© Rose & Associates, LLP. 2005 GEOTECHNICAL PROJECT RISKING AND E&P PORTFOLIOS: ASSUMPTIONS, REQUIREMENTS, FALLACIES, AND CONSEQUENCES Peter R. Rose Rose

© Rose & Associates, LLP. 2005

GEOTECHNICAL PROJECT RISKING AND E&P PORTFOLIOS:

ASSUMPTIONS, REQUIREMENTS, FALLACIES, AND CONSEQUENCES

Peter R. RoseRose & Associates, LLP.

APPEX London28 February 2005


CONTINUALLY ADVANCING E&P TECHNOLOGY

Image and Understand Subsurface

Find and Produce in Deep Ocean Settings

Recover from Previously Non-commercial Reservoirs


BUTBUT -- IF SCIENCE AND TECHNOLOGY ARE SO GOOD, WHY DO WE STILL:

Drill Expensive Dry Holes?

Find Non-economic Fields?

Revise Proved Reserves Downward?

Overspend on Capital Projects?

-- Mother Earth is still a “Coarse Filter”, and we’re still learning to deal with Uncertainty!



MANY E&P PROJECTS: NFW’S ACQUISITIONS

A REPEATED-TRIALS GAME

• 20 Prospects with five classes of risk and reserves

• Probabilistic expression of chance and reserves-outcomes.


E&P PORTFOLIO

• Unbiased Estimates

• A predictive tool -- 3 - 23MMBOE (mean 12)-- 4 - 8 discoveries (6)

• Strategic Planning

• Tactical Choices

• Portfolio-management software tools


Professional Responsibilities Of Petroleum Geoscientists And Engineers

1. Find promising Opportunities

2. Measure them without Bias

3. Communicate effectively with Decision-makers

BIAS IS THE MORTAL ENEMY OF PORTFOLIO MANAGEMENT


Manage by Managing the Portfolio

• Fit project-mix to stated goals

• Desired number and mix of projects from BU’s

• Reward oil-finders

• Reward geotechnical objectivity (post-audits)


E and P Capital Allocation (Portfolio)

Prospect Inventory

Prospect Risk Analysis

Play Analysis

INVENTORIES AND PORTFOLIOS

A selection from the inventory to achieve a specific objective

The collection of projects

Consistent, systematic evaluation of prospects

To properly position yourCompany in key trends


“Portfolio Management”:

• Projects characterized consistently, probabilistically, and objectively (chance, reserves, cash flows, costs)

• Stochastic simulations of possible projects in candidate portfolios

• Find best portfolios re goals and budgets to carry out strategy.


AREA

RESERVOIR YIELD

P10 = 600 Ac P50 = 200 Ac

P90 = 60 Ac

10 1000100

P90

P10

(P1 = 1500)

P99=25

AVERAGE NET PAY

P10 = 40’

P90 = 10’P50 = 20’

P90

P10

(P1 = 75)

400 BAF = P10200 BAF = P50100 BAF = P90

ESTIMATING PROSPECT RESERVESESTIMATING PROSPECT RESERVES

10 1001

P99=6

P90

P10

(P1 = 700)

P99= 60

10 100 1000


10 1000100

P99=25

(P1 = 1500)

P90

P50

P10

(P1 = 700)

P99= 60 10 100 1000

AREA, ACRES RESERVOIR YIELD, BAF

(P1 = 75)

10 1001

P99=6

AVE. NET PAY, FT.

P90

P50

P10

P1

P990.01 0.1 1 10

RESERVES, MMBO

9.6

0.06

3.3

0.800.20

DISTRIBUTIONS OF AREA, Ave NP, AND RY ARE MULTIPLIED

TO DERIVE THE PROSPECT RESERVES DISTRIBUTION…

x x =

1.37


Five Factors:

- Hydrocarbon Source Rocks - Migration and Timing - Reservoir Rocks - Closure (Structural or Stratigraphic)- Containment (Seal, Preservation)

When Multiplied Together, Represent the Chance of an Active Hydrocarbon

System That Provides Oil/Gas in Quantities Sufficient for Sustainable Flow

Pg, PROBABILITY OF GEOLOGICAL SUCCESS

0.9 x 0.9 x 0.6 x 0.8 x 0.7 = 0.27 = Pg

(0.9)(0.9)

(0.6)(0.8)

(0.7)


Product of the Geological Chance Factors

CHANCE OF GEOLOGICAL SUCCESS

Pg = 0.27

The Chance of Finding Sustained Flowable Hydrocarbons; From P99, and up, on the prospect reserves distribution.

