M.SC Petroleum Economics
M.SC Petroleum Economics
M.SC Petroleum Economics
ECONOMICS
BY
G.C.ENYI
SCHOOL OF COMPUTING, SCIENCE AND
ENGINEERING
UNIVERSITY OF SALFORD
MANCHESTER, UK.
AIMS
To introduce the basic concepts
and background for the financial
and economic assessment of
projects within the petroleum
industry.
OBJECTIVES
Be able to calculate the NPV of a project
including the collection of all necessary
data, carry out Decision Tree Analysis and
be able to select the best option from
several possibilities.
Be able to assess risk and uncertainty
related
to
projects
and
carry
out
probabilistic resource calculations.
Be able to carry out simple portfolio
management decisions under conditions of
uncertainty, including economic, technical
and political risk.
TEXTS
Petroleum Evaluations and Economic
Decisions: Arthur W. McCray, PrenticeHall, Englewood Cliffs, New Jersey.
Risk Analysis and Management of
Petroleum Exploration Venture: Peter
R. Rose, AAPG, ISBN 0-89181-663-1.
Economics of Worldwide Petroleum
Production: F.H. Allen and R.D. Seba,
OGCI, ISBN 0-930972-17-1.
OUTLINE
INTRODUCTION
PROFITABILITY OF A VENTURE
PRODUCTION ECONOMICS
INTRODUCTION
The Engineering economy and engineering
economics or engineering economic analysis
are all used interchangeably to denote the
study of the economics of engineering
systems.
Engineering economy is an applied economics
course. Since the application is engineering
systems this economics course is taught by
engineering faculty.
As future engineers, no matter what type, you
will sooner or later have to deal with problem
situations similar to the ones covered in this
course. At the end of the course you will be
ECONOMIC
DECISION
Why
economics?
WhyI need
do toIdoneed
to study
"Is
it not enough for me to be a
economics?
good engineer? I am not an
"Is
it not enough for me to be
accountant.
good
engineer?
I am
a
I will
ask the
accountant
in mynot an
company
to do that work for me.
accountant.
OTHERS
lor
a
an tion
Ge d
olo
gy
Envir
onm
en
tal
n
uctio
Prod
in
neer
Engi
g
Wel
l
En
g
i
n
e
e
r
i
n
g
Economi
cs
ss n
e
c
ri
o
r
e
P ne
i
g
g
En
DECISION MAKING
ENVIRONMENT
The environment within which
decision making takes place can be
logically divided into three parts or
states:
Certainty
Risk
Uncertainty
DECISION MAKING
ENVIRONMENT
Certainty exists when one can specify
exactly what will happen during the
period for which the decision is being
made.
Risk refers to a situation where one can
specify a probability distribution over
possible outcomes.
Uncertainty refers to the condition when
one cannot specify the relative likelihood
of the outcomes.
WHY DO WE MAKE
ECONOMIC EVALUATION
1 Prioritize projects.
2 Re-evaluation of priorities in allocation of
investment funds by
the company.
3
Planned change in development or
production methods that
consequently may affect the production
rate and ultimate
recovery.
4 Assessment of value of assets for taxation
purposes.
Whatever
the
reason
for
conducting
an
WHY DO WE MAKE
ECONOMIC EVALUATION
The economic analysis should
lead toward an unbiased answer
to two questions:
1 Does the particular
investment project seem to
satisfy the stated objectives of
the firm?
WHY DO WE MAKE
ECONOMIC EVALUATION
Even if there were only one
investment opportunity under
review,
it
must
favourably
compare
with
other
profitgenerating activities This is the
concept of opportunity cost the
advantage
forgone
due
to
alternative use of investment
CHARACTERISTICS OF OIL
AND GAS RESOURCES
In addition to factors normally considered in capital
investments, some of the characteristics of oil and gas
that may affect the results of economic analysis are:
1 The long lead time from geologic discovery to
full use of the resource (5 12 years)
2 The political and social environment in the
region ( takeovers, shutdown of operations)
3 Tax burden and special allowances customary
in oil and gas accounting
4 The heterogeneous nature of deposits ( no two
deposits are identical)
5 The nonrenewable nature of oil and gas
resources
ASPECTS OF LEASING
* OIL AND GAS ARE MINERALS AND PART OF
LAND:
HOME GOVERNMENT (HG) OR LANDOWNERS
(LO) LEGAL RIGHT
IF HE SAYS NO THEN NO SHOW.
