Posted on June 15, 2017 by Lisa Ward

Rose & Associates Success Plan

Suppose I said to you “Sue’s got a bug”. Quickly now…what do you think Sue has? If you’re a programmer, you probably think Sue has a computer virus. But if you’re a doctor, perhaps the flu comes to mind. And if you’re an entomologist, a ladybug may be your first thought. Did you consider all three as possible outcomes? Probably not. And what about some others? If you’re a spy, you might think Sue found a listening device. If you sell cars, you might think Sue bought a Volkswagen Beetle. The list goes on and on.

So why didn’t all of these come to your mind? Well first off, I asked you to respond quickly, which reduced the time you spent thinking about it. And second, you based your response on your intuition, instinct, or experience. You responded reflexively. This is inherently how we make most decisions every day. Do you know how much fat and calories are in that Sausage McMuffin you ordered? Did you review the economic fundamentals before acting on a friend’s stock tip? Did you read the TripAdvisor reviews that mentioned bedbugs in the hotel you booked? The answer to all of these is probably “no”. We neither have the time nor stamina to properly frame each decision in terms of uncertainty and risk.

The same is true in our working lives. However, the difference is that we’re paid to make good decisions in our jobs, and those decisions often involve millions of shareholder dollars. In these situations, we can’t afford to think reflexively. Instead, we need to think reflectively, which requires deliberate time and effort.

There are multiple tools to help us approach oil and gas decision analysis reflectively including…

  • staged approach focuses on determining what project stage you’re in, the key risks and uncertainties associated with that stage, and what data gathering and analyses you want to undertake to make a good decision about whether to move to the next stage.
  • Probabilistic thinking requires that we quantify the range of possible outcomes and assign a degree of confidence to any given outcome. This is much better than providing a single deterministic value as the most likely case because this is rarely (if ever) the actual outcome.
  • An assurance process, which provides independent and consistent guidance in the assessment of opportunities. This commonly involves subject matter experts involved in peer assistance and/or peer reviews.
  • Asking the right questions, means decision-makers need to probe 01. the work used to justify the recommendation, 02. whether the base case could be pessimistic/optimistic, and 03. whether credible alternatives were considered.

This sounds straightforward enough, but companies struggle to implement and apply these processes to their decision-making consistently. New management teams want to reorganize the way things are done. Staff turnover erodes the memory of what worked and what didn’t. Teams have turf to defend and walls to build. All of these contribute to lapsing into reflexive thinking.

“So what”, you say. “Let’s be bold and use our gut to guide us”. Could this be a successful strategy? Occasionally it does work, which provides memorable wildcatter stories (consider Dad Joiner). But given that oil and gas companies are in the repeated trials business, you’ll eventually succumb to the law of averages. For example, if we look at shale plays in the U.S., only about 20% of these have been commercially successful. You might get lucky by drilling a series of early horizontal wells in a shale play, but it’s more likely that you’ll squander millions of dollars you didn’t need to spend to realize that the play doesn’t work. In this sense, we’re like Alaskan bush pilots. There are old bush pilots and bold bush pilots. There are no old and bold bush pilots. If you want longevity, you need discipline.

Recently, we’ve begun to understand more about how people make decisions with their gut. It turns out that these reflexive decisions are very likely to be affected by cognitive bias. These are errors in thinking whereby interpretations and judgments are drawn in an illogical fashion. Some definitions and examples of this cognitive bias in the oil and gas industry are listed below:

  • Anchoring: attaching an evaluation to a reference value. Example: focusing on one geological model or a favored seismic interpretation.
  • Availability: overestimating the likelihood of more memorable events. Example: the recent well drilled by an offset operator with a huge initial production rate.
  • Confirmation: interpreting data in a way that confirms our beliefs. Example: collecting data in the most prospective area and extending this interpretation elsewhere.
  • Framing: reacting to a particular choice depending on how it is presented. Example: only comparing your opportunity to successful analogs.
  • Information: having a distorted assessment of information and its significance. Example: equating missing or low-quality data with a low or high chance of success.
  • Overconfidence: overestimating the accuracy of one’s own interpretation or ability. Example: generating a narrow range of resource estimates.
  • Motivational: taking actions or decisions based on a desire for a particular outcome. Example: Overstating the chance of success or size of the prize to get a project funded.

