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Unformatted text preview: f the decisions
taken in the upstream. These are: they form part of a multi-stage decision process
(figure 5.1); they are, to a large extent, irreversible; there is uncertainty associated
165 with most of the input parameters to the decision analysis; and a decision-maker
can postpone the decision to allow the collection of additional data to reduce risk
and uncertainty. These characteristics mean that traditional DCF techniques can
be modified through the application of option theory (see, for example, Dixit and
Pindyck, 1998 and 1994) to assign credit to an opportunity for being able to assess
and to avoid the downside uncertainty involved in a decision by aborting or
postponing that decision until certain conditions are met. Many companies having
been doing this to a limited extent, perhaps without realising that it represented the
application of option theory, through the use of decision trees. The simple representation given by the decision tree in figure 7.1, illustrates the benefit of
minimising expenditures by realising that a discovery may be too small to be
economic and exercising the option of limiting investment to exploration and
appraisal seismic and drilling, and waiting until commercial considerations (price,
costs, taxes) change and the field becomes economic, or not developing at all,
rather than developing at a loss. Dixit and Pindyck (1994) outline more rigorous
mathematical techniques for assessing the option value of the uncertainty in an
investment over which one has the ability to delay commitment, but the principle
is the same.
The value of applying option theory to the oil industry has still to be proven. It
has only recently begun to attract significant attention within the industry
literature and there is no software currently available to automate its use.
Cost/value xx N
ci a Discovery P90
P50 xx = xx Dry
Hole * xx * xx = xx * xx = xx xx * xx = xx xx * xx = xx
xx Cost/value Cost/value
xx xx l Commercial P10 Opportunity EMV Figure 7.1: A decision tree 166 = xx 13 Preference, or utility, theory. As indicated in Chapter 5, this aspect of decisionmaking recognises the fact that companies (or, indeed, decision-makers within
companies) do not all have the same attitude towards money. For example, a
smaller company will be much less able to sustain losses than a larger company,
and will therefore be much more wary of risky projects with downside risks that
could bankrupt the company.
Whilst preference theory has been widely applied to the industry in the literature,
its value is questionable. There are difficulties in obtaining preference curves and
in the construction of corporate preference curves. There is, however, some
software available to automate the technique.
For techniques 8-13, two points will be assigned where the technique is used
routinely in organisations for investment appraisal and appropriate training is
given to staff. One point will be allocated for partial implementation and zero
points for non-usage. 14 Qualitat...
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- Summer '14
- The Land