-
nual returns. A possible explanation of the superior performance of annual return data is the observation that a time lag exists between
the arrival of new information and the incorporation of this information in stock prices (Lo and MacKinlay 1990; Mech 1993).
However, it appears that researchers have a preference to use monthly return data (Black et al. 1972; Fama and French 1992). Where
feasible, given data constraints, the robustness of any resulting b derived from a monthly data series should be tested against those
derived from quarterly or even annual regression analysis. Intuitively, perhaps, the desirable return period should be set with regard to
the average period in which company stock is held.
Fig. 4 summarizes the bs of companies with different operating models: E&P, integrated, and infrastructure firms. These different
types of firms have distinctly different bs. The relatively high b of E&P companies is reflective of a disproportionately high exposure to
commodity-price volatility, whereas the lower b of infrastructure companies reflects a lower exposure to market risk.
Risk-Free Rate. In the CAPM model, the risk-free rate, which is the return of an asset with no risk of default and no uncertainty
regarding reinvestment rates, serves as the minimum threshold for expected returns by a stockholder. The most appropriate benchmark
is generally assumed to be the yield on federal US securities (Brealey et al. 2011). To ensure that no reinvestment is required, a govern-
ment bond should be chosen with a maturity that broadly matches the life span of the project to be valued (Damodaran 2001). Fig. 5
shows the time path of the yield on 10-year bonds since 1994, which at the time of this writing are approximately 2.1% in the US.

9
A bid/ask bounce is the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it.

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1.8
1.6 E&P companies
1.4 Integrated companies
1.2 Infrastructure companies
1
β 0.8
0.6
0.4
0.2
0 Hess
Chesapeake
Anadarko
EOG
Apache
Devon
ConocoPhillips
BG
Woodside

Chevron
Eni
Repsol
Total
Exxon
Shell
BP

Cheniere Energy lnc.

Sempra Energy
Energy Transfer Equity
Markwest Energy
Cheniere Energy Partners
Enterprise Products Partners
Enbridge Energy Partners
Energy Transfer Partners
Magellan Midstream
Plains All American
National Grid
Buckeye
Kinder Morgan Energy Partners
Williams
Sunoco
APA Group
Fig. 4—b-values for 32 energy companies.

10
9
UK 10-year-bond yield
8
US 10-year-bond yield
7
Yield (%)

6
5
4
3
2
1
0
1 February 1994

1 February 1996

1 February 1998

1 February 2000

1 February 2002

1 February 2004

1 February 2006

1 February 2008

1 February 2010

1 February 2012

1 February 2014

Fig. 5—The historical yield on UK and US government bonds.

However, as with any proxy, issues inevitably arise. The presumption that the US federal government has zero default risk is unreal-
istic, particularly given the currently elevated debt levels, modest observed growth rates, and the highly polarized political context
within which service-policy decisions regarding budget and debt are made (downward revisions in Social Security payments could be
cited as possible examples of a “quasi” default). In May 2016, for example, market prices for credit-default swaps implied an annual
default risk of 0.3% (Deutsche Bank 2016).
More importantly, US Treasury bill rates can embody large liquidity premiums because of favorable taxation treatment or scarcity
premiums (Fontaine and Garcia 2012). At the time of this writing, we have reason to believe that risk pricing may be subject to large
distortions arising, for example, from an extended period of extraordinary monetary policies after the economic crisis.10 For example,
10-year US Treasury yields dropped approximately 15% after the recent Brexit vote in the UK.
In response to these and other issues, other measures have been proposed. Alquist et al. (2014), for example, suggest the use of the
London interbank offered rate. Although this measure may have certain attractive features, it is important to recognize that the counter-
party default risks underpinning these trades are inherently greater than US Treasuries.
Market-Risk Premium. The market-risk premium is the difference between the expected return on the market Rm and the risk-free
rate Rf . The market-risk premium is arguably the most discussed and controversial parameter in CAPM. This is reflected by the vari-
ability of market-risk premiums that have been proposed: 8.6% (Ibbotson Associates 2016), 7.1% (Brealey et al. 2011), 6.4% (Mehra
and Prescott 1985), 4.5–5% (Copeland et al. 2000), and 4.3% (Dimson et al. 2014).
Unfortunately, the detailed assumptions and calculation methods behind the different estimates are often omitted. The choice of the
time horizon (duration and start date), market index, bond (country and life span), discounting method (discrete or continuous) and type
of average (arithmetic or geometric) have a significant effect on the calculated market-risk premium.
In this study, a market-risk premium is determined that is dependent on the Standard & Poor’s 500 Index (S&P 500) and US 10-year
bond data spanning from 1927 to 2015 for different periods [major share indices such as the FTSE 100 and the S&P 500 are commonly
used by analysts (Hull 2006; Copeland et al. 2000)].11 A 10-year-moving-average geometric annual market return (including dividend)
is calculated by use of continuous discounting.