So if you’re going to make decisions “with your gut”, at least realize the types of cognitive bias that could impact your decisions, and take some steps to lessen their impact on your exploration risk analysis, resource play evaluation, or production type curve generation.

With this in mind, we’ve come up with a new 2-day course at Rose and Associates called “Mitigating Bias, Blindness, and Illusion in E&P Decision-Making”. This course, in concert with our portfolio of courses, consulting, and software designed to help you think more reflectively about your project, is aimed at helping you make better decisions. Check out our offerings.

~ Creties Jenkins, P.E., P.G., Partner – Rose and Associates

Posted on April 27, 2015 

The oil and gas industry remains the primary source of the world’s energy despite efforts to enhance the viability and acceptability of alternative sources. The growth potential for this industry is stable provided oil and gas risk analysis is deployed at strategic phases. The challenges faced by this sector span various aspects, including financial, strategic, operational, and regulatory compliance.

Risks Faced by the Oil and Gas Industry

Financial Risks
Price volatility has been a major concern for the sector, but the urgency of this issue has been heightened with increasing costs of extraction and the frequency of political events that affect oil prices. For the most part, the industry favors extraction locations where the political system is stable since a change in leadership may lead to different regulations that directly affect operations.

Strategic Risks
While competition from alternative energy sources and new technologies remains limited, the oil and gas industry has to contend with fluctuations in demand. Politics may also add to strategic challenges. Access to reserves, risk of nationalization, and a shift in the regulatory climate can be costly for the industry.

Operational Risks
Oil and gas experts are involved in frequent testing to ensure that estimates of accessible reserves approximate actual values, but geological risk also includes challenges with extraction, cost containment issues, and ensuring safe conditions as drilling has moved to less hospitable environments.

Compliance Issues
Regulatory compliance has exacerbated operational and financial challenges. As safety regulations and environmental guidelines are tightened, the oil and gas sector is pressured to add substantial investments to ensure compliance.

Quantitative Oil and Gas Risk Assessment

Significant risks faced by the oil and gas industry coupled with massive investments involved to sustain operations have driven the need to deploy leading-edge methodologies to evaluate projects and measure risks. Mitigation strategies are most effective when oil and gas risk assessment involves an in-depth study of risks involved, including detailed determination and quantitative evaluation of risks involved to optimize investment returns.

DCF or Discounted Cash Flow, Sensitivity, and Scenario Analyses
The Discounted Cash Flow method compares the targeted rate of return or hurdle rate to the estimated net present value of the cash flow of the project. The DCF method is widely used in the industry as it provides a sound approach to accounting for the time value of financial investments, and it provides a clear baseline for critical decision-making. This method comes with a few inherent issues, including assumptions that cash flow is static, the discount rate sufficiently accounts for project risks, and inadequate assessment of risk mitigation efforts.

The application of sensitivity analysis and scenario analysis methodologies may address these shortcomings of the DCF method. Evaluating for uncertainty generates a range of values for the project’s metrics although the output may not adequately describe the range of possible outcomes for the project.

Quantitative Risk Analysis
Quantitative risk analysis takes each input and defines a set of characteristics to describe probability distributions. These metrics may include minimum and maximum values, expected values, standard deviations, and percentiles. Valuation models correlate the distributions to generate a relevant description of possible outcomes.

Advantages of Risk Analysis

Quantitative oil and gas risk assessment provides for a broader and more in-depth accounting for uncertainties in project outcomes. The qualitative portion of the analysis identifies underlying factors that enhance risks. The ability to evaluate critical risk factors for oil and gas projects is crucial to optimizing outcomes and planning for effective and cost-efficient risk mitigation programs.

Substantial investments are required for gas and oil exploration and production projects. The attendant risks involved in this industry are considerable especially given increased regulation and vulnerability to political factors, which are among the wide-ranging factors affecting this sector.

Regardless of the size of the project or the outfit, operators may benefit from experts who specialize in petroleum economics consulting. Professionals with the experience and skill set to audit project risks, generate risk assessment surveys, and present mitigation strategies based on possible outcomes will certainly provide industry-relevant parameters for managing oil and gas projects.