Impact of Crude Oil Price Volatility on Capital Budgeting: Aramco Case

This research proposal explores the effect of crude oil price volatility on capital budgeting practices within petroleum companies, using Aramco Saudi as a case study. It investigates the impact of price fluctuations on the company's budgets, the capital budgeting techniques employed, and the budgetary policies used for project assessment. The study aims to determine the effectiveness of current methods in achieving Aramco's 2020 Vision. The research questions address the specific effects of oil price volatility, the capital budgeting techniques used, how managers evaluate projects based on budgetary policy, and the overall effectiveness of the applied methods. The study is limited to publicly available data from 2010-2015 and acknowledges potential time constraints in scheduling interviews. Desklib provides access to similar research papers and solved assignments for students.

Running head: RESEARCH PROPOSAL 1
The effect of crude oil price volatility on the capital budgeting practices for petroleum
companies case study on Aramco Saudi
Name
Institution
Date

RESEARCH PROPOSAL 2
Contents
Research proposal............................................................................................................................5
Title..............................................................................................................................................5
Introduction..................................................................................................................................5
Problem statement.......................................................................................................................5
Research objectives.....................................................................................................................7
Research questions.......................................................................................................................7
Scope of the study........................................................................................................................8
Anticipated Significant contribution............................................................................................8
Feasible limitation.......................................................................................................................8
Thesis structure............................................................................................................................8
Summary of the Chapter..............................................................................................................9
References......................................................................................................................................10
Literature Review..........................................................................................................................12
Introduction................................................................................................................................12
Research Background................................................................................................................12
Historical Development of Research in the Area......................................................................13
Relevant Theories in the Research............................................................................................14
Review of Recent Research in the Area....................................................................................16
Capital budgeting...................................................................................................................16

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Capital asset pricing model CAPM.......................................................................................17
Net Present Value..................................................................................................................17
Net Present value for Foreign Investment.............................................................................18
Budgetary policies.................................................................................................................19
Participative Budgeting.........................................................................................................21
Beyond Budgeting.................................................................................................................21
Capital Budgeting for Long-term Infrastructures Projects....................................................22
Risk budgeting.......................................................................................................................22
Throughput analysis...............................................................................................................23
Discounted Cash Flow...........................................................................................................24
Internal Rate of Return..........................................................................................................24
Payback Period......................................................................................................................25
Crude oil Price Volatility in Saudi Arabia.............................................................................26
Research Gaps Identification and Deliberation.........................................................................30
Conceptual Model Development...............................................................................................31
Hypothesis development............................................................................................................32
Chapter's Summary....................................................................................................................32
References......................................................................................................................................33
Methodology..................................................................................................................................39
Introduction................................................................................................................................39

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Background of The Research - Objectives, and Questions.......................................................39
Research objectives...............................................................................................................39
Research questions.................................................................................................................39
Basic Research Method Selected and Rationalization...............................................................40
Population, Sample, and Respondents.......................................................................................41
Research instruments - Questionnaires Design and Development............................................42
Unit of Measurement and the Measurement of Variables.........................................................42
Pilot Study and The Reliability and Validity Test - Multiple Regression Test.........................43
Method of data analysis.............................................................................................................43
Summary of the chapter.............................................................................................................45
Research timetable.....................................................................................................................45
References......................................................................................................................................46
Research proposal
Title

RESEARCH PROPOSAL 5
The effect of crude oil price volatility on the capital budgeting practices for petroleum
companies case study on Aramco Saudi.
Introduction
The goal of the firm is to maximize shareholders’ wealth. In order to achieve this target, a
complex decision-making process required. The first element of this complex process is the
investment decision, the utilization of the current investment opportunities, to provide a better
future return for the firm. The second element is the financing decision, which supports the
investment decision, by deciding on possible sources of funds, which can be utilized in profitable
investments opportunities. The third element is the dividend decision, which supports the
financing decision, by deciding on the optimal balance between retained earnings, and
stockholders’ interest in the form of distributed dividends. An interdependent approach to
capital budgeting has been presented by Spies (1974) as an answer to this complex process. The
model defines the optimal capital budget as a function of dividends, short-term investments,
long-term investments, debt financing, and equity financing. The model performs well and yields
several insights into the capital budgeting process. When the capital budget is out of equilibrium,
dividends, and long-term investment quickly approach their equilibrium values. Short-term
investment takes up slack by compensating for lagging adjustments of other components (Spies,
1974).
Problem Statement
The capital budgeting decision process can mold the firm’s future opportunities, and it is
one of the key decision areas confronting contemporary financial management issues. (Gitman &
Forrester, 1977). Capital sources can be provided through many avenues, and each of these
avenues has its costs. The sources of capital can’t be viewed separately, each source is affected
by the other. Equity capital has been found to be difficult to value, due to the ownership interest

