An application of the real option framework to large infrastructure projects : evidence for Thailand's transportation system

Abstract

Governments from many countries, specifically developing countries, have sought private participation in large-scale infrastructure projects because of their limited resources and budgets. Then, many public infrastructure projects have been privatized worldwide, where benefits and risks are substantially distributed between the public and private sectors. However, the complexity of the project arrangement has constituted a dilemma for governments to balance the benefits and risks between the public and private sectors, i.e., financial institutions and private companies. Large infrastructure projects typically involve various risk factors so that the successful implementation of those projects depends on the effective management of those key risk factors. There is a requirement for a tool to help the government evaluate the delivery of value on the infrastructure projects while still sustaining the interests of private investment. This research studies the use of the real option methodology as a tool for the valuation of large-scale infrastructure projects. A comprehensive literature review of the real option methodology is undertaken and an application of the methodology to a large-scale public infrastructure project in Thailand is considered. More specifically, this research studies real options and the option interactions for a hypothetical toll road concession involving the Second Stage Expressway System (SES) in Thailand. Real options for the public and private parties are identified and evaluated. The interactions of the options are investigated in the form of multiple real options. The aim of the research is to demonstrate how real options can mitigate risks to the main stakeholders of the project. The study provides a practical insight into project risks within transportation system projects in Thailand. This research studies options and the option interactions as applied in the SES project. Overall, the application of the real option approach in large infrastructure projects is promising. The evaluation shows that the value of options and their interactions can be significant. The findings of this research would facilitate the risk analysis and mitigation process that can be conducted by governments, financial institutions, or project developers prior to the development of the infrastructure project. The real option applied to value an infrastructure project is complicated but the mechanism can help for policy design and implementation. The findings from the real option modelindicate that governments, financial institutions and private companies play a crucial role in the risk allocation in large infrastructure projects. It is found that projects developed solely by government are insufficient and require a high government budget. The government can design an appropriate level of guarantee and type of guarantee which attracts private interest in the project as well as an affordable government budget. The research finds that many option combinations such as i) the combination of the equity guarantee option (government) and the deferral option (financial institution); ii) the combination of the deferral option (financial institution) and the grant option (private company) iii) the combination of the deferral option (financial institution) and the deferral option (private company) and iv) the combination of the deferral option (financial institution), the abandonment option (financial institution) and the deferral option (private company) are recommended for policy design and implementation. With such option combinations, governments can properly evaluate the economic viability of such arrangements prior to offering optimal option proposals to the project company. With real option application, this research study can critically compare the effects of different policy designs in order to design a suitable public financing scheme.