An Oil Exploration Portfolio Management Process:

Why? How? Learnings? Challenges?

David M. Cook, Jr.

DAAG 2001 Exploration Portfolio Management

Why Portfolio Management Needed?

1998 Situation

Oil price plummeting Annual Exploration Capital Budget slashed by 1/3 Too Many Opportunities competing for limited
funding

Decision-Maker Problem

Needed mechanism to prioritize strategic

opportunities

DAAG 2001 Exploration Portfolio Management

Exploration Management Desires

Understand relative fit of worldwide oil/gas opportunities based on economic decision-making criteria appropriate to Exploration uncertainties. Improve decision-making at the strategic geologic play or opportunity level (an aggregate of prospects). Evaluate multiple year, multiple well outcomes based on unbiased probabilistic (lognormal) estimates gathered in a consistent manner. Recognize and model conflicting objectives and tradeoffs.
DAAG 2001 Exploration Portfolio Management

Exploration Portfolio Management Process

Model and Data Capture/Calculation Tool

Multi-Attribute Utility (MAU) Analysis

Ranking and Budgeting

DAAG 2001 Exploration Portfolio Management

Model Calculates Risk, Volumes and Value

Two-Armed Decision Tree Estimates an Opportunitys Unrisked Value & Volume and Risked Value Probability of Opportunity Economic Success Ps Pf = 1-Ps Probability of Opportunity Economic Failure Failure Cost
DAAG 2001 Exploration Portfolio Management

Risked Expected Monetary Value = Ps x Success Value - Pf x Failure Cost

Opportunity Success Value & Volume

Tool Input & Reality Checks

Input (* lognormal range) Risk Oil/Gas Volume Activity Cost Value
Dependent Risk, P(petsys) Independent Risk, P(prosp)

Reality Checks
Petroleum System Database Risks Dependent & Independent Prospect Size Distribution Economic Threshold Historical Drilling Results Actual Success Probabilities (technical and economic) Well Costs Historical Company % Discovery Sizes Discovery Value Current Prospect Inventory (Product Pipeline) Prospect Risk Prospect Size Number of Leads/Prospects Planning & Budget Submittals Number Wells, Costs, Size, Risk
DAAG 2001 Exploration Portfolio Management

* Prospect Field Size Distribution (technical volume including noneconomic accumulations) * Failure Case Number of Consecutive Dry Holes * Success Case Number of Prospects Drilled * Well Cost * Failure Case Exploration $ Prospect Economic Threshold Company %, Discount Rate, Tax % * Success Case Net Present Value per Barrel-Oil-Equivalent

Ps, Probability of Opportunity Economic Success

Dependent Risk, P(petsys)
Probability that Petroleum System exists in the defined opportunity. Probability of average prospect encountering technical oil & gas. Probability of any individual discovery exceeding the Economic Threshold.

Independent Risk, P(prosp)

Economic Risk, P(threshold)

Failure Case Number of Consecutive Dry Holes

Wells willing to drill before exiting the opportunity.

Ps = P(petsys) x [1-{1-[P(prosp) x P(threshold)]}#ConsecutiveDryHoles]

DAAG 2001 Exploration Portfolio Management

Ps is Asymptotic at Dependent Risk

P(petsys) x [1-{1-[P(prosp) x P(threshold)]}#ConsecutiveDryHoles]

Dependent Risk
100% Proba bility of O or More ne 90% E conomic Successes 80% 70% 60% 50% 40% 30% 20% 10% 0% 0

Independent Binomial Probability Equation

Asymptotic at Dependent Risk

P(petsys) = 0.70 P(prosp) = 0.40 P(threshold) = 0.80

1 2 3 4 5 6 7 8 9 10

Number of "Consecutive Dry Holes"

DAAG 2001 Exploration Portfolio Management

Calculated Tool Output

Individual Prospect
Probability of Prospect Exceeding Economic Threshold Prospect Economic Field Size Distribution

Opportunity
( * critical output for MAU)

