Optimal involvement in multiple environmental projects under budgetary constraints

Abstract

Environmental companies bidding on multiple projects are presented with the opportunity for diversification in several areas of the environmental market but, also, with the risk of exposure to uncertain events that can result in major financial loss and/or make the company liable to future claims. Accordingly, each corporation determines its maximum financial involvement in a project by evaluating a project's risk characteristics. Further, a company usually takes a global perspective on the total amount it is prepared to lose without compromising its operational viability. This frequently translates into taking less than 100% working interest in a contract and having to determine the combination of working interests for the projects that satisfy both the financial constraints to risk and the requirement to maximize the total profit. This study provides a procedure that can be easily implemented numerically to quantitatively assess the participation in a number of projects under exponential and parabolic utility models. In particular, the parabolic utility model lends itself to analytic expressions for the working interests. Application of the method is illustrated in the case of three projects arranged at an increasing order of expected return, tolerance to risk, uncertainty, and potential to financial loss. Depending on the global risk tolerance, a greater interest is taken in the least uncertain (but least profitable) project, riskier projects considered only after full participation has been achieved in safer projects.