Price Uncertainty Quantification Models Advance Project Economic Evaluations
- Grant Theodore Olsen (Devon Energy Corp.) | Festus Lekan Fariyibi (Texas A&M University) | W. John Lee (Texas A&M University) | Duane Allen McVay (Texas A&M University)
- Document ID
- Society of Petroleum Engineers
- SPE Hydrocarbon Economics and Evaluation Symposium, 3-5 April, Dallas, Texas
- Publication Date
- Document Type
- Conference Paper
- 2005. Society of Petroleum Engineers
- 3.2.1 Risk, Uncertainty, and Risk Assessment, 3.1.2 Economic Analysis Guidelines
- 0 in the last 30 days
- 677 since 2007
- Show more detail
- View rights & permissions
|SPE Member Price:||USD 5.00|
|SPE Non-Member Price:||USD 28.00|
Conventional oil and gas price forecasts typically include pessimistic, most-likely, and optimistic cases in an attempt to quantify economic uncertainty. An analysis of forecasts presented by industry and governmental organizations illustrates that conventional forecasting methods typically underestimate significantly the full range of uncertainty in oil and gas price forecasts. Economic indicators calculated using such forecasts will not reliably quantify investment risk. In this investigation we compared and contrasted several recently developed methods for quantifying upstream petroleum investment risk due to uncertainty in future prices. We analyzed five forecasting techniques - conventional, bootstrap, Inverted Hockey Stick (IHS), historical, and Sequential Gaussian Simulation (SGS). These techniques were applied to three synthetic projects and 23 industry projects to examine the uncertainty associated with economic indicators such as net present value, investment efficiency, and internal rate of return. Across all 26 projects, the conventional forecasts predicted a narrower range of economic indicator values than the four alternative methods, indicating that conventional methods routinely underestimate uncertainty.
All four alternative forecasting techniques can provide operators with more reliable quantification of the uncertainty inherent in their investment decisions than provided by conventional methods currently in widespread use. The four alternative methods have unique strengths and weaknesses that may affect their applicability in particular situations. The SGS methods is the most rigorous and accurate method; however, it is also the most difficult to apply. The IHS method serves as a reasonable approximation, and can be easily incorporated into existing procedures and software.
Investments in the petroleum industry are made under significant uncertainty. According to Capen, uncertainty is underestimated on an almost routine basis. Stermole and Stermole note that uncertainty will be a factor "no matter how comprehensive or sophisticated an investment evaluation may be." Experts have stated that oil and gas producing assets are subject to three classes of uncertainty: technical, political, and economic. Economic uncertainty affects investments within the petroleum industry at least as much as its technical counterpart. Unlike technical uncertainty, which should decrease with production of a reservoir, economic uncertainty does not decrease over the life of a petroleum reservoir. Future oil and gas prices represent a substantial source of economic uncertainty for operators considering exploration and development opportunities. Wiggins claims that price projections are as important as reserves determinations and production forecasts when evaluating hydrocarbon-producing properties. Campbell et al.  affirmed that errors in project valuations are more attributable to price forecasts than any other component. Although we cannot eliminate uncertainty from investment evaluations, we can better quantify the uncertainty by accurately predicting the volatility in future oil and gas prices. Reliably quantifying economic uncertainty will enable operators to make better decisions and allocate their capital with increased efficiency.
Price projections within the petroleum industry are often comprised of pessimistic, most-likely, and high cases in an attempt to quantify uncertainty. Typically, these forecasts initially decline or remain flat for a period of time before increasing monotonically. Such price projections are referred to as "hockey stick" forecasts. The California Energy Commission (CEC) published a natural gas price forecast beginning in 1997 that clearly illustrates the characteristic "hockey stick" shape commonly exhibited by conventional price forecasts (Fig. 1). A segment of the CEC natural gas price forecast beginning in 2002 is shown in Fig. 2 along with actual gas price data realized by the market. The CEC forecast clearly underestimates the true range of product price uncertainty. A considerable portion of the actual gas price data falls outside of the high and low extremes presented in the forecast.
|File Size||415 KB||Number of Pages||9|