Risk Oil/Gas Volume Activity Cost Value

* Probability of Opportunity Economic Success

Success Case Technical Volume * Success Case Economic Volume

Success Case Number of Technical Discoveries Success Case Number of Economic Discoveries * Failure Cost Success Case Dry Hole Cost * Success Case Cost Success Case Discovery Value * Success Case Net Present Value * Risked Expected Monetary Value

DAAG 2001 Exploration Portfolio Management

Key Model & Tool Learnings

Management support and championing is critical. Dedicated data gathering team for consistency and QA. Reality check vs. other databases. Technologists understood and bought-in. Re-interview and iterate anomalies. Data is dynamic update with new information. Spreadsheet allowed quick, easy sensitivity analysis.
DAAG 2001 Exploration Portfolio Management

Multi-Attribute Utility Analysis

What Objectives Define the Best Exploration Opportunity?

Maximize Economic Value Maximize Economic Volume Minimize Economic Risk

Use Multi-Attribute Utility theory when

$ is not the sole measure of value, or objectives not easily translated into monetary-equivalents, or objectives conflict or have trade-offs.
Utility = Goodness based on decision-makers preferences. Define:

Objectives Objective Attribute(s) Attribute Utility Attribute Weight

DAAG 2001 Exploration Portfolio Management

Objectives Hierarchy, Attributes, Weights

Maximize Value

45%

Maximize Reward

Expected Monetary Value

10%

Success Attribute NPV

15%
Minimize Cost Failure Cost

Best Exploration Opportunity

15%
Success Cost

5%
Maximize Volume 35% Success Econ. Volume

35%
Minimize Risk

20%

Prob. of Opp. Econ. Success

20%
DAAG 2001 Exploration Portfolio Management

Utility: Risk Neutral, Averse, Seeking

Risk Averse Utility Curve. an 800 million barrel
discovery has about same utility as a 1000 million barrels.
1.00

U(800)=0.95 U(800)=0.80

U(1000)=1.00

Linear Utility curve is Risk Neutral.

Utility(x)

U(800)=0.50

0.00 Min: 1 Company Success Case Volume Level: 800

Risk Seeking Utility curve shows gambling tendency. Only big payoffs have big Utility.
Max: 1000

Calculate weighted-average composite utility for each opportunity.

DAAG 2001 Exploration Portfolio Management

Utility Ranking Shows Impact

Constrained capital budget requires prioritized ranking Rank order on descending Utility Fund the highest Utility projects
20

Cumulative Failure Cost vs. Cumulative Utility

18

16

14

C .U um tility

12

10

Linear expected a curve. No relationship between Failure Cost and Utility.

$0 $400 $800 $1,200 $1,600 $2,000 $2,400

Cum . Expl. Cos t (BT) ove r Five Ye ar s

DAAG 2001 Exploration Portfolio Management

Efficiency Ranking Shows Bang-for-Buck

Efficiency = Utility / Failure Cost Rank order in terms of Efficiency Fund the most Efficient projects
20 18

16

Efficient Frontier
By ranking on Efficiency can attain: -the same Utility for $400 million less or -a 20% higher Utility for same dollars.
$0 $400 $800 $1,200 $1,600 $2,000 $2,400

14

C .U um tility

12

10 8

Cum . Expl. Cos t (BT) ove r Five Ye ars

DAAG 2001 Exploration Portfolio Management

Dialog and Understanding of S/W/B/C

Low Utility & High Efficiency: More funding to increase Utility?
Utility Ranking 3Q 2Q 30

60

4Q

45

15

1Q

High Utility & High Efficiency: Fund As-is Sunk Costs Questions? High Utility & Low Efficiency: Decrease & Control Costs

1Q
Efficie ncy Rank ing 2Q 3Q

Low Utility & Low Efficiency: Reject & Farm-Out

4Q
DAAG 2001 Exploration Portfolio Management

Key MAU and Ranking Learnings

Management support and championing critical. Defining objectives, attributes, utilities, weights is key.
Too many attributes led to regression to the mean so that hard to differentiate middle-of-the-pack.

Rankings are not the final answer.

Facilitate dialog and understanding.

