Time to build : a real options analysis of port capacity expansion investments under uncertainty

Port capacity investments are large, expensive and uncertain. They also involve long construction lead times. Therefore, choosing the timing and size of port investments appropriately to serve trade growth is important. This paper presents a real options model to value the option of single-phase (service) port expansions with flexible investment timing and size under uncertainty. The model moreover takes the construction lead time into account. This model allows comparing investment in the expansion of a port already operating and generating revenues with an investment in a greenfield project. An existing port has incentives to protect users from congestion resulting in delays and to protect their port revenues. Therefore, the higher the port users’ aversion to waiting, the earlier the port is expanded and the smaller the expansion. Oppositely, in a greenfield project, increased waiting-time aversion leads to projects being undertaken later and being larger. The impact of increased time to build on both the investment timing and size is ambiguous, since this construction lead time increases uncertainty, but at the same time also reduces the present value of cash flows. Increased public ownership leads to earlier investment, but not necessarily more capacity.