10
Nevertheless, although such factors are likely to bear down on current rates for sovereign bonds, it is perhaps noteworthy that neoclassical economic theory would suggest the potential
for falling real returns over the longer term (as the most promising investment projects are steadily exhausted).
11
These indices are dependent on the weighted performance of the largest companies. Fama and French (1992, 2015) demonstrated a relationship between stock returns and company
size, where smaller firms tend to yield larger returns. Hence, it can be expected that a view of market performance dependent on market indices that exclude results from small firms will
be biased. An additional issue with the use of stock-market indices is that the stock market does not encompass all investment opportunities that are available to an investor. Examples of
assets that are not traded on the stock market include real estate and art objects.

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The yield of the stock market, Rm ðt þ sÞ, over S periods at time t þ s is given by
X
S n . o
ln ½mðt þ sÞ þ dðt þ sÞ mðtÞ ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð9Þ
s¼1

where mðt þ sÞ is the market index in period t þ s and dðt þ sÞ is the dividend in period t þ s.
The market premium is given by
 
Rm ðt þ sÞ=S  Rf ðtÞ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð10Þ

where Rf ðtÞ is the risk-free rate at time t that is set equal to a government bond that matures over S periods.
The 10-year moving average of the yield on the S&P 500 and the yield on US 10-year bonds and the corresponding risk premium are
shown in Fig. 6. The average market-risk premiums for a number of periods are shown in Table 1. This analysis shows that the market-
risk premium is highly variable and that this variability is driven by volatility of both market return and the yield of government bonds.

20

15
Annual Yield (%)

10

S&P 500
–5 US 10-year bond

Market-risk premium
–10
1935 1945 1955 1965 1975 1985 1995 2005 2015
Years

Fig. 6—Annual yield of the S&P 500 and US 10-year bonds and the market-risk premium.12

Period Length Yield, S&P Yield, US Market-Risk Yield, US 3-month Market-Risk

(years) Start Year End Year 500 10-yr Bond Premium Treasury Bill Premium
87 1928 2015 9.0% 4.9% 4.1% 3.4% 5.6%
70 1945 2015 10.6% 5.3% 5.3% 4.0% 6.6%
50 1965 2015 9.4% 6.6% 2.8% 4.8% 4.6%
25 1990 2015 9.3% 6.1% 3.2% 2.6% 6.7%
25 1965 1990 9.1% 6.8% 2.3% 6.9% 2.2%
25 1940 1965 13.7% 2.0% 11.6% 1.6% 12.0%

Table 1—Annual market premium for different time periods.

Clearly, the market-risk premium is highly dependent on the referenced time period. In response to this problem, several authors
(Copeland et al. 2000; Dimson et al. 2014) have expressed a preference for their use of market data spanning a long period, rather than
a shorter, more recent period. Others, by contrast, argued that market data stretching back over half a century bear little, if any rele-
vance, to future market developments (Jagannathan and Wang 1996; Damodaran 2001).
In general, we would caution against the use of short reference periods. Periods of heightened volatility are typically short-lived. A
view that present market risk may be in some sense “particular” could lead to the use of a market premium that is materially larger than
historical averages. For example, financial planners in 2016 may point to elevated risk premiums caused by heightened instability in the
Middle East, political and economic pressures on the EU and Eurozone, or a slowdown in many major emerging markets. However,
Dimson et al. (2013) conclude that there is no market evidence to support this view.13
Some studies advise the use of government bills rather than government bonds because these most closely approximate risk-free invest-
ment (Mehra 2008). Bonds are riskier than bills because of their exposure to changes in inflation or real interest rates. Given the long time-
line of typical E&P projects, we advise the use of long-term bonds because those incorporate long-term interest-rate expectations.
Cost of Debt. The yield on corporate bonds can be used as a proxy for the cost of corporate debt.14 The interest rate on corporate
bonds equals the risk-free rate plus a default spread. The default spread is a risk premium that reflects the bankruptcy risk of a

