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around the world. The projects included typical producing the capital development costs were scaled around the
assets, acquisitions and a large proportion of exploration individual outcomes using a historically validated function.
projects (Table 1). The projects do not however represent This leads to a far more robust and complex evaluation of the
any single company or country, and the values have been individual projects. Typical results from four of the
modified slightly to ensure anonymity. exploration projects evaluated are shown in Fig. 5.
Each project was fully evaluated using a probabilistic
reservoir simulator, and the resultant distributions were used Incorporation of Price Uncertainties
as the basis for all evaluations. Deterministic development One of the issues with portfolio risk evaluations is that if
profiles were created for the most likely successful outcomes. you need to include price uncertainty, it usually needs to be
For the exploration projects; failure, low and high fully correlated across all the projects, unlike most technical or
deterministic evaluations were also created, and the reservoir uncertainty. This can be achieved in Monte Carlo
probability of each outcome was derived from the simulator simulations by applying a single price distribution to the entire
results. The combination of these creates a “simple set of projects. This global application of a price uncertainty
stochastic” evaluation of the projects. These can be allows fully correlated prices across multiple projects. This is
represented by multiple branch uncertainty trees (Fig. 4), and easily accomplished in many of today’s Monte Carlo
could have included as many outcomes as required to describe simulating systems, but adds a considerable complexity to
the development options. uncertainty tree analyses.
In order to illustrate the importance of this correlation, a
second set of project data was generated in which the Monte
Carlo evaluated projects used a fully correlated price
distribution, while the simple stochastic evaluations used a
typical 3-branch price uncertainty (Fig. 6).
Portfolio Optimization Process evaluations were selected. They are labeled on Fig. 7, and
In order to evaluate the effect that these two approaches had their characteristics are listed in Table 1. The same portfolios
on the portfolio risk measurement, an efficient frontier was (groups of projects) were then identified in the simple
developed for each of the four project evaluations. stochastic efficient frontier graph (Fig. 8). As can be seen
• Full Monte Carlo evaluations without price most of the portfolios remained efficient or did not shift
uncertainty. markedly from the efficient frontier in the simple stochastic
• Simple stochastic evaluations without price optimizations. This indicates the differences in the evaluation
uncertainty. detail did not significantly effect the portfolio selection or
• Full Monte Carlo evaluations with fully correlated portfolio risk comparisons, when price uncertainty was
price uncertainty. ignored.
• Simple stochastic evaluations with price uncertainty
without correlation.
This was accomplished by defining a strategy that
consisted of the following requirements.
• A minimum annual produced oil volume and gas
volume was required from year 2003 to 2010.
• Annual exploration capital and production capital
expenditure was limited for all years
• Cumulative reserve replacement over the first five
years and over the first ten years were specified.
Only portfolios that met all of the above goals were
included in the efficient frontier graph. In this case, the
projects could either be included or not. The model was not
permitted to vary the percent working interest in any of the
projects. This was representative of the majority of projects Fig. 7—The optimized efficient frontier graph based on the full
we were working with, and is often how some companies Monte Carlo based project evaluations without price uncertainty.
The highlighted efficient portfolios were chosen for comparison
evaluate portfolio selection. with the simple stochastic based efficient frontier.
The optimizer objective value was set to maximize NPV at
a 10% discount rate, or to minimize the semi-standard
deviation of NPV at a 10% discount rate, our risk measure.
By varying the minimum required NPV for a given
optimization, and optimizing on minimum possible risk,
specific portfolios from the set of the most efficient portfolios
found were noted. Randomly generated portfolios were used
to supplement the efficient portfolios, in order to populate the
efficient frontier graph. In total over fifteen optimizations
were run for each graph.
The exact same optimization procedure was performed for
all sets of input data (Figs. 7 to 10), and the efficient frontiers
were compared for both project selection and overall risk
measures.
Results Fig. 8—The efficient frontier graph based on the simple stochastic
project evaluations, without price uncertainty. Note that most of
Using the full Monte Carlo evaluations, the resultant portfolio the portfolios identified as efficient in Fig. 7 are efficient or close
NPV’s ranged from MM$1,510 to MM$3,070, while the to efficient here.
associated risk ranged from MM$225 to MM$660 (Fig. 7).
While using the simple stochastic evaluations, the resultant
portfolio NPV’s ranged from MM$1,510 to MM$3,070, and The same procedure was carried out using the projects
the associated risk ranged from MM$200 to MM$490 (Fig. 8). evaluated with price uncertainty. Using the full Monte Carlo
The identical NPV values are no surprise as the expected evaluations with correlated price uncertainty, the resultant
values of the simple stochastic evaluations matched the mean portfolio NPV’s ranged from MM$1,565 to MM$3,040, while
values (expected) from the full Monte Carlo evaluations the associated risk ranged from MM$610 to MM$1,000 (Fig.
(Table 2). 9). Using the simple stochastic evaluations with non
In order to compare the optimized project selection correlated price uncertainty, the resultant portfolio NPV’s
between the two project risking methods, fourteen of the most ranged from MM$1,560 to MM$3,040, and the associated risk
efficient portfolios found based on the full Monte Carlo ranged from MM$310 to MM$590 (Fig. 10).
SPE 69594 SIGNIFICANCE OF PROJECT RISKING METHODS ON PORTFOLIO OPTIMIZATION MODELS 5
TABLE 1— Expected Value Project Characteristics TABLE 2— Portfolio Properties, w/o price uncertainty
Semi-Standard Semi-Standard
AT Cash Capital Oil Prod. Probability deviation based deviation based
Name NPV 10% Undisc. Type of Success Number
AT Cash on Full on Simple
(MM$) (MM$) (MMSTB) (%) Name of
NPV 10% Monte Carlo Stochastic
Projects
EP 1 127 142 56 Acq. - Inputs Inputs
(MM$) (MM$) (MM$)
EP 2 102 62 50 Dev. - Max V 3,070 660 25 490
EP 3 200 133 182 Dev. - HV - 1 2,860 639 22 477
EP 4 251 119 212 Dev. - HV – 2 2,796 611 23 485
EP 5 367 345 47 Acq. - HV – 3 2,690 565 23 442
EP 6 68 75 57 Del. 90 HV – 4 2,613 540 25 378
EP 7 90 137 88 Expl. 72 AV – 1 2,552 523 21 377
EP 8 77 28 48 Expl. 35 AV – 2 2,420 460 24 350
EP 9 125 88 44 Expl. 41 AV – 3 2,352 430 24 315
EP 10 128 204 111 Expl. 17 AV – 4 2,240 403 23 310
EP 11 80 71 80 Del. 94 LV – 1 2,186 380 22 285
EP 12 85 121 85 Expl. 30 LV – 2 2,034 362 20 276
EP 13 30 86 38 Expl. 27 LV – 3 1,889 337 21 255
EP 14 92 95 66 Dev. - LV – 4 1,771 311 19 225
EP 15 51 31 21 Dev. - Min R 1,510 225 19 200
EP 16 47 96 47 Expl. 40
EP 17 8 21 11 Expl. 30
EP 18 7 20 10 Expl. 20
EP 19 5 9 7 Del. 95
EP 20 6 5 6 Del. 90
EP 21 106 452 182 Expl. 30
EP 22 38 182 79 Expl. 60
EP 23 110 352 138 Expl. 23
EP 24 148 42 28 Expl. 43
EP 25 184 387 237 Dev. -
EP 26 50 73 46 Expl. 80
EP 27 118 143 103 Del. 90
EP 28 187 82 32 Expl. 15
EP 29 283 69 39 Del. 90
EP 30 23 51 39 Expl. 25