P90

P1

P10

P50

P99

“The Chance of landing somewhere on the curve”


Chance of finding the Minimum Commercial Field Size (MCFS) or more

CHANCE OF COMMERCIAL SUCCESS

Pc = 0.22

Fields > MCFS generate PV > 0 when burdened by the cost of completing and connecting the well.

P90

P1

P10

P50

P99 MCFS

Pc = Pg x P MCFS

0.8 x 0.27 = 0.22


Sound portfolio management reflects the choices that are made after understanding project interactions relative to goals…

provides insights, not the answer


Review Model Portfolio

20 PROSPECTS20 PROSPECTS

Pc = 0.1 Pc = 0.1 0.5 0.5

Mean reserves = Mean reserves =

0.39 0.39 10.82 10.82


record your predictions: P90 P10

______ to ______ Number of discoveries

______ to ______ Reserves discovered

______ to ______ Average reserves / discovery

PORTFOLIO EXERCISE:

Unbiased spinner =Unbiased Portfolio

84 (6)

23MM3.5MM (12MM)

3.0MM0.6MM (1.92MM)


PORTFOLIO SPINNER RESULTS

MMBO – 230 Trials

3.5

10

23

12


0 2 4 6 8

Incre

asin

g lik

elih

ood

0 2 4 6 8 10 12 14

Incre

asin

g lik

elih

ood

Number of Discoveries

Average Reserves per Discovery1.92

© Rose & Associates, LLP. 2005 Trial

PORTFOLIO SPINNER RESULTS


-100

-80

-60

-40

-20

0

20

40

60

80

100

0 20 40 60 80 100

NUMBER OF WELLS IN PORTFOLIO

% D

IFF

ER

EN

CE

F

RO

M

ME

AN

P90P10

VARIANCE FROM THE MEAN OF FORECAST PORTFOLIO REDUCED AS NUMBER OF WELLS INCREASES


DEALING WITH HIGH-RISK PORTFOLIOS

1. Add more wells (increases exploration costs)

2. Expand the portfolio by joint ventures

3. Measure performance over multi-year periods

4. Replace some high-risk ventures with lower-risk ventures (Trade-offs on high side?)

5. Improve chance of success through geotechnology

6. Management recognizes the consequences of lognormality and risky projects, and accepts higher annual risk for expected longer - term growth

(Sometimes a bad year goes with the territory)


Making a Simplistic E&P Picture More Realistic

Balance “Holistic” Portfolio -- Expand via Development, EOR, and Property-acquistions

Include “Resource Plays”

Covariance among Projects

Copyright 2004, Portfolio Decisions,Inc.

Example 6-Pack

Capital ($MM)

0

500

1,000

1,500

2003

2005

2007

2009

2011

0.000.200.400.600.801.00

Op Income ($MM)

0500

1,0001,5002,000

2003

2005

2007

2009

2011

0.000.200.400.600.801.00

Production (MMBO)

050

100150200

2003

2004

2005

2006

2007

2008

2009

2010

2011

0.000.200.400.600.801.00

Staff Reqd

050

100150200250

2003

2004

2005

2006

2007

2008

2009

2010

2011

0.000.200.400.600.801.00

ROCE (%)

0.05.0

10.015.020.0

2003

2004

2005

2006

2007

2008

2009

2010

2011

0.000.200.400.600.801.00

Reserves (MMBOE)

0500

1,0001,5002,0002,500

2003

2005

2007

2009

2011

0.000.200.400.600.801.00

Probability of Achieving (dashed line)


-500

0

500

1000

1500

2000

2500

3000

1991 1992 1993 1994 1995 1996 1997 1998

INVENTORY, SUM OF RW MEANS, MMBOE

EUR DISCOVERED, MMBOE

est PV(10), $MM

INVENTORY AS LEADING INDICATOR“Larger Inventory leads to Better Portfolio Performance”

McMaster & Citron 1997


IN PRAISE OF JOINT VENTURES . . .