12
Source: http://www.stern.nyu.edu/~adamodar/pc/datasets/histretSP.xls.
13
The authors find that present annualized market volatility is lower than the average of the past 3 decades, remarking that “equity markets almost always face a wall of uncertainty.”
14
In the event a company holds no public debt, the cost of bank loans is known internally. From an external perspective, a common approach is to extrapolate this from financial statements
by dividing the figure for interest payments with the declaration of outstanding debt. For guidance on the determination of the cost of debt for companies that have not been credit rated,
we refer the reader to Hull (2006).

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corporation. The bankruptcy risk is expressed by the corporate credit rating (Damodaran 2001). The reader is referred to Hull (2006)
for a detailed explanation of the relationship between credit rating, historical default intensity, and the consequential default spread.
Table 2 lists the default spread for different credit ratings.

Rating Default Spread Rating Default Spread

Aaa/AAA 0.75% B1/B+ 5.50%
Aa2/AA 1.00% B2/B 6.50%
A1/A+ 1.10% B3/B- 7.50%
A2/A 1.25% Caa/CCC 9.00%
A3/A– 1.75% Ca2/CC 12.00%
Baa2/BBB 2.25% C2/C 16.00%
Ba1/BB+ 3.25% D2/D 20.00%
Ba2/BB 4.25% – –

Table 2—Default spreads for different credit ratings for nonfinancial US companies with a
market cap in excess of USD 5 billion. Data are compiled by Damodaran (2016), from
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/, which was consulted in February 2016.

The cost of debt can be calculated as

ðRf þ default spreadÞ  ð1  TÞ: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð11Þ

Although interest rates are known to be variable over time, it appears that the default spread for a given credit rating is relatively stable
in time. For example, Damodaran (2001) reported default spreads of 1.7% and 1.75% for an A– rating in 2001 and 2016, respectively.

Discussion
As noted previously, applying the NPV raises a number of practical issues. Nevertheless, the simplicity and transparency of the model
undoubtedly remains an attractive feature, a factor that has contributed to its widespread, almost ubiquitous, use in corporate finance.
The implications of the failure of these assumptions are readily studied in a standard corporate-finance textbook (Brealey et al.
2011). This section, by contrast, focuses on deeper-rooted conceptual issues that may be particularly relevant to a financial planner, par-
ticularly those operating in the upstream oil-and-gas sector.

CAPM and the Market-Risk-Premium Debate. CAPM is dependent on economic returns, but investors are ultimately interested in
consumption, not economic returns. More specifically, investors aim to maximize the utility of their consumption. The utility of incre-
mental consumption depends on the economics environment at the time the consumption occurs. In times of economic recession, incre-
mental consumptions is valued higher than in times of strong economic growth. Investors have a strong desire to smooth consumption
over time.
CAPM postulates a linear relationship between systematic risk quantified by an asset’s b and the expected return of the asset. Vari-
ability in the return of the stock market is reflective of good and bad times in the economy. In CAPM, the observed rate of return on the
stock market is a proxy for consumption, and the market-risk premium as observed in the market is used as a measure for consumption
preference of investors. Although high-b stocks yield a high expected rate of return, the return of these stocks should be expected high-
est when the stock market is experiencing high growth rates and consumption is already high. Consequently, these stocks trade at a dis-
count. A stock that yields a relatively high expected return during market downturns enables an investor to smooth their consumption,
and is therefore highly desirable and will demand a price premium. Insurance policies are a classical example of assets that smooth con-
sumption. Households purchase various kinds of insurance despite their low rates of return.
In an alternative approach to CAPM, utility functions are developed that directly capture the utility of consumption. These consump-
tion-based utility models suggest that the market premium observed in the stock market cannot be explained by reasonable levels of
risk aversion of investors (Mehra and Prescott 1985). The average equity premium in the US, the difference between return on the
US stock market and the return of US bills, over the past 116 years has been approximately 6%. Consumption-based utility models
suggest that stocks on average should command, at most, a 1% premium over bills. This discrepancy is referred to as the “equity pre-
mium puzzle.”
Once the “equity premium puzzle” was posed by Mehra and Prescott (1985) a plethora of research efforts have been made to explain
the observed discrepancy. A large number of studies focused on issues around the aggregation of risk; for example, it has been sug-
gested that the observed rate of return on the stock market is inflated because of a survival bias. High-performing stocks are dispropor-
tionately represented in the stock market because lower-performing stocks exit the market, and hence the average rate of return of
stocks is expected to be lower than what is observed in the market. For example, in 2007 at the S&P 500’s 50th anniversary, S&P
revealed that only 86 original constituents of the 500-member index had stood the test of time. Other authors investigated issues regard-
ing borrowing constraints, the appropriateness of using governmental securities for the risk-free rate, and the abstraction of taxes. The
reader is referred to Mehra (2008) for further details.
Despite the fact that much progress has been made over the past 3 decades, the “equity premium puzzle” has not been satisfactorily
resolved, and there is a real possibility that the risk-premium rate that is currently used in the NPV method by practitioners is inflated.
The use of a biased discount rate would have a particularly strong effect on the valuation in the E&P industry given the extended
project timelines.
This paper discussed three separate lines of argument to support this view, specifically empirical issues with the model (the subsec-
tion CAPM and the Market-Risk-Premium Debate); the extent of CF risk implied by the assumptions around time and risk (future sub-
section Term-Structured Discount Rates); and normative arguments regarding the intergenerational transfer of benefits and detriments
(the next subsection, Measuring Long-Run Costs and Benefits).