In some countries Govt owns the mineral rights
and only Govt can explore the minerals unless it
transfers right to another. If this happens we say
that Govt gives another a CONCESSION.
THREE COMMON OPTIONS FOR HG/LO
LEASE INTEREST
-There will be written agreement b/w HG (lessor) and the
Petroleum company (lessee) granting legal interest in HG
property.
-The right will revert to LO at the end of the lease term.
-The lease is granted for explicit period (primary term) and for
as long as petroleum is found in paying quantity.
-The LO reserves certain rights and privileges
* Bonus payment
Royalty payment
* Reversion of right
Surface rights
MINERAL RIGHTS
-
CONCESSIONARY
- No more prevalent
JOINT VENTURE
WORKED EXAMPLE
A well was drilled into an oil reservoir. Well logs
indicate that the reservoir has a thickness of 105 feet,
average porosity of 18.5 percent and average water
saturation of 25 percent. Analysis of offset wells
production in the area indicate that this well will drain
160acres with a recovery efficiency of 15 percent, and
the initial oil formation volume factor is 0.8 STB/res
bbl. What are the recoverable oil reserves.
SOLUTION
N = [7758 x 160 x 105 x 0.185 x (10.25) x 0.15] / 1.25
N = 2,170,068 STB
CASH
FLOW
EXPENDITURES
The total expenditures incurred in producing oil and gas wells may be
divided into two groups:
- the total capital cost (expenditure)
- the total operating cost (expenditure)
TAXES
Vary widely throughout the world.
Severance taxes: They include conservation and production taxes. They are levied by
governments and are based on production volume
Ad valorem taxes: These include property taxes
OVERHEADS
Costs not directly assigned to any unit of production but are
incurred as a result of general operations (R&D, Administration
and Management, Debt interest).
INCOME TAXES
The net revenue before income tax (net revenue after
expenses) is determined by subtracting total expenditures
before income tax from total revenue. The council, state and
federal taxes are subtracted from the net revenue before
income tax to give after tax net cash flow.
CASH FLOW
DIAGRAM
Dividends to
shareholders
Borrowed capitals
Income from
Patents, R&D
Corporat
ion cash
Cash flow
Outside investment
R&D
Working
capital
Sales
revenue
Depreciation
Direct
investment
Operations
Operating costs
Gross profit
Depletion
Amortisation
Other deductions
Net profit
Taxable income
Income tax
CASH FLOW
ANALYSIS
CASH FLOW
ANALYSIS
The accounting method that a company
chooses affects how its net income and
cash flow
numbers
are
reported.
Therefore, when analyzing companies
involved
in
the
exploration
and
development of oil and natural gas, the
accounting method used by such
companies is an important consideration.
CASH FLOW
ANALYSIS
successful
efforts (SE) method allows
The
a
company to capitalize only those expenses
associated with successfully locating new oil and
natural gas reserves. For unsuccessful (or "dry
hole") results, the associated operating costs are
immediately charged against revenues for that
period.
The alternative approach, known as the full cost
(FC) method, allows all operating expenses
relating to locating new oil and gas reserves regardless of the outcome - to be capitalized.
CASH FLOW
ANALYSIS
According to the view behind the
SE
method, the ultimate objective of an oil
and gas company is to produce the oil or
natural gas from reserves it locates and
develops so that only those costs relating
to successful efforts should be capitalized.
Conversely, because there is no change in
productive
assets
with
unsuccessful
results, costs incurred with that effort
should be expensed.
CASH FLOW
ANALYSIS
On the other hand, the view represented by
the FC method holds that, in general, the
dominant activity of an oil and gas company
is simply the exploration and development of
oil and gas reserves. Therefore, all costs
incurred in pursuit of that activity should first
be capitalized and then written off over the
course of a full operating cycle. The choice of
accounting method in effect receives
regulatory approval.