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and residual right attached to it (Dickerson, 1963). Net present value (NPV) method is very
popular and widely used by firms in capital budgeting in practice. The main disadvantage of the
NPV approach is that it lacks flexibility and the firm need to make the decision today in spite of
uncertain factors the project faces in the future. The way to address such deficiency is to
incorporate real options tool to supplement the NPV criterion. Although survey literature
indicates that firms seldom use real options method in capital budgeting due to lack of
knowledge/skill and lack of support of top executives, using real options technique to
supplement NPV method in capital budgeting can be the future trend (Chen, 2012). The
Discounted Cash Flow model (DCF), is another tool used for capital budgeting. The Discounted
Cash Flow assumes that managers can make a decision, implement it, but with limited
capabilities to alter that decision. The methodology used to implement this technique is to
estimate the future net cash flows over the supposed life of the project and then discount those
cash flows at the appropriate discount rate. In truth, the Discounted Cash Flow model is perfectly
appropriate only when the future cash flows are known with certainty. In stable circumstances,
the results of applying this model will be acceptable. This model has the shortcoming of failing
to capture the value of flexibility (Schubert & Barenbaum, 2007).
As recent sharp price volatility of crude oil price, Aramco Saudi as a major crude oil
company in an crude oil-dependent economy of the Kingdom of Saudi Arabia is affected. Based
on the new strategic direction for vision 2020 for Aramco Saudi “We’re going to be the world’s
largest integrated energy and chemicals company by 2020. To achieve this goal, we are currently
undergoing a transformation program, expanding our upstream and downstream operations and
diversifying into renewables, nonconventional resources, and environmentally beneficial
technologies. We’ve embarked on a series of mega-projects, ranging from expanding crude oil

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and natural gas production capacity to new refining, petrochemical, and marketing
ventures”( Aramco,2014). The changes that may result of this price volatility on the capital
budgeting process for the company can’t be marginalized, therefore understanding this volatility;
its effect on the capital budgeting process; and the possible techniques that can be implanted to
mitigate this effect is needed.
Research Objectives
The recent volatility of crude oil prices can have an effect on the capital budgeting
decision of petroleum companies.
• To determine the effect of crude oil price volatility on the budgets of Aramco Saudi.
• To determine the applied capital budgeting technique for Aramco Saudi.
• To investigate the applied budgetary policy, used by the managers for project assessment.
• To Assess the effectiveness of the applied capital budgeting methods on the Aramco’s efforts
to reach its 2020 Vision.
Research Questions
• What is the possible effect of crude oil price volatility on the budgets of Aramco Saudi?
• What is the applied capital budgeting technique(s) for Aramco Saudi?
• How do managers evaluate projects, based on the applied budgetary policy in Aramco Saudi?
• How effective is the currently applied capital budgeting methods on the Aramco’s efforts to
reach its 2020 Vision?
Scope of the Study
The study will be limited to Aramco Saudi, the evaluation of the company for the past
five years will be implemented to understand capital budgeting techniques, whether the volatility
of crude oil price has an effect on the implemented capital budgeting techniques.

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Anticipated Significant Contribution
Investigate the effect of crude oil price volatility on capital budgeting techniques
implemented in Aramco Saudi Crude oil Company based in the Kingdom of Saudi Arabia.
Aramco Saudi has been chosen as a case study for this research, to enable studying its various
projects capital budgeting techniques. The company has downstream upstream projects,
diversified portfolio of business operations, and being the main company for crude oil production
in an crude oil-dependent economy –Kingdom of Saudi Arabia – with the current volatility of
crude oil, this case study can contribute to the body of knowledge of capital budgeting
techniques for crude oil-dependent economies.
Feasible Limitation
The research will be limited for public data available from the year 2015-2010 only
through the company’s website. Time constraints regarding interviewees schedule, and any
possible clash of schedules that can’t be mitigated.
Thesis Structure
This thesis is made up to of three main parts which the introduction, literature review and
the methodology. The introduction has the rationale of the projects which include the problem
statement, research objectives, hypotheses and the research questions. The literature review has
the previous studies conducted in the past and the gap in the body of language. The methodology
consists of the techniques which will be used to collect and analyze the data
Summary of the Chapter
In summary, this section has introduced the study by addressing the problem which the
research will be focusing on. The impact which the crude oil price volatility has of the capital
budgeting in Armco Saudi which is one of the crude oil supplying companies in Saudi Arabia.
The research objectives and research questions of the have been outlined based on what the