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Measuring Long-Run Costs and Benefits. The problem of discounting utility has taken central stage in the recent public discussion
on greenhouse-gas emissions and the cost of climate change to future generations. In the Stern report (Stern 2006), on the economics of
climate change, it was questioned whether “a grandparent would tell a grandchild that simply because the latter’s consumption flow
came later (e.g., 50 years) in time than his or her own consumption flow it would be correct to assign a value of less than half to it in
thinking about the consequences of actions today” and “Many people would find this ethical position very unattractive.” This view is
consistent with the argument posed by Ramsey (1928), who stated that placing different weights upon the utility of different generations
is “ethically indefensible.”
Choices that dictate whether consumption takes place at present or many decades into the future are common during the develop-
ment of E&P assets. Many E&P projects have very-long timelines, such as the world’s largest conventional oil field, Ghawar Field in
Saudi Arabia, which started production in 1951 and is expected to continue production for many more decades. The decision made in
1959 by the Dutch government to start the development of Europe’s largest conventional gas field, Groningen, ultimately resulted in a
sequence of earthquakes damaging a large number of residential properties 60 years later. Although the ultimate cost of the damage is
unclear at present, it is a given that the generation of Dutch citizens who approved the development of Groningen Field, and who bene-
fited most from the gas revenues, will not pay for the incurred damages.
The relevance of the weighting of short-term vs. long-term benefits is also important to the decision-making process of independent oil
companies, which affects decommission costs to be incurred far into the future. For example, the choices made by the executives of Shell
and Exxon on the infrastructure design of Brent Field in the North Sea in the early 1970s affect the decommissioning of the Brent infra-
structure that is currently ongoing, approximately 50 years later. The generation of individuals that invested in their pension by purchasing
stock in Shell and Exxon in the 1970s is currently retired and is monetizing their investment. The return on their investment, made more
than 4 decades ago, will be affected by the weighting of short-term and long-term benefits during the design phase of Brent Field.
To ensure that costs that will be incurred far into the future are not simply discounted away, Stern (2006) suggested an annual dis-
count rate of 1.5%. After the publication of the Stern (2006) report, this low discount rate has been widely criticized (Nordhaus 2007).
The implication of such a low discount rate is that our collective wealth in such long-term project yields a very-low rate of return.
Investments to curb greenhouse-gas emissions compete for funding with other social initiatives that potentially yield higher returns,
such as pension reforms, the appropriate level of public debt, investment in public infrastructure, investment in education, and the level
of funding for research and development (Gollier 2013). As such, there remain powerful arguments to ensure that the opportunity costs
of capital reflected in the discount rate are properly balanced as part of resource-allocation decisions.
Although the low discount as proposed by Stern (2006) received widespread criticism, there is a general support for the view that
currently used discount rates are generally too high for investments with long payback periods. The recent past with high economic-
growth rates are perceived by many as abnormally high, and it is expected by many that growth will revert to a lower, sustainable, rate
(Gollier 2013). Such a perspective would imply that a CAPM-derived risk premium in many real-life E&P projects that span several
decades could be too high.