Sensitivities can easily and quickly:

Address management concerns. Identify ways to optimize opportunities.

Portfolio Management is learning process.

Be willing to modify and enhance.
DAAG 2001 Exploration Portfolio Management

Challenges and Concerns

Management Championship
Communication Understanding

Opportunity Granularity
Consistency Compositing

Sunk Costs Or Costs-Forward Only? Political, Regulatory, Environmental Risks Ranking on Utility or Efficiency?
Before-Tax or After-Tax

Multi-Year Budgeting Sticking to Failure Case Models Enhance with Monte Carlo and Linear Programming
DAAG 2001 Exploration Portfolio Management

Backup

DAAG 2001 Exploration Portfolio Management

Exploration Portfolio Management Process

Model and Data Capture/Calculation Tool Input: Interview, Capture, Reality Check Output: Calculate, Gather, QC, Re-interview Multi-Attribute Utility (MAU) Analysis Objectives Hierarchy Attributes and Weights Utility Curve for Each Attribute Ranking and Budgeting Calculate Weighted-Average Utility for Each Opportunity Rank Order All Opportunities in Portfolio Facilitate Dialog about Opportunity S/W/B/C
DAAG 2001 Exploration Portfolio Management

Utility Curves: Risk Neutral,Risk Averse

Risk Averse Utility Curve. an 800 million barrel
discovery has about same utility as a 1000 million barrels.

1.00

U(800)=0.95

U(1000)=1.00 U(800)=0.80

Utility(x)

A linear Utility curve is Risk Neutral.

0.00 Min: 1 Level: 800 Max: 1000
DAAG 2001 Exploration Portfolio Management

Company Success Case Volume

Utility Curves: Risk Seeking

1.00

$ Utility curves should be Risk Neutral.

U(800)=0.80

Utility(x)

U(800)=0.50

Risk Seeking Utility curve shows a gambling tendency. Only big payoffs have big Utility.
0.00 Min: 1 Level: 800 Max: 1000

Company Success Case Volume Calculate weighted-average composite utility for each opportunity.
DAAG 2001 Exploration Portfolio Management

Success Arm Economic Volumes & Value

On the Success Arm of the Decision Tree,
Number of Economic Discoveries = Number of Wells Drilled x P(local) x P(threshold) Conditional Field Size Distribution = Range of Volumes in excess of Economic Threshold Company Economic Volumes = Number of Economic Discoveries x Conditional FSD x Company % Discovery Value = Company Economic Volumes x NPV/Barrel-Oil-Equivalent (note that NPV/BOE is for a successful development, excluding exploration dry hole costs) Success Arm Dry Cost = (Number of Wells Drilled - Number of Discoveries) x Co. Well Cost Success Value = Discovery Value - Success Arm Dry Cost
DAAG 2001 Exploration Portfolio Management

Failure Arm Cost and EMV

On the Failure Arm of the Decision Tree,
Failure Cost = Number of Consecutive Dry Holes x Co. Well Cost + Overhead + Seismic & Geology Costs + Land Cost (Discounted at Co. Discount Rate. Before-Tax and After-Tax Costs also calculated)

The risked Expected Monetary Value is:

Expected Monetary Value = Ps x Company Success Value Pf x Company Failure Cost

DAAG 2001 Exploration Portfolio Management

Quartile Ranking: Utility vs. Efficiency

Utility (Volumes, Value, Risk) Efficiency (Utility/Failure Cost)

4Q 1Q 2Q 3Q 4Q
EDWNG KPS CD AKC KLO CS S ISA

3Q
AKT

2Q
TPS NH ACG BC PF ACO SPF

1Q

M IMDWC UFSB IB IMRT KLO IS

NCVGT LOE LG LM NCVGJ UHRFB PAO BDW UMBQP VCLB VE

CFP BCT LSE PAGC BES EDWNO IDWKG

SAS G NAM RS STP SMCT NDW KFSO IEJC SLRFB

VM UAS UMBPM URT

A SWT UMBPM CDNS CA

DAAG 2001 Exploration Portfolio Management