Cumulative Cashfows
Redevelopment
0
Appraisal
Production
Exploration
time
= Final Investment Decision
(incl. economics)
= Economic Analysis
Primary
Development
For Economist
WORKED EXAMPLE
From volumetric calculations, the recoverable reserves for a proposed well are
15 million barrels of oil. A joint venture agreement between the host
government and the IOC allows the host government 51% of the after tax profit.
Determine the host government take if the following economic conditions
prevail.
Oil price = $18 / bbl; Capex = $ 75 million; Opex = $ 30 million; Royalty = 20%;
Depreciation = $ 50 million; Tax rate = 75%.
SOLUTION
Revenue = 15 million x $18 = $ 270.00 million
Royalty (20% of Revenue) =
54.00 million **
Opex
= 30.00 million
Capex
=
75.00 million
Depreciation
=
50.00 million
Before tax profit
= 61.00 million
Tax (75%)
= 45.75 million **
After tax profit
= 15.25 million
JVA ( 51%)
=
7.78 million **
HG take
= 107.53 million
DEPRECIATION
DEPLETION AND
AMORTIZATION
Depreciation, Depletion and Amortization are the
means of recovering investment in certain types of
property in before tax basis.
DEPRECIATION
A reduction in the value of an asset over time, due in particular
to wear and tear. It is a non-cash expense that reduces the
value of an asset over time. Provision should be made for
depreciation of fixed assets.
DEPRECIATION
DEPLETION AND
AMORTIZATION
Depreciation, Depletion and Amortization are the
means of recovering investment in certain types of
property in before tax basis.
METHODS OF COMPUTING
DEPRECIATION
Straight Line
Double Declining Balance
WORKED EXAMPLE
A drilling bit with an estimated life of 5 years is purchased for
$33,000. Its salvage value at the end of the fifth year is estimated
to be $3000. Calculate the annual depreciation using the three
methods.
SOLUTION
EFFECTS OF
DEPRECIATION ON CASH
FLOW
WORKED EXAMPLE
A
C
Sales
$1,000,000
$1,000,000
Operating Cost
200,000
200,000
Depreciation
50,000
000,000
Taxable Income
750,000
$1,000,000
200,000
50,000
750,000
800,000
Income Tax (50%)
400,000
375,000
Net Revenue
375,000
400,000
375,000
375,000
DEPRECIATION
DEPLETION AND
AMORTIZATION
DEPLETION
An accounting method that companies use to allocate the cost
of extracting natural resources such as, minerals and oil from
the earth. Depletion is calculated for tax-deduction and
bookkeeping purposes. Unlike depreciation and amortization,
which mainly describe the deduction of expenses due to the
aging of equipment and property, depletion is the actual
physical depletion of natural resources by companies.
Cost depletion is calculated by taking the property's basis, total
recoverable units and number of units sold into account.
Percentage depletion looks at the property's gross income and
METHODS OF COMPUTING
DEPLETION
After the life of the well. How will the
operator survive? HG/LO should give
some allowance to keep going until new
discovery Concept of Depletion.
Cost Depletion
Percentage Depletion (% of Gross
Income/Revenue)
50% of Taxable Income
NOTE:
COST DEPLETION
Where:
CD = Annual cost depletion allowance
B = Adjusted basis of the property ( C
CDprev)
P = Units of production sold or for
which payment was
received during tax year
R = Recoverable units of production
remaining at the
WORKED EXAMPLE
The purchase price of a producing property was
$150,000.
Engineering
estimate
of
the
recoverable reserves is 1,000,000 barrels.
Determine the cost depletion if the yearly
depletion for two years in the life of the project
is 50,000 barrels.
