Decision Support for Port Investments

Abstract

Expansions for future demand? How much capacity will be required? Until when the decision can be postponed? When to expand? What should be the magnitude of expansion? What is the position of such an investment? These are the kind of questions which a port authority is subjected to while making a decision to expand or develop a port. The decision to invest in the expansion of the port is based on the anticipation of the market in future. The port authorities try to bridge the gap between “What the port is doing?” and “What the port should be doing?”. The choice of timing and expansion is of extreme importance as it allows the port authority to ensure that the project is financially viable and at the same time they achieve its objectives. During the feasibility stages, while making these decisions, a static discounted cash flow (DCF) model is used to calculate the financial outcomes of the expansion plans. However, such a model gives an impression that the decision-maker is obliged to the expansion decisions and cannot delay or alter their scale of investments. However, the reality is otherwise, the decision-maker is an active manager, who adapts the development/expansion plans to the changes based on the project progress.

The current study presents an alternative to the Predict and Control approach of the static DCF model. This is done using Real Options Analysis(ROA). Within the scope of the research, a conceptual framework for ROA for port decision making was derived. The conceptual framework is translated into a mathematical numerical model for a test case in Southeast Africa. The numerical model values the option of multi-stage capacity expansion for the port. Focus is maintained on incorporating flexibility “on” infrastructure based on timing and magnitude under the uncertainty of demand. Through the use of stochastic processes, Monte Carlo simulations, solution algorithm and sensitivity analysis a total of 96 strategies have been evaluated.

Through the analysis of results, it was understood that flexibility has a monetary value when the expansions are done using multi-stage sequential methodologies. Sequential expansions allow the port authority to gain more information based on which the supply can be adapted. In the short term, rather than installing extra capacity, optimising the current operations has a greater benefit for the port authority. While for the long term, the port authority should hold their flexible options until the boundary value wherein the probability of pay-offs exceeding the initial capital expenditures drastically reduce. The option value was seen to be influenced the time until expiration, lead times, number of stages of expansion, modal split factor and dwelling times. ROA was seen to be more of a decision support tool to understand the position of the investment rather than a financial valuation model.