I Would Rather be Vaguely Right than Precisely Wrong: A New Approach to Evaluating Oil and Gas Investment Decisions
  Steve Begg
 Director for Decision Science, Landmark Graphics in Austin        

ABSTRACT:

Over the past two decades many oil companies have consistently under-performed in returning the economic metrics that were the basis of investment decisions. One must conclude that their evaluation procedures fail to properly account for uncertainty, resulting in a systematic over-estimate of returns and/or under-estimate of the risks of loss. Also, in today's business climate many companies are finding it imperative to do more with less. This requires making faster, smarter decisions that use an appropriate level of technical analysis (detail, rigor) with the acquisition of appropriate data (type, quantity and quality). But what is "appropriate" and how is it impacted by the presence of uncertainty?

It is proposed that answering this question requires a holistic approach that incorporates all of the key components (G&G, Drilling, Production, Facilities, Economics, etc.) that might influence a decision, whilst comprehending nested layers of uncertainty-a Stochastic Integrated Asset Model (SIAM). In this approach we deliberately trade-off precise technical analysis (classical modeling) within any one component for the ability to model the complex dynamics of the interactions between components, whilst gaining an accurate, global assessment of the impacts of uncertainties. The role of classical modeling changes to one of supporting the SIAM approach by providing uncertainty estimates on the input parameters of simplified component models, calibrating them or generating simple surrogates.

Such an approach can identify which "state-of nature" uncertainties (e.g. porosity, saturation, oil price) can be ignored, mitigated, or need to be resolved, thus focusing classical analysis and/or additional data collection on only those areas that have the biggest impact on the decision criteria. More importantly a SIAM approach can determine when it is better to invest in dealing with uncertainty by developing flexible responses to it's revelation over time, rather than in trying to reduce it. More intriguingly, and counter-intuitively, it can lead to change in mindset, where, rather than being seen as a foe, uncertainty can be exploited to create value. (This latter point is illustrated by a simple example.) Thus, a SIAM can be used to implement both real options thinking and valuation. It also provides consistent risk assessment for input to portfolio management activities. Finally, a SIAM approach can also identify which "choice" variables (e.g. numbers of wells, pipeline diameter) the decision criteria are most sensitive to, thus indicating value levers that can be used to optimize the investment.