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research is intended to achieve such as to give the reality of how the crude oil price volatility
affect the capital budgeting. The concept of the capital budgeting model has been outlined in this
section but will be developed in the next section. The scope of the study is that it will be limited
to crude oil price volatility, capital budgeting, and Saudi Arabia specifically the case study of
Armco Saudi. The study will address some gaps in the body of language because very few
studies have focused on the price volatility impacting the capital budgeting or at least the public
investment decision -making. the study is limited on time to conduct the interview and the
number of the previous years studied. The budgetary policies of the companies to a large extent
affect the capital budgeting techniques and the third hypothesis will be assessing the budgetary
policy of the company.
References
Aramco, Annual Review 2013, http://www.aramco.com/content/dam/Publications/Annual
%20Review/AnnualReview2013/2013AR_Expanding_Our_Portfolio.pdf, date of
Publish: February 24, 2014. Date of Access :January,12,2015.
Braun, V. and Clarke, V. (2006) Using thematic analysis in psychology. Qualitative Research in
Psychology, 3 (2). pp. 77-101. ISSN 1478-0887

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Chen, J. (2012). Adding Flexibility for NPV method in capital budgeting. Global Confidence on
Business and Finance Proceedings, 7, 49–57.
Dickerson, P. J. (1963). Capital Budgeting--Theory and Practice. California Management
Review, 6, 53–60.
Damodaran, a. (2007). Return on capital (ROC), return on invested capital (ROIC) and return on
equity (ROE): measurement and implications. New York University: Stern School of
Business, 1–69. doi:10.2139/ssrn.1105499
Feibel, Bruce J. Investment Performance Measurement. New York: Wiley, 2003
Galbraith, J., 1973. Designing Complex Organizations. Addison-Wesley, Reading, MA
Gitman, L. J., & Forrester, J. R. (1977). A Survey of Capital Budgeting Techniques Used by
Major US Firms. Financial Management, 6(3), 66–71.
Schubert, W., & Barenbaum, L. (2007). Real Options and Public Sector Capital Project
Decision-Making. Journal of Public Budgeting Accounting Financial Management,
19(2), 139–152.
Lin, Grier C. I.; Nagalingam, Sev V. (2000). CIM justification and optimization. London: Taylor
& Francis. pp. 36
Smit, H.T.J., Ankum, L.A., 1993.Areal options and game-theoretic approach to corporate
investment strategy under competition. Financ. Manage. 22 (3), 241–250.
Simerly, R.L., Li, M., 2000. Environmental dynamism, capital structure and performance: a
theoretical integration and an empirical test. Strategic Manage. J. 21, 31–49.
Spies, R. R. (1974). The Dynamics of Corporate Capital Budgeting. Journal of Finance, 29, 829–
845.

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Zhong, L., & Jiang, C. (2011). Delegated portfolio management under active risk budgeting. In
2011 2nd International Conference on Artificial Intelligence, Management Science and
Electronic Commerce, AIMSEC 2011 - Proceedings (pp. 2922–2926).
Zhu, K., Weyant, J.P., 2003. Strategic decisions of new technology adoption under asymmetric
information: a game-theoretic model. Decision Sci. 34 (4), 643–675.
Literature Review
Introduction
In this section, the literature related to the study question will be analyzed to find out
what other researchers have done in the past and how they concluded their researches. The topic
on the capital budgeting has been researched by many researchers because many industries
usually have a problem in choosing the most capital budgeting techniques because all the

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developed model have limitations (Abor,2017). the case becomes more difficult especially when
the company is dealing with the volatility of the price. The crude oil companies are the most
affected by the price volatility because there are very many factors which comes into play and
which determines the price of the crude oil. These factors are not fixed and the change quacking
making the capital budgeting of the crude oil companies to be difficult. Some researchers who
will be reviewed this section have conducted the research on the best capital budgeting
techniques which the crude oil companies can use taking the price volatility of the crude oil into
account. However, the problem persists because even after companies applying those techniques,
the crude oil companies still venture into projects which prove unprofitable and, in some cases,
put the companies in the risk of been bankruptcy (Aldaarmi et al, 2015). This section will focus
on the theories of capital budgeting as well as review different capital budgeting model and
where they have been used. This will enable us to discover the strength and the weakness of
those model and then hence find the gap which exists in the body of knowledge.
Research Background
Capital budgeting is important to managers because it helps them to make the informed
and proper decision so that they can venture into certain investment. The process has to take into
consideration the future cash inflow and outflow of the business for the technique to be
considered as reliable and quite accurate. The main problem arises where the volatility of the
price experiences to the extent that it becomes impossible to predict the future price of the
product. The price volatility makes it had for the company accountants to determine the future
cash inflow of the business (Ahmad,2017). The worst case occurs when the company
accountants assume that the price of the product will increase and the end up predicting the
future cash inflow which is higher that which will be generated. this cause the company to be
unprofitable to the extent which the investors fail to get the equity returns. The investors are the