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Thirty years ago, the Federal Energy Regulatory Commission changed the natural gas market forever, deregulating the interstate transportation by unbundling transportation, storage, and marketing. Then in 2015 came another major shift, with the decision to lift a ban on exports, and the U.S. became the marginal exporter of crude and NGL to the rest of the world. 

Through both of these massive transitions, Real Options have played a vital role. 

Real Options are business decisions that a company makes with a given asset. It’s choosing a different logistical path that results in a potentially asymmetric payout to the business. Real Options are sometimes referred to as Physical Options (as opposed to Financial Options) because they involve physical assets, not just financial ones. 

Some trading businesses are built entirely on owning Real Options. Over the years, many Merchant Energy trading groups have profited from identifying and owning low-cost physical options. The most successful firms developed a robust valuation methodology combined with structuring, origination, and trading teams. These collective teams are integrated with the purpose of implementing a strategy that maximizes the time value inherent in these physical options, which are based on a liquid forward curve. The ability to combine financial hedging with Real Option valuation in order to cycle in and out of the option — or lock in profits on a forward basis — creates a powerful potential for maximizing risk-adjusted returns.

History in the energy trading markets has given us multiple examples of how market evolution creates dislocations or gives market participants the ability to own the constrained points in a value chain that didn’t exist before. The ultimate creation of Real Options has been seen in Market deregulation. 

FERC Order 636 in the early 1990s opened up the Natural Gas market by deregulating the interstate transportation market by unbundling transportation, storage, and marketing. Merchant Energy Trading Floors were built out all through the 90s from previously regulated Utilities, and they were able to produce outsized returns by owning Real Options throughout the Natural Gas value chain from wellhead to burner tip. Into the late 90s they expanded this model into Electricity trading in the form of power plant tolling arrangements and transmission options.

Fast forward to the present and we see Real Options created in the form of energy export opportunities born from the US lifting export restriction in 2015. Through this export value chain Real Options can be structured through tolling arrangements in the export space and locational delivery flexibility. Both Crude and NGL exports are continuing to evolve as the US becomes the marginal exporter of these products to the rest of the world. 

Creating this “Merchant Mindset” of Real Option valuation, ownership, and exercising them inside a traditional energy business gives management teams the tools to take advantage of market dislocations in the future. Any time an asset owner has the right, but not the obligation, to change the direction of their business they have an opportunity to monetize a Real Option if they integrate the teams proactively. 

In light of the collapse in Oil prices back in March due to the economic shutdown, we at Mobius asked ourselves, can Real Option analysis be applied to Producing Assets? How can business decisions such as Shutting In production be optimized using Real Option modeling to expedite business decisions during future price collapses? Can we extend this to the world of PUDs? How can Producers optimize the value of the assets in a cost efficient manner?

The Mobius team is designed to efficiently deliver the information, strategy, and execution of Real Options to create value on behalf of our clients, as though we are your internal trading team. We continuously apply our analytic, deal structuring, origination, and trading expertise developed over the past decades into present day problem solving. Identifying, modeling, and executing Real Options then becomes a mindset for operations, not just a theory on paper.

Author Profile
Chuck Carlton
Chuck Carlton
Director, Commodity Risk

Chuck has over 20 years of experience in energy trading and analytics positions covering Natural Gas, NGLs, LNG, and Crude Oil. Chuck’s experience has included 7 years at Williams in both risk control and natural gas derivatives trading, 7 years at Citibank as a trading manager on the natural gas desk within their energy trading business, 5 years as a portfolio manager and strategist in both Natural Gas and NGL hedge funds, and 2 years as a financial analyst at Golar LNG. Chuck holds both an MBA and a BSBA in finance from the University of Tulsa.

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