SOLUTION
For Year 1: Production = 50,000 bbls
Cost Depletion = $150,000{ 50,000 /
1,000,000} = $7,500
For Year 2: Production = 50,000 bbls
PERCENTAGE DEPLETION
EXAMPLE 1
COMPUTATION OF DEPLETION ALLOWANCE ASSUMING
PERCENTAGE DEPLETION (15%)
DEPRECIATION
DEPLETION AND
AMORTIZATION
AMORTIZATION
It refers to spreading an intangible asset's
cost over that asset's useful life. For
example, a patent on a piece of oilfield
equipment usually has a life of 17 years. The
cost involved with creating the equipment is
spread out over the life of the patent, with
each portion being recorded as an expense
on the company's income statement.
CLASSWORK
Consider an oil field to be developed. The first and second year
outputs were 3.6 and 1.8 million barrels of crude oil respectively
and the per barrel cost of the oil was $24.00. One-eighth of this
amount was paid as royalty to the landowner. The first and
second year operating costs were $18,000 and $9,000
respectively, overheads was $8,000 each year, taxes for years 1
and 2 were $7,600 and $3,800 respectively. Depreciation
allowance was $7,500 yearly while depletion was $8,000 for
year 1 and $4,000 for year 2. The capital investment for this
field was $22,000. Assuming income tax at 50%, generate the
field cash flow.
SOLUTION
The revenue and cost items are listed and the cash flows generated in
thousands of dollars are shown.
Year 1
Revenue
Year 2
75,600
37,800
-18,000
-9,000
Overheads
-8,000
-8,000
Taxes
-7,600
-3,800
Depreciation
-7,500
-7,500
Depletion
-8,000
-4,000
Taxable income
26,500
5,500
-13,250
-2,750
Net profit
13,250
2,750
Depreciation
+7,500
+7,500
Depletion
+8,000
+4,000
Capital investment
-22,000
6,750
14,250
Operating costs
TIME VALUE OF
MONEY
A basic concept in economic analysis is that
money has a time value. A sum of money now
is normally worth more than an equal sum of
money at some future date.
Long lead time between initial investment in
exploration and development of oil and gas
resources and the inflow of revenue when the
fields are fully productive implies dealing with
TIME VALUE OF
MONEY
INVESTMENT
TERMINOLOGY
The Principal is
money borrowed
or invested.
the
amount
of
INTEREST FORMULAS
The symbols used for interest
formulas are:
i = interest rate per interest
period (%)
n = number of interest periods
(years)
P = present sum of money ($)
F = future sum of money form n
interest
F = P(1 +
D
iscountFacor1/i
DISCOUNT
FACTORS
F=
=
$53,972.50
2)To receive $10,000 in the future 20 years from now,
how much should I deposit today at 10% interest per
CONTINUOUS INTEREST
FORMULAS
Many people believe that it is more
representative
of
actual
business
conditions to treat those transactions
which occur fairly uniformly throughout
the year as continuous cash flows.
Because
these
cash
flows
are
continuous and earnings are created
uniformly through the year, interest is
also treated continuously in such cases.
PROFITABILITY OF A
VENTURE
This is the yardstick for measuring
the
productivity
of
individual
investment.
Companies
usually
consider the possible benefits they
may derive from ventures before
investing
money. The
financial
benefits,
expressed
by
the
profitability of the investments are
PROFITABILITY OF A
VENTURE
There are two kinds of yardsticks:
Screening which ventures meet the
minimum qualifications to be considered
for investment.
Ranking which of two or more
mutually exclusive ventures is the most
desirable.
PROFITABILITY OF A
VENTURE
PAYOUT (PAYBACK) PERIOD
This is the time required for the cumulative net earning to equal
the initial investment. It measures the speed with which invested
funds are returned to the business.
The shorter the period, the better and the higher the project is
rated.
PROJECT
B
Investment
A
250,000
250,000
Annual Income
75,000
50,000
DISCOUNTED PROFIT-TOINVESTMENT
RATIO (DPR)
It is defined as the ratio of total net profit to
the investment.
i = minimum acceptable
ROR
It is used when money is limited but you
have
several investments options.
PROFITABILITY OF A VENTURE
NET PRESENT VALUE (NPV)
The net present value (NPV) or net
present worth profit is the algebraic sum
of all net cash fows when discounted to
time zero using a single discounting rate.
