This section has examined the current situation in

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Unformatted text preview: way in which the oil and gas industry does business by driving improved SCM and industry-wide collaboration. This section has examined the current situation in the U.K. oil industry. It has highlighted the increasing complexity of the business environment of petroleum companies operating in the U.K.. The next section shows why, given these recent changes, the industry provides such a useful example in which to study investment decision-making. The effect of these changes on the investment decision-making 51 processes adopted by companies in the industry will then be examined using the results from recent studies of current practice. 3.4 INVESTMENT APPRAISAL DECISION-MAKING IN THE OIL INDUSTRY Risk and uncertainty are inherent in petroleum exploration (Bailey et al., in press; Simpson et al., 2000 and 1999; Lamb et al, 1999; Watson, 1998; Newendorp, 1996; Rose, 1987; Ikoku, 1984; Megill, 1971 and 1979). The circumstances that led to the generation of oil and gas are understood only in a very general sense (Newendorp, 1996; Ikoku, 1984). The existence, or more particularly the location of traps, cannot be predicted with certainty. Even when a trap is successfully drilled, it may prove barren for no immediately discernible reason (Ikoku, 1984). Indeed, worldwide approximately nine out of ten wildcat wells (which cost approximately $15 million to drill offshore) fail to find commercial quantities of hydrocarbons (Watson, 1998; Pike and Neale, 1997; Hyne 1995). Whilst in the North Sea, of the 150,000 square miles of the U.K. area that have been offered for licence, it has been estimated that only 2% has hydrocarbons beneath it (Simpson et al., 1999). Furthermore, the economic factors that ultimately affect the exploitation of the resources are subject to capricious shifts that, it has been claimed, defy logical prediction (Ikoku, 1984); an effect that is exacerbated in the oil industry since exploration projects require a large initial capital investment without the prospect of revenues for ten to fifteen years (Simpson et al., 1999). Such observations led Newendorp (1996) to conclude that risk and uncertainty are frequently the most critical factors in decisions to invest capital in exploration. In reality he argues, each time the decision-maker decides to drill a well, he is playing a game of chance in which he has no assurance that he will win (Newendorp, 1996). Previously, when most exploration wells were shallow and drilling anomalies were numerous and easy to locate, the upstream decision-maker was content to utilise intuition, judgement, hunches and experience to determine which prospects to drill (Newendorp, 1996). However, as noted in sections 2.2 and 2.3, the worldwide petroleum industry has changed, and many decision-makers are uncomfortable basing their investment decisions on such an informal approach (Chapter 6; Ball and Savage, 1999; Newendorp, 1996). Consequently, decision analysis tools, which allow risk and uncertainty to be quantified, have recently begun to receive in...
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This document was uploaded on 03/30/2014.

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