Term-Structured Discount Rates. One proposed method to increase the weighting of distinct CF is to use term-structured discount
rates. The UK government15, for example, recommends the use of declining discount rates over time. Benefits that occur with the next
30 years are discounted at 3.5%, whereas benefits that are expected to occur 100 years from the present are discounted at 2.5%.16
A term-structured discount rate is not necessarily in conflict with the CAPM framework. CAPM assumes that the equity-risk pre-
mium Rp is proportional to the covariance of returns of an investment and the market:

covðra ; rm Þ ra
Rp ¼ bðRm  Rf Þ ¼ ðRm  Rf Þ ¼ q ðRm  Rf Þ: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð12Þ
r2m rm

Hence, the equity-risk premium is proportional to q; ra ; and rm for small changes of these parameters.
The uncertainty of a stock price increases as stock prices are projected further into the future; that is, the spread of stock returns is
expected to increase with time. CAPM assumes that the progressive increasing range of stock returns can be described by a stochastic
process called a geometric Brownian motion. An important property of this process is that the variance of the distribution of returns
increases linearly over time. Hence, within the CAPM framework, there is an explicit relationship between risk and time. The risk pre-
mium applied to a CF, by means of discounting, increases as CF is expected to occur further into future. Note that the CAPM frame-
work only relates to systematic risk. For example, uncertainties in project CFs might decrease with time as production uncertainty is
resolved over time. This uncertainty is, however, a nonsystematic risk and should be addressed outside the CAPM framework (see the
Systematic Risk, Nonsystematic Risk, and WACC subsection for further details).
The assumption that the variance of E&P project returns̀ is proportional to time into the future is not generally valid. E&P projects
are subjected to tax regimes that tend to ensure that excessive project profits are returned to the tax collectors.17 In addition, many com-
mercial arrangements limit the spread of future project returns. For example, in typical liquefied-natural-gas sales contracts, the effect
of future commodity-price swings are dampened through application of the so-called S-curves, and regulation around the business of
shipment and processing of hydrocarbons tend to cap the economic returns that can be realized by the infrastructure owners.
Given these considerations, project returns might be more realistically modeled by use of a mean-reverting stochastic process,
opposed to a geometric Brownian-motion process. Mean-reverting processes ensure that the variance of project returns over time
approaches a stable level; i.e., the variance is bounded. The development of the variance over time assuming an Ornstein-Uhlenbeck
mean-reverting process is given by

r2
var½RðtÞ ¼ ð1  eht Þ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð13Þ
h

where h is the factor that determines the strength of mean reversion.

15
A discussion of public-project discount rate vs. private-project discount is beyond the scope of this study.
16
HM Treasury (2013).
17
For example, in many production-sharing contracts, the split of the project’s economic return between the government and the independent oil company is linked to the project’s profitabil-
ity and is defined by the R-factor.

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If h approaches zero, the Ornstein-Uhlenbeck process converts to a geometric Brownian-motion process (Thierfelder 2015):
r2
var½RðtÞ ¼ lim ð1  eht Þ ¼ r2 t: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð14Þ
h!0 h

By use of the assumptions listed in Table 3, the development of the variance over time for three degrees of mean reversion has been
determined (left panel of Fig. 7). The right panel of Fig. 7 shows the development of the risk-adjusted discount rate over time.
Although we recognize that the development of the distribution of real-life project returns, over time, is much more complex, as sug-
gested by Fig. 7, the principle that the distribution of project returns widens much less as assumed by CAPM does hold for many E&P
projects. From this, it is to be expected that for a significant proportion of E&P projects, CAPM will overestimate the risk premium of
distinct project CFs.

Constants Value
Risk premium 5.3%
Risk-free rate 5.3%
SD market returns, FTSE 100 0.050
SD asset returns, BG Group 0.090
Correlation market and asset 0.630

Table 3—Assumptions on market and asset performance.

Risk-Adjusted Discount Rate (%)

0.25 14
No mean reversion (h = 0) No mean reversion (h = 0)
13
Low mean reversion (h = 0.1) Low mean reversion (h = 0.1)
0.2
High mean reversion (h = 0.5) 12 High mean reversion (h = 0.5)
Variance

0.15 11
10
0.1 9
8
0.05
7
0 6
0 5 10 15 20 25 30 0 5 10 15 20 25 30

Time (years) Time (years)

Fig. 7—The development of the variance and risk-adjusted discount rate over time for three different assumptions regarding mean
reversion.