STRATEGY FOR SELECTION
1)Accept projects that maximize NPV
profit and reject all project having
negative NPV profit (except to meet
certain objectives pollution control to
WORKED EXAMPLE
The cost of putting a well on stream is $1,500,000. The after tax
cash flows generated by the investment for six years are:
Year
Cash Flow
(Revenue) ($)
1,000,000
800,000
600,000
400,000
200,000
100,000
Total
3,100,000
SOLUTION
CONCLUSION
The NPV discounted at 15% is positive. This means
that the six years cash revenues are preferred to our
initial investment of $1,500,000 if the discount rate is
15%. If we invest the $1,500,000 we would make a
15% rate of return plus increase our net worth by
MID-YEAR PAYMENT
SOLUTION
Similarly:
ROR
PROCEDURE TO CALCULATE
DCFROR
It is calculated by a trial-and-error series of
calculations
List the annual cash flow.
Select a discount rate and list the discount
factors.
Calculate the present value of each annual
cash flow and
add the discounted values to obtain the NPV
of the cash
WORKED EXAMPLE
The cost of putting a well on stream is $1,500,000. The after tax
cash flows generated by the investment for six years are:
Year
Cash Flow
(Revenue) ($)
1,000,000
800,000
600,000
400,000
200,000
100,000
Total
3,100,000
SOLUTION
This involves trial and error computation. The
final stages of the computation are as follows:
SOLUTION
Interpolating between 0.35 and 0.45:
DCFROR = 0.35 + {105,112/(105,112 +
100,587)} (0.10)
= 40.11%
Hence investing $1,500,000 to buy the
future series of six annual revenues is
equivalent to investing $1,500,000 in a
project that pays 40.11% compound
PROFITABILITY OF TWO
PROPOSALS
Compare the profitability of the following two
investment proposals:
Proposal A: An investment of $100,000 today to
receive $120,000 continuously in one year.
Proposal B: An investment of $100,000 today to
receive $200,000 continuously in seven years.
Use continuous compounding method.
Profitability of two
investments proposals
Data for preparation of the present value profile are shown
below using the continuous compounding relationship.
Rate
(j)
NPV of
A
0
5
10
15
20
25
30
35
40
45
50
20000
17049
14195
11434
8762
6176
3673
1250
-1096
-3368
-5567
NPV of
B
100000
68750
45833
23821
7629
-5574
-16424
-25412
-32915
-39229
-44583
Profitability of two
investments proposals
The present value profiles for proposals A and B are shown
below
Profitability of two
investments proposals
Proposal A has a discounted cash flow
rate of return of 37.5% and a net profit
of $20,000 while Proposal B has a
discounted cash flow rate of return of
22.8% and a net profit of $100,000.
Using the profit-to-investment ratio, B is
a better option than A. However, P/I does
not reflect the time-rate pattern of
income from the prospects. This is one of
Profitability of two
investments proposals
The discounted cash flow rate of return
indicates A to be better proposal, while the
NPV at 15% indicates B to be the better
proposal.
The present value profiles give the whole
picture. The profile intersect at a discount rate
of 19.5%. This is the break-even point.
NOTE:
B/w: 0-19.5: B is good
Both are good
At 19.5:
Note
Primary production is better since it has lower
PBP and higher P/I at i of 20%.
If i =20%, and (Y-X) is 28%, then we can do
waterfooding (optional).
If i = 30%, and (Y-X) is 28%, then do not
ACCELERATION PROJECTS
An acceleration project is defined as a project applied to an
already existing profitable venture in order to bring future net
income forward in time.
The economic justification for accelerating lies in the fact that
the accelerated income is earned in fewer years than the unaccelerated, so that discounting will have less effect on the
accelerated than un-accelerated. Hence discounted profit from
the accelerated project might exceed that from the original
project.
Problems when no new reserves are generated.
The existence of two ROR further
interpretation of the profit indicators.
complicates
the
EXAMPLE
The estimated future net incomes for a certain project
are shown below. The project is under consideration
for acceleration, and the estimated future net incomes
are also shown. The capital cost involved in
undertaking the acceleration is $3000. Determine the
discounted profit and payback time, draw a curve of
difference in cumulative discounted net incomes
(accelerated less un-accelerated) against discount
rate, and find the rate of return if the earning power of
the company is 10% per cent/year. Assume that
income is paid as lump sum at the midpoint of the
year.