Reduce risk via OWI

Expand Portfolio (participate in more ventures)

Improve Estimates & Decisions (group wisdom)

Learn from Partners (expand expertise)

Expand Contacts & Influence

Fill-in Portfolio-gaps (time, balance)

Costs: generation vs. promotion

CostxPf

PVxPcx

PVCost

RTln


FACTS OF LIFE FOR MANY FIRMS:• Companies can’t afford the luxury of accumulating a large multi-

year inventory, instead they proceed rejecting or accepting prospects on a serial basis

• One solution: Design a model Portfolio, where different divisions provide certain types of prospects, consistent with:

1) firm’s needs for a balanced portfolio 2) firm’s needs with respect to acceptable risk vs. reward

Caveat: This techniquecould impair the

predictive power of the portfolio


KEY MESSAGE:Plays and Large Concessions

can be Systematically and Objectively Evaluated as

Full-cycle Business Ventures for Undiscovered Potential –

Volumes, Value, and Chance of Success –

Just Like Prospects.

The Most Important Exploration Decision Is Not Which Prospect To Drill,

But Rather, Which New Play To Enter!


E&P WORRIES:

Does PM commonly tend to encourage Risk-aversion?

How does Frontier Exploration (new plays) fit into E&P Portfolio Management (new prospects/projects)?

Has “Amplitude-emphasis” impeded new-play developments in Frontier areas?

“No DUMB (?) Dry Holes”


INTEGRATED PORTFOLIO MANAGEMENT

Technical and Conceptual

Human and Organizational

• poor estimating

• motivational bias

• counterproductive incentives

• inconsistency

• ethical lapses

• reliance on intuition

• hidden hurdles

BARRIERS TO IMPLEMENTATION


1) Reduce volatility of E&P program results

BENEFITS OF E&P PORTFOLIO MANAGEMENT:

BOE $$

2) Balance reserves growth vs. future cash flow needs

3) Plan by assessing interactions & consequences of different choices

4) Choose projects that implement strategy

5) Deliver what you promised


1) RA & PM don’t find oil & gas directly – help you drill more good prospects with the $ you didn’t waste drilling bad ones.

2) Need transparent Project RA process at BU level (no “black boxes” for RA); staff accountable for objective estimating.

3) Centrally coordinated portfolio management not incompatible with autonomous BU operations.

4) Exploration play analysis may not fit neatly into project-oriented portfolios.

KEY INSIGHTS (1):


5) Elegant software tools cannot fix problems that are behavioral, cultural, or professional.

6) PM allows you to ask the right questions to let you choose options that best fit your strategy.

7) RA & PM may lead to excessive risk-aversion and avoidance of some frontier projects.

8) Successful implementation of portfolio management changes corporate cultures.

KEY INSIGHTS (2):


Does Implementation of E&P Risk Analysis and Portfolio Management Guarantee Superior Performance?

But Any Company That Does Not Employ But Any Company That Does Not Employ These Techniques Probably Cannot Hope These Techniques Probably Cannot Hope To Sustain Improving E&P Performance To Sustain Improving E&P Performance

Over Multi-year Periods!Over Multi-year Periods!


GEOTECHNICAL PROJECT RISKING AND E&P

PORTFOLIOS: ASSUMPTIONS, REQUIREMENTS, FALLACIES,

AND CONSEQUENCES

Peter R. Rose

APPEX

28 February 2005

London

Documents

© Rose & Associates, LLP. 2005 GEOTECHNICAL PROJECT RISKING AND E&P PORTFOLIOS: ASSUMPTIONS, REQUIREMENTS, FALLACIES, AND CONSEQUENCES Peter R. Rose Rose