Satellite missions are one instrument of earth observation targeted at obtaining information for improved decision-making in sustainable development. On the other hand, satellite missions are expensive undertakings involving large sunk costs and facing uncertain benefits streams. In the area of avoiding damages through e.g. better weather forecasts, the benefits are high, but also difficult to quantify. Using real options to derive the optimal timing of the launch of a satellite enables us to derive the value that such information conveys when it can be used to reduce the extent of the damages from disasters and their consequences. Improving weather information, forecasting and warning will deliver benefits in almost all sectors of the economy and for societal welfare. Severe weather events – hurricanes, tornadoes, flash floods, freak waves, lightning strikes, blizzards, and poor air quality episodes – impact every person and nation on the face of the Earth. The value of additional information from a satellite mission for disaster mitigation is represented by the ability to reduce the amount of losses suffered. Note that in contrast to models where the value of information is derived by comparing decisions taken when facing stochasticity to those taken under certainty, the framework used in this study takes on a different approach, since we do not assume that the occurrence of high-impact disasters can be avoided most of the time. However, better warning systems and also damage mitigation through improved and better informed rescuing operations after the event of the disaster can significantly reduce the losses suffered.
The analysis is motivated by data on economic losses from disaster incidents from OECD Information Technology Outlook 2006, whereas all results are derived analytically. Numerical results are calculated with the cost data for the Galileo Programme and the avoided damages estimated from the OECD Information Technology Outlook.
A real options model is used to asses the optimal timing of investment into a satellite project and it enables us to derive the value of earth observations used to reduce the extent of the damages and consequences from severe weather events. The optimal timing is derived analytically following the procedure presented in Dixit and Pindyck (1994) under the assumption that avoided losses are equal to a fixed proportion of all damages suffered under the events that are modelled as a geometric Brownian motion. As a baseline a single satellite project is considered. The framework is further expanded to consider also a possibility of hosted payload capturing the feature of economics of scale. The optimal decision of the investor is then derived (into which project and at which time to invest) analytically.
Applying the analytical analysis to the numerical data, some important conclusions can be derived from the solution by conducting some sensitivity experiments. Figure 1 displays the option value (dashed line) and the net present value (solid line) of the satellite mission. The critical value triggering the launch of earth observation mission occurs at the intersection of the two lines. Increasing the volatility parameter will shift the option value line upwards, resulting in postponement of the launch, whereas an increase in trend shifts both lines upwards and makes them a bit steeper, so that the launch occurs somewhat earlier.
Fig.1. Net Present Value (solid line) of Launching a Satellite Mission vs. Option Value (dashed line)
Another important result can be derived directly form the analytical analysis without any data assumptions: considering the possibility to expand the project by hosting more equipment, which would further improve the quality and amount of observations. Under the assumption that the additional payload benefits from economics of scale, the optimal decision of the investor is to invest into the satellite with the hosted payload, where not only more damages can be avoided, but also the optimal investment timing (the launch) is sooner.
A manuscript entitled ‘Using Real Options to Assess the Value of Information in Satellite Mission Planning’ by Sabine Fuss, Jana Szolgayova and Michael Obersteiner has been submitted for publication at Space Policy (as of June 2008).