SOLUTION
ROR
ROR
RISK AND
UNCERTAINTY
When an organisation
undertakes project in which it has little or no recent
experience, there will be three distinct areas of uncertainty.
-Timing of the project and the cash flow it is expected to generate
- Direct outcome of the project ( accomplishment)
- The side effects of the project (its unforeseen consequences)
There is little one can do to eliminate the uncertainty. Decisions must be
taken in the face of the uncertainty.
We try to reduce such uncertainty by analysing the risk associated with it.
Risk analysis does not remove the ambiguity, it simply describes it in a
way that provides decision maker with a useful insight into their nature.
A risk is any uncertain event that, if it occurs, could prevent the project
realising the expectations of the stakeholders as stated in the agreed
business case of the project definition.
A risk that becomes a reality is treated as an ISSUE
Every risk always has a cause and if it occurs, a positive or negative
consequence sets in.
Many risks are well hidden away in the schedule and unless you look for
them, will impact your efforts at a time you least expected.
WHAT IS IMPACTED ?
1)Cost the overall cost of the project.
2)Schedule the time the project will take.
3)Scope the project deliverables and quality of the work.
ONE-POINT-ANALYSIS
Consider an opportunity to acquire an exploration concession for a
considerable sum of money. An analysis must first be made to
ascertain discovery that will offset all financial outlays and yield an
adequate return on expended capital.
The traditional approach is to perform the reserve in place using
volumetric reserve formula for best estimate values for the
individual petrophysical parameters. Through a combination of
experience, intuition, judgment and consensus the manager must
WEIGHTED AVERAGE
SENSITIVITY
Example:
Probability
0.15
0.30
Reserves
EV
NPV
0 Mbbl
75 M
200 Mbbl
900 M
500 M
3,000 M
Decisions and
Probability (Risk)
graduate 2
FALSE
Shell
120
The Graduate
0
120
Accept Job
200
Schlumberger
TRUE
200
1
200
Decisions and
Probability (Risk)
graduate 4
The graduate realizes that his expectation
earning with Schlumberger is only [0.8x85 +
0.2x200] = $108k, $12k less than with Shell.
He should join Shell.
TRUE
Shell
120
The Graduate(2)
1
120
Accept Job
120
Burn out
80.0%
85
Schlumberger
FALSE
0
0
85
Survive
108
Doing fine
20.0%
200
0
200
LIMITATIONS OF EMV
The assumption is that a decision maker will
want to choose a project that has the highest
EMV.
The analyses assume that decision makers will
want to play the average on all deals
regardless of the potential negative
consequences that might result. BUT IS THIS
TRUE?
Purely mechanical (judgment, experience of
Decision Maker NOT
incorporated)
Failure to take into account the different
financial circumstances
UTILITY THEORY
Utility theory states that each individual has a
measurable preference when faced with
choices among alternatives uncertainty, which
is called his utility.
It has unit called utiles.
The relationship between utiles and dollars
is called an individuals utility function
(curve).
The function is strictly personal and differs
UTILITY THEORY
It
recognises
that
the
second
increment of a substance may have
generally less value (utility) to a
person than the first increment.
Different people will of course have
different regard or desire for the same
substance.
Thus each person would have his
EXAMPLE
A company is planning to embark on a drilling
venture. The possible outcomes of the venture
are given below and the utility curve of the
company is attached:
Outcomes
Alternatives
Probability
Drill
0.4
0.6
-200,000
DECISION TREES
ANALYSIS
A line (pictorial) representation of a sequence
of events and possible outcomes.
The main problem is too many branches in the
future.
The point from which two or more branches
emanate is called a Node.
Two types of Node:
DECISION NODE: represented by a square. The
decision maker dictates which branch is taken.
