Real option evaluation of complex infrastructure projects: The case of dabhol power

Development of large-scale infrastructure projects that solicits the support of private capital is no longer a new phenomenon. This is commonly implemented using governance arrangements such as Build-Operate-Transfer and other technical variations of public-private partnerships. Frequently, concessions and guarantees are included in the contract in order to protect the interests of some project stakeholders. Flexibilities may also be built into the terms and conditions, thus allowing participants to react to changes that could occur during the implementation stage. All these features essentially reallocate risks and rewards within the contract, the effects of which may not be quantified by conventional evaluation methods such as the Net Present Value method. Real option (RO) modelling has been identified as a superior approach, although the method is more complicated and cases of application to complex infrastructure projects remain to be limited. In this paper, discrete-time RO models are used to evaluate several options found in the Dabhol Power Project in India. Limitations and challenges in modelling these options are also discussed. Overall, the RO approach demonstrates a great promise in capturing and evaluating flexibilities. The case study however shows that some implementation issues need to be overcome before RO can be commonly and practically applied to the infrastructural context.