Interaction Between Projects. Standard NPV analysis provides a standalone assessment of project value. Investment strategies are
generally developed in isolation. However, strategic interactions between different stakeholders active in the E&P industry are common
(Willigers et al. 2009). Players include competing E&P companies, governments, and nongovernmental organizations. A game-theo-
retic framework is required to understand the effect of the competitive pressure surrounding a project to establish an accurate view of
the value proposition of an investment (Grenadier 2002). Despite its relevance, few game-theoretic studies focus on the E&P industry
(Willigers et al. 2009), and in our experience game theory is rarely applied to gain insight in the value of real-life E&P investments.
Several studies in the financial literature attempted to model CFs, options, and strategic interaction between players. Childs et al.
(2004) discussed optionality and the interaction of multiple projects, and Smit and Trigeorgis (2004) discussed optionality in the context
of the strategic interaction of players and optionality. Despite these studies and some others (Jaoquin and Butler 2000; Ziegler 2004;
Pawlina and Kort 2006), it appears that no single approach succeeded in gaining broad (academic) support.

Systematic Risk, Nonsystematic Risk, and WACC. The cost of equity and the cost of debt that are combined into the WACC have a
different relationship to systematic and nonsystematic risk.
The cost of equity in CAPM is dependent on the premise that investors can eliminate nonsystematic risk by diversification.18 Smith
and McCardle (1998) recommend market-based valuation techniques for market risks and subjective probabilities for private risks. This
principle is illustrated in Fig. 8. The CF of many projects is affected by both market and private risk. Market risk is accounted for by a
risk-adjusted discount rate, and the private risk (e.g., operating efficiency) is accounted for by a number of probability-weighted scenar-
ios (Fig. 8). A certain CF bears no market risk and is therefore discounted at a risk-free rate.
The distinction between a systematic and a nonsystematic risk is not always unambiguous. For example, drilling costs have elements
of both risk types. The number of drilling days required to complete an operation is a nonsystematic risk, whereas future rates to hire
drilling equipment or future drilling-crew salaries are examples of systematic risks. In reality, there is a spectrum, from risks that are
limited to a single firm (nonsystematic risk) to risk that affects all projects (systematic risk) (Damodaran 2001).
The cost of equity does not reflect the possibility of company bankruptcy. The mathematical formulation of CAPM implies strictly
positive stock values and, consequently, the chance of default is zero. In contrast, the cost of debt is a reflection of the chance that a

18
This principle can be illustrated with a dice-throwing experiment. The outcome of a single cast of a die is highly uncertain; there are six possible outcomes that range in value from 1
through 6. However, if we were to cast 1,000 dice, the average of those dice is almost certainly very close to 3.5. Compared with the outcome of the first experiment, there is little uncer-
tainty of the outcome of the second experiment.

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company defaults. Companies default because of deteriorating performance that can be caused by systematic risks, nonsystematic risks,
or both. The effectiveness of portfolio diversification on the exposure on default risk is difficult to assess. In a world where company
defaults are independent events, the cost of debt is a strictly nondiversifiable risk premium. In the real world, company defaults are not
independent (Koopman and Lucas 2005), and dependency was illustrated in early 2016 when the S&P500 simultaneously downgraded
the 10 largest US energy companies in a response to the deteriorating oil prices.

Scenario 2: High operating efficiency

and expected market conditions
Value

Scenario 2: Low operating efficiency and

expected market conditions

Fixed tariff receipt

1 2 Time

PV = valueTariff/ (1 + Rf)2

PV = (p × valuehigh OE + (1 – p) × valuelow OE)/ (1 + Re)1

Fig. 8—Treatment of private and market risk.

NPV and Ranking. The NPV method aims to determine the market value of an investment opportunity. The ability, at least theoreti-
cally, to determine a market value yields an important advantage over ranking methods such as the multiattribute utility theory (von
Neumann and Morgenstern 1953). Although companies can rank their project portfolio by use of the multiattribute utility theory, such
ranking does not inform whether any of the projects are expected to create shareholder value; that is, rather than invest in the best inter-
nal project, it might be better to return funds to the shareholders.