DECISION TREES
ANALYSIS
The trees normally reads from left to right and
Decisio
n
Node
rry ella
a
C br
Luem
a
um ve
a brell
Even
Chance
t
Stay
Node
n
Dry
Rai
No
Ra
in Unnecessa
ry
Burden
Rain
No
Ra
in
Get
Wet
St
Dr ay
y
PIZZA
RESTAURANT
y
u
B
Don
t
Buy ($0)
Outcome
Low
-25,000
Medium
50,000
High
150,000
Low ($25,000)
Mediu ($50,00
m
0)
High ($150,00
0)
Probability
NPV
0.6
0.3
0.1
EXAMPLE
A company has a nontransferable short-term option to drill on a certain plot of
land. This option is the only business deal which the company is involved
now. Two recent dry holes elsewhere have reduced the companys liquid
assets to $130,000, and John Doe the president of the company must decide
within two weeks if drilling is to commence by then. Doe has three possible
choices:
1 Drill immediately
2 Pay to have a seismic test run, then, depending on the result, decide
whether or not to drill.
3 Let the option expire
The cost of seismic test is $30,000 and the well can be drilled for $100,000.
Another oil company has promised to buy any oil discovered for $400,000. A
geologist states that there is a 0.55 probability that there will be oil if a well is
drilled immediately. Data on the reliability of seismic tests indicate that if the
test result is favourable the probability of finding oil will increase to 0.85, but
if unfavourable it will fall to 0.10. The geologist has also said that there is a
0.60 probability that the result will be favourable if a test is made. If you were
Mr. Doe what will you do?
SOLUTION
The EMV at the top branch: (0.85)(+$400,000) + (0.15)($0) = $340,000
Compare with the EMV of dont drill = $100,000
(The maximum EMV of $340,000 is chosen for the top node.)
The EMV at the middle branch: (0.10)(+$400,000) + (0.90)($0) = $40,000
Compare with the EMV of dont drill = $100,000
(The maximum EMV of $100,000 is chosen for the middle node.)
The EMV at the bottom branch: (0.55)(+$430,000) + (0.45)($30,000) = $250,000
Compare with the EMV of dont drill = $130,000
(The maximum EMV of $250,000 is chosen for the bottom node.)
The EMV at the last top branch: (0.60)(+$340,000) + (0.40)($100,000) = $244,000
Compare with the EMV of dont drill = $250,000
(The maximum EMV of $250,000 is chosen for the last node.)
Does Decision
Drill
able
vour
a
f
t
0.6
Tes
c
mi
eis 00
s
,0
ke
Ta t $30
s
te
Test
unf
Oil
0.85
0
-$100,00
No Oil
Don
test t take s
eism
ble
0.15
Dont drill
Oil
avou
ra
$400,000
0.4
Drill
00
-$100,0
No Oil
Dont dri
ll
ic
Drill
Oil
$400,000
0.10
0.90
0.55
$430,000
No O 0.45
il
0
-$100,00
Dont drill
$340,000
0
-$100,00
Drill
$244,000
eis
es
k
Ta t
e
t s
c
mi
e
rabl
vou
a
f
t
Tes
Test
unfa
voura 0.4
ble
No Oil
Dont dri
ll
0.6
00
-$100,0
Drill
$400,000
Oil 0.85
0.15
$100,000
$100,000 il 0.10
O
0.90
No Oil
Dont drill
Don
test t take s
eism
ic
Drill
0
-$100,00
Dont d
rill
$0
$400,000
$0
$100,000
Oil
0.55
$430,000
0.45
$250,000 No Oil
$30,000
$130,000
DOES CHOICE
es
Tak
Don
t
ei
t
te s
c
i
sm
Tak
e se
ism
ic
test
+$244,000 (REJECT)
+$250,000 (ACCEPT)
CONCLUDING
REMARKS
The uncertainties in geology will always
be as the Creator made them. How the
problems of decision making in petroleum
engineering are solved depend on how
well engineers and managers apply new
ideas, knowledge and technology.
Petroleum exploitation is always an
exciting and challenging game a game
of chance but also of change.
Chi U. Ikoku
THANK
YOU
AND
GOODLUC