10 Chapter I Introduction I.1 Background As the world moves toward cleaner energy, energy demand will increase 15% by 2050 which count 54% by oil and gas, 15% by renewable energy (RE), 14% by coal, 11% by bio energy and 7% by nuclear (ExxonMobil 2023). Oil and gas will continue to account for over 50% of global energy supply (Heidari et al. 2022; Tong et al. 2018). As the main contributor to the global emission, the energy sector holds the key to be responsible for climate change (Grasso 2019; Nejat et al. 2015). In 2023, natural gas contributes to 23% (global) and 14% (domestic) primary energy consumption (Energy Institute 2023), which largely to meet increasing demand for gas fired power plant and lower emission industrial fuel. Natural gas is utmost importance in meeting the energy demands of consumers across the globe while also contributing to reduce the risk of climate change with lower carbon footprint (Ghoniem 2011; Omer 2008). Natural gas burning for heat production emits approximately 40% less CO2 than coal burning and 20% lower than oil (International Energy Agency 2017). Coal emits a considerably greater quantity of CO2 during electricity generation in comparison to natural gas due to higher carbon content of coal fired power plants (CFPP) and higher efficiency in natural gas power plant (Myhrvold and Caldeira 2012; Beér 2007; Jaramillo, Griffin, and Matthews 2007). In 26 th UN Climate Change Conference (COP26) 2021, Indonesia Electricity Company (PLN) has declared its roadmap to achieve net zero emission. PLN is transforming to become a clean power company and will focus to power capacity expansion with RE technology (Perusahaan Listrik Negara 2021). If disruptive scenario executed which power model re-run for 1499 TWH demand, PLN capacity share by technology by 2030 (will be 32% for RE, 20% for gas, 46% for coal), 2050 (will be 60% for RE, 31% for gas, 3% for coal) and 2060 (will be 69% for RE, 15% for gas, 0% for coal). As the result, CO2 emission is estimated to be 0.75 tCO2/MWh by 2030, 224 tCO2/MWh by 2050 and zero by 2060 (Perusahaan Listrik Negara 2021). During Group of 20 (G20) 2022, the Just Energy Transition Partnership (JETP) was launched to provide financing related to acceleration in the early retirement of CFPP and establishing RE based power plants. Outside coal capacity included in the Electricity Supply Business Plan (RUPTL 2021) new CFPP is restricted under Presidential Regulation No. 112/2022. In order to fulfil growing electricity demand, PLN need $ 654 billion (accelerated scenario, allows Carbon Capture and Storage (CCS) but no nuclear technology) and $ 724 billion (disruptive scenario, allows for both CCS and nuclear technology) funding to support RE projects (Perusahaan Listrik Negara 2022). CFPP restriction will increase gas demand slightly during 2024 – 2025 (1.8 GW Jawa- 1 project will be online), moderately in 2026 (last batch CFPP completed), 2027 – 2030 (6 GW GFPP will be built), 2030 – 2040 (21 GW GFPP added) and strongly in 2040 - 2060 (gradually replace coal as base load)(S&P Global 2024). Prior 2040, the load of gas fuel will be constrained as coal remains the cheapest fuel and existing CFPP will be operated at increasingly higher capacity factors for base load while RE penetration is slow. Despite natural gas support in energy transition, policy and market reform are necessary to create pricing framework for greater natural gas usage (Gürsan and de Gooyert 2021; Wilson and Staffell 2018; Paltsev and Zhang 2015). 11 Despite RE power plants (REPP) will dominate in the future, natural gas is required to complement REPP for grid stability, given the intermittent characteristic of RE (Camargo et al. 2024; Ahmed et al. 2023). Natural gas also acts as medium and peak load carrier when the power system requires rapid ramp up for prioritized customers (Raheli et al. 2021; Alizadeh et al. 2016). In small and isolated power system, natural gas is also the main option for fuel oil replacement (Shahidehpour, Yong Fu, and Wiedman 2005; Thomas 2003). As countries aim to transition from fossil fuel toward RE, natural gas demand also increase to make the energy transition smoothly, making the natural gas sector become prospective investment in more decades to come (Safari et al. 2019; Jefferson 2008; Dorian, Franssen, and Simbeck 2006). Despite the challenges and uncertainties in the oil and gas industry, there is a pressing need for new investment as demand for oil and gas keep increasing (Lu et al. 2019; Kellogg 2014). As such, the valuation method chosen is fundamental to determine the accuracy of investment value amid many uncertainties. By incorporating these challenges and uncertainties into investment valuation, the investors could maximize the upside profit and minimize the downside risk of FID. 2023 was a significant year for Indonesia, because rising energy security issue resulted highest record investment for the oil and gas industry for the last seven years, which amounting to $ 15.6 billion in 2023 compared to $ 11.0 billion in 2017 (Minister of Energy and Mineral Resources or MEMR 2024) with oil and gas supply and demand continuing to rise year on year. In order to assess the economic feasibility of three development scenarios during FID, ROV is used to select the best development scenario using sequential compound options for multiple phases. I.2 Company Profile This research is based on data from an upstream oil and gas company (the PSC), which its identity kept confidential to protect sensitive information. The PSC was established through a joint venture between national and international firms and operates under a production sharing contract with the government of Indonesia. The PSC, which has been conducting operations in the offshore area of Java Island for the past decade, plays a vital role in ensuring regional energy security by supplying pipeline