NPV Is Not a Deterministic Model. Although NPV models are sometimes regarded as deterministic, the NPV method is intrinsically
probabilistic. The method discounts an expected CF, which implies a range of possible states of the CF, and the applied discount rate is
reflective of the distribution of a CF at a given point in the future. This realization has deeper implications.
The NPV framework was originally developed to value stock prices. In this context, the probability of all future prices of a stock, at
all future time points, is defined by the present value of the stock and the assumed discount rate.19 In the context of project valuation,
the NPV method makes specific assumptions on the future systematic risk, such as future hydrocarbon prices, the dominant source of
systematic risk in many E&P projects. Hence, there is a conflict between the NPV method and the common practice to determine the
project’s economic returns at a given hydrocarbon price. Most E&P companies use “price decks,” a time series of future hydrocarbon
prices. Typically, companies use several price decks that are reflective of different future economic environments. In the NPV frame-
work, the likelihood of the realization of each price deck is explicitly defined. The treatment of price decks as nonprobability-weighted
sensitivities or the use of secondary probability weighting (i.e., a weighting that is not dependent on the NPV assumptions) is theoreti-
cally inconsistent with the NPV framework. The same issue arises when evaluating other source of systematic risk (such as inflation or
exchange rates). The importance of this theoretical error is difficult to assess, and more research is needed to develop practical method
to mitigate potential inconsistencies.

Country Risk and International-Project Portfolios. In the authors’ experience, the common practice in the E&P industry is to
assume that country risk is diversifiable and that therefore no additional risk premiums are required.
For countries with a sovereign rating of AAA, the US equity-risk premium can be used. For countries with a poorer sovereign rating,
Damodaran (2016) suggested calculating country-specific Rp by use of

RCountry
p ¼ RUS
p þ default spread  relative equity market volatility: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð15Þ

The default spread for a country can be determined by use of spread on sovereign bonds in USD; credit-default-swap spread; and a
rating table.
The relative equity-market volatility is defined as:
SD of emerging market-equity index
Relative equity-market volatility ¼ : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ð16Þ
SD of emerging market-bond index

19
CAPM assumes that asset prices are subject to a geometric Brownian motion, which is a type of stochastic process with a set of specific statistical properties. This probabilistic process
defines the probability density of future states at all time points.

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Damodaran (2016) suggests that the appropriate equity-risk premium of the project is a weighted average that reflects the equity-
risk premium in the different countries and the proportion of revenue that is expected in those countries. Table 4 shows an example of
the calculation.

RpCountry Weight × RpCountry

Expected Revenues Revenue Weight
North America 2,000 17% 5.8% 1.0%
Brazil 3,000 26% 8.7% 2.3%
Europe 5,000 43% 7.0% 3.0%
Rest of the world 1,500 14% 8.9% 1.2%
– – – 7.5%
RpWeighted global

Table 4—The calculation of the weighted global equity-risk premium.

The limitation of the approach is that many internal E&P projects have their expenditures and revenues in different countries. A
practical approach is to recognize country-specific CFs and apply the appropriate equity-risk premiums to these CF elements. However,
some issues remain, because in this approach it is unclear what discount should be used for tax payments because this CF is affected by
all the CF elements.
Some sources of country risk, such as the risk of the nationalization of E&P assets, could be viewed as nonsystematic risk in the con-
text of an internationally operating E&P company. Other risks, such as the prospect of an armed conflict, could be arguably considered
as either a systematic or a nonsystematic risk, depending on one’s perspective.

Conclusions
The E&P industry is currently faced with an NPV paradox. Although the NPV method is criticized by both practitioners and academics,
the traditional NPV calculation is by far the most commonly used tool for E&P-project valuation. We speculate that one cause for
the NPV paradox might relate to a lack of understanding among practitioners of the theory and assumptions that underpin the
NPV calculations.
This study explains and summarizes the assumptions behind the NPV method with a particular focus on the risk-adjusted discount
rate. It emphasizes that the risk-adjusted discount rate is highly dependent on the data that are chosen for the analysis (given that the
economic performance of markets and companies is highly variable), and provides rigorous guidance on which data, and how to use the
data, in a succinct and accessible way.
Although not entirely satisfactory, we argue for a moderate downward revision of discount rates for projects with timelines exceed-
ing 20 years. This recommendation is dependent on recent advancements in public finance and the reality that the exposure to system-
atic risk in the long run is significantly less in many real life E&P projects than is implied by CAPM. The inflated discount rate that is
presently used, combined with the extended investment horizons that are common in the upstream sector, will for example result in an
underweighting of decommissioning and future legacy costs.
CAPM does not consider the effect of defaulting companies because bankruptcy risk is not reflected in the cost of equity. The cost
of debt, on the contrary, is reflective of the probability of corporate bankruptcy. However, a theoretical framework that allows for a
translation of systematic risk and nonsystematic risk into a bankruptcy-risk premium that is useful for practitioners has yet to be devel-
oped. In the conventional application of NPV, the cost of equity is reflective of the exposure of systematic risks and the cost of debt is
reflective of the exposure to nonsystematic risk.
The NPV model is sometime referred to as a deterministic model. A calculation of a single NPV value implicitly assumes a specific
probabilistic development of the CF. The practice of developing a probabilistic range of NPV values or the development of a set of
NPV values of a number of market scenarios is principally incorrect. In an NPV calculation, an implicit assumption is made on the like-
lihood of certain realizations of systematic risks. Unfortunately, we currently lack the practical tools to address these issues.

