Page 376 - Hydrocarbon Exploration and Production Second Edition

Petroleum Economics 363

performed not simply by scaling, but by tailoring an engineering solution to each
case assuming that we would know the size of reserves before developing the field.
For example, the low case reserves may be developed as a satellite development tied
into existing facilities, whereas the high case reserves might be more economic to
develop using a dedicated drilling and production facility.
We define the EMV of the exploration prospect as

EMV ¼ Unrisked NPV POS PV exploration costs
where POS is the probability of success of an economic development; unrisked NPV
is the mean of the H, M, L NPVs (without any consideration of exploration and
appraisal costs); PVexploration costs are the discounted cost of the exploration activity.
The POS is estimated using the techniques discussed in Chapter 3.
An alternative way of considering EMV is by presenting the outcomes on a deci-
sion tree. Figure 14.16 is an example of a decision tree which uses the above values.
It is assumed that the cost of the exploration activity is $10 million. The NPV of
developing the high, medium and low case reserves are assumed to be $200, $80 and
$5 million respectively, so the low case actually makes a loss when taking into
account the exploration costs. With an equal probability of low, medium and high
cases occurring, and assuming that the low case would be developed to make the
small gain, the EMV of the prospect is $85 million, again assuming an exploration
cost of $10 million. The above problem has used software from Palisade, called
‘Precision Tree’ (Figure 14.16).
In very simple terms, evaluating an exploration opportunity means weighing up
the potential prize (multiplied by the probability of winning it) against the certain
loss of the exploration cost. Figure 14.17 is a representation of this risk-reward
calculation.

TRUE 0.333333333
develop
Exploration costs 10 200 190
33.3% Decision
high reserves 100 MMb
-10 190
FALSE 0
no development
0 -10
TRUE Chance
yes
0 85
TRUE 0.333333333
develop
80 70
33.3% Decision
medium reserves 48 MMb
-10 70
FALSE 0
no development
0 -10
TRUE 0.333333333
develop
5 -5
33.3% Decision
low reserves 20 MMb
-10 -5
FALSE 0
no development
0 -10
Decision
explore
85
FALSE 0
no
0 0
Figure 14.16 Decision tree example.