gas. Its main business is to meet natural gas demand and ensure stable and reliable natural gas supply for fertilizer, industrial, and power generation sectors. Over the years, the PSC has successfully achieved a major market share in the pipeline gas within the region, highlighting its significant presence in the national energy landscape. I.3 Business Issue Despite government has set an ambitious target of reaching natural gas lifting for 12 BCFD by 2030, the actual production levels as of 2023 have only reached 6 BCFD. This shortfall is mainly due to insufficient development and investment of natural gas fields. Given the uncertainties in the domestic gas market and the limitations of the DCF method for investment valuation, it is essential to adopt a more comprehensive approach to promote the development of natural gas fields. This research highlights the importance of using the ROV instead of the DCF method for conducting important investment valuation during the FID process. By incorporating ROV into investment valuation, the decision makers can better account uncertainties and strategic options, which enables the PSC to be better informed about their investment alternatives. 12 I.4 Research Questions and Research Objectives The research questions are: a. What is the comparison between DCF and ROV methods in valuing offshore natural gas field development project. b. What is the best development scenario that favour decision makers most. c. What are the implications of key factors such as volatility factor, gas price and TOP volume on the stability of best development scenario selected. The research objectives are; a. Assess the economic feasibility for valuing offshore natural gas field development project using Indonesia case study, highlight how ROV enhance the investment valuation over DCF method by incorporating managerial flexibility and strategic options. b. Assesses how different project ranking presented using ROV and DCF methods. By exploring combine impacts of key factors such as volatility factor, gas price and TOP volume c. Perform the robustness check and advanced sensitivity analysis to validate and evaluate the stability of best development scenario selected. I.5 Research Novelty and Contribution Although most of previous researches in the energy sectors have integrated the ROV during FID (Acheampong 2021; Huang et al. 2018; Luis M. Abadie and Chamorro 2014; Compernolle et al. 2017; Fonseca et al. 2017; Guedes and Santos 2016; Jafarizadeh and Bratvold 2015; Qiu, Wang, and Xue 2015; Zhu, Zhang, and Fan 2015; Lin et al. 2013; Fan and Zhu 2010; Zhu, Zhang, and Fan 2011; Lima and Suslick 2008; Guimarães Dias 2004), there is little evidence (Jafarizadeh and Bratvold 2015, Qiu, Wang, and Xue 2015, Silitonga 2015) that discussed about the implication of three dependent variables e.g. volatility factor, gas price and TOP volume on the best development scenario selected. This research is the first research of ROV application using in FID for natural gas development plan under PSC framework, which identify the interrelationship among three dependent variables e.g. volatility factor, gas price and TOP volume. This research fills research gap by incorporating the interrelationship among those key variables during robustness check and advanced sensitivity analysis to validate and evaluate the stability of best development scenario selected. This research contributes the academic and practical understanding of managing investment under highly volatile and uncertain business environments that could influence strategic decision making in the energy sector. I.6 Research Scope and Limitation This research assesses three development scenarios on natural gas field project under PSC framework. This research focus on a major gas producer in Indonesia and use data and scenarios relevant to the PSC. The data analysis is using RO SLS and Oracle Crystal Ball software combined with Microsoft Excel Spreadsheet. This research finding might be limited to typical gas field in Indonesia’s PSC. The ROV models may not capture all real-world contingency, the ROV result could vary based on the input assumption and the ROV operate under the ceteris paribus assumption, which assumes that external factors remain constant except for the variable and parameters input under assumption. 13 I.7 Brief Writing Structure This research structures are employed in following outlines. a. Chapter I Introduction. This section includes background on the role of natural gas in meeting the energy demands of consumer across the globe while also contributing as energy transition to reduce the risk of climate change with lower carbon footprint, research questions, research objectives, research novelty and contributions, research scope and limitations and writing structure. b. Chapter II Literature Review. This section summarizes the previous research that used in ROV and classifies it according to sector, country, pricing option, project lifetime, volatility, option lifetime, time steps, model, method and tool. c. Chapter III Research Methodology. This section explains the research methodologies and conceptual framework applied in DCF method and ROV method using sequential compound options for multiple phases, including the formulation of binomial lattice model, expanded NPV and return to risk ratio and step by step. d. Chapter IV Results and Discussion. This section presents the case study and results of valuing natural gas field development plan using ROV and DCF methods in terms of ranking on three development scenarios. e. Chapter V Conclusions and Recommendation. This section summarizes the key conclusion of utilizing ROV in conjunction with DCF method and the advantage of understanding the degree to which different gas price and TOP structures affect the project valuation are beneficial during gas sales negotiation with gas buyers..