Improved Framework for Measuring the Magnitude and Impact of Biases on Project Evaluation
- Malik K. Alarfaj (Texas A&M University) | Duane A. McVay (Texas A&M University)
- Document ID
- Society of Petroleum Engineers
- SPE Reservoir Evaluation & Engineering
- Publication Date
- February 2020
- Document Type
- Journal Paper
- 45 - 67
- 2020.Society of Petroleum Engineers
- probabilistic, uncertainty assessment, biases, calibration
- 3 in the last 30 days
- 115 since 2007
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Several authors over several decades (Capen 1976; Brashear et al. 2001; Rose 2004) have observed that the petroleum industry has consistently performed below expectations. Although this has been painfully obvious during the industry downturn beginning in 2014, available evidence suggests that even when the industry is profitable (e.g., during the decade before the most-recent downturn), it still performs substantially below expectations and its potential (Nandurdikar 2014). Many attribute this underperformance to cognitive biases in project evaluation, resulting in poor project valuation and selection. McVay and Dossary (2014) presented a simplified framework to estimate the cost of underestimating uncertainty. They demonstrated that chronic overconfidence and optimism (estimated distributions of project value are too narrow and shifted positively), which are common in the industry, produce substantial disappointment (realized portfolio values being less than estimated values), also common in the industry.
In this work, we generalized the McVay and Dossary (2014) framework to include full estimated distributions (e.g., normal or lognormal), instead of the truncated distributions they used. In addition, we extended their framework to model underconfidence (estimated distributions too wide) and demonstrate that underconfidence is just as detrimental to portfolio performance as overconfidence. Decision error will be minimized and portfolio value will be maximized only when there is no bias in project estimation (i.e., neither overconfidence nor underconfidence and neither optimism nor pessimism). We compared the value gained from reducing biases with that from reducing uncertainty and found that reducing biases consistently generates more value than reducing uncertainty.
Using either framework, operators can quantitatively measure biases—overconfidence, underconfidence, optimism, and pessimism—from lookbacks (comparing actual performance with probabilistic forecasts) and calibration plots. Once aware of the direction and magnitude of biases, operators have means for eliminating these biases in new forecasts through a combination of internal adjustment of uncertainty assessments, by means of training or ongoing feedback, and external adjustment of assessments, using measurements of bias from calibration results.
|File Size||2 MB||Number of Pages||23|
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