Nomenclature
CF(t þ s) ¼ cash flow in period t
d(t þ s) ¼ dividend in period t + s
D ¼ market value of debt
E ¼ market value of equity
h ¼ factor that determines the strength of mean reversion
m(t þ s) ¼ market index in period t + s
NPV ¼ net present value
PV ¼ present value
R ¼ return of an asset
Ra ¼ risk-adjusted discount rate
Rd ¼ cost of debt
Re ¼ cost of equity
Rf ¼ risk-free rate
Rm ¼ expected return of the market
Rp ¼ equity risk premium
s ¼ a period
S ¼ total number of period
t ¼ time
T ¼ corporate tax rate
V ¼ asset value
WACC ¼ weighted average cost of capital

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E() ¼ expectation operator

ra
b¼q
rm
q ¼ correlation between asset return and market return
ra ¼ standard deviation of the return of the asset
rm ¼ standard deviation of the return of the market

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Appendix A—CAPM and Private Risk

One can demonstrate that within the CAPM framework, investors do not demand a risk premium for nonsystematic risk (Brealey et al.
2011). A stock for which the return bears no relationship with the market performance yields a correlation, q, that equals to zero. This
implies that
ra ra
b¼q ¼0 ¼ 0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ðA-1Þ
rm rm
and

Ra ¼ Rf þ bðRm  Rf Þ ¼ Rf þ 0  ðRm  Rf Þ ¼ Rf : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ðA-2Þ

This proves that, within the CAPM framework, investors do not demand a risk premium for private risk.

Bart J. A. Willigers is a decision analyst responsible for the improvement of corporate decision-making abilities and valuation
methodologies at AstraZeneca. He has 2 decades of experience in various technical and leadership roles in the E&P industry, as
well as the pharmaceutical industry. Willigers has published numerous papers on decision analysis, real-option valuation, portfo-
lio optimization, and geology. He is an associate editor for SPE Economics & Management. Willigers holds a PhD degree in geol-
ogy from Copenhagen University, Denmark; an MBA in general management from Nyenrode University, The Netherlands; and a
master’s degree in geology from Utrecht University, The Netherlands.
Benjamin Jones is a senior research fellow at the Bartlett School of Construction and Project Management, University College
London, and a principal consultant at CRU International Limited. Previously, he worked as an economist at BG Group, the Inter-
national Monetary Fund, and the UK Treasury. Jones’ research interests include commodity markets, energy and infrastructure
investment, sustainable growth, and fiscal policy. He holds a PhD degree in economics from the University of Birmingham, UK.
Reidar B. Bratvold is a professor of investment and decision analysis at the University of Stavanger and at the Norwegian Univer-
sity of Science and Technology. His research interests include decision analysis, valuation of risky projects, portfolio analysis, real-
option valuation, and behavioral challenges in decision making. Before entering academia, Bratvold spent 15 years in the indus-
try in various technical and management roles. He is a coauthor of the SPE primer Making Good Decisions. Bratvold is the execu-
tive editor for SPE Economics & Management and has thrice served as an SPE Distinguished Lecturer. He is a fellow and board
member in the Society of Decision Professionals and was made a member of the Norwegian Academy of Technological Scien-
ces for his work in petroleum investment and decision analysis. Bratvold holds a PhD degree in petroleum engineering and a
master’s degree in mathematics, both from Stanford University, and has business and management science education from
INSEAD and Stanford University.

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