Simple Decision Tree Analysis
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The Point Thomson project in Alaska, operated by ExxonMobil, presents significant investment challenges due to uncertainties surrounding high-pressure wells, technology, and environmental permits. A decision tree analysis shows that despite various potential outcomes, the best strategy remains pursuing drilling over selling rights. Effective management must utilize various decision-making tools, including quantitative analysis and Monte Carlo simulations, to navigate these complexities and assess project viability.
![As we can see from the above decision tree is; even if we find a reservoir or do not find a
reservoir, the decision will not change, we will still go for drilling the wells and not sell the
rights even before or after discovery.
Investment decisions in projects
The decision tree is used in this case, but there are other analytical decision tools commonly
employed in the oil and gas business domain to determine risk probabilities distribution and
uncertainties in exploration activities like options pricing of the sales with “futures, call
options, risk-free bonds” according to (Smith and McCardle, 1999). The Monte Carlo
simulation tool performs probabilistic analysis as opposed to a deterministic analysis (Finch,
Macmillan and Simpson, 2002). It is used at different stages during exploration that gives
management the “expected value” (i.e. market value or value to shareholders) and where the
decision tree and Monte Carlo tool provides you with the discounted rates and option pricing
provides you with the “risk neutral probabilities.” However, the first step is to find net present
values based on worst, median and best scenario with pre-set criteria that the project life cycle
is established, and no new development are determined without regards to market price
variations of the petroleum. On the other hand, in our day to day environment, management
have to change these values and its variable factors due to uncertainties. Those factors must be
sequences and taken into consideration over time to give multiple scenarios (Suslick, Schiozer
and Rodriguez, 2009: Galli, Armstrong and Jehl, 1999).
Conclusion
The Point Thomson project is a significant investment of $4 billion and has a high degree of
uncertainties due to its characteristics of high-pressure wells, new technologies, transportation
to market with pipelines, and its delays could have an impact and may force the operator to
increase the storage capacity at Prudhoe Bay. It is, therefore, crucial for management to use all
decision-making procedures that is commonly available, i.e. quantitative analysis, holistic
views, discounted cash flows, Monte Carlo for simulating reserves, and the decision trees
(Finch, Macmillan and Simpson, 2002).
References:
Bradner, M. (2015) ‘Point Thomson: Alaska's big Arctic project,' Alaska Business Monthly,
31 (3), pp.124-128.
Finch, J.H., Macmillan, F.E. & Simpson, G.S. (2002) ‘On the diffusion of probabilistic
investment appraisal and decision-making procedures in the UK’s upstream oil and gas
industry,' Research Policy, 31 (6), pp.969-988.
Galli, A.G., Armstrong, M. & Jehl, B. (1999) ‘Comparison of three methods for evaluating
oil projects’, Journal of Petroleum Technology, 51 (10), pp.44-49.
Inkpen, A.C. & Moffett, M.H. (2011) The global oil & gas industry: management, strategy &
finance. Tulsa, OK: PennWell [Online]. Available
from:http://library.liv.ac.uk.ezproxy.liv.ac.uk/record=b2632439~S8 (Accessed: 5 February
2016).
Loy, W. (2010) ‘First Point Thomson well reaches the target,' Petroleum News, Vol. 15, No.
7, February 14, [Online]. Available from:
http://www.petroleumnews.com/pnads/611076461.shtml (Accessed: 5 February 2016).](https://image.slidesharecdn.com/decisiontreeanalysis-170224235015/85/Simple-Decision-Tree-Analysis-3-320.jpg)
![Petroleum News. (2009) The Explorers 2009: ExxonMobil, Petroleum News, Vol. 14, No.
46, November 15, pp. 1 – 124, [Online]. Available from:
http://www.petroleumnews.com/pnads/171091570.shtml (Accessed: 5 February 2016)
Smith, J. E., & McCardle, K., F. (1999) Options in the Real World: Lessons Learned in
Evaluating Oil and Gas Investments, Operations Research, 47(1), pp. 1 – 15.
Suslick, S., Schiozer, D. & Rodriguez, M.R. (2009) ‘Uncertainty and risk analysis in
petroleum exploration and production,' Terræ, 6 (1), pp.30-41 [Online]. Available
from: http://www.ige.unicamp.br/terrae/V6/PDF-N6/T-a3i.pdf (Accessed: 6 February 2016).](https://image.slidesharecdn.com/decisiontreeanalysis-170224235015/85/Simple-Decision-Tree-Analysis-4-320.jpg)
Simple Decision Tree Analysis
- 1. Simple Decision Tree Analysis Published: February 6, 2016 Introduction Oil and gas projects are risky business with significant uncertainties in prices and the ability to produce the forecasted or estimated oil and gas where the revenue created from the commodity is dependent upon the demand, the production and its financial motives for pursuing a project (Inkpen and Moffett, 2011). Operational uncertainties Suslick, Schiozer and Rodriguez (2009, p.33) argued, “Uncertainty refers to the range of probabilities in which some conditions may exist or occur.” The Point Thompson is an onshore drilling project in Alaska operated by ExxonMobil with several major IOC partners that have and estimated reserve of eight trillion cubic feet of gas and two hundred million of barrels of condensate that will be transported to market through the Trans-Alaska Pipeline Systems (TAPS) (Bradner, 2015). After the Valdez accident in 1989, ExxonMobil suspended its exploration activities in Alaska. They resumed their exploration activities in 2009 after two years battling court cases with the Department of Natural Resources (DNR) due to Exxon's inability to start drilling and produce within the time frame set and were asked to relinquish its acres to the government or start drilling (Petroleum News, 2009). They did settle with DNR, and two wells were approved, i.e. PTU-15 and PTU 16 and completed in 2010 (Loy, 2010). The Point Thomson project has multiple uncertainties due to its high pressure wells, technology and materials (i.e. well casings and tubular), infrastructure and environmental permits, (i.e. dependent on winter roads and use of permafrost advantages for not destroying the environment and waterway access for supplies during summer months) and is dependent upon high-level competence. Moreover, the new requirement from DNR in regards to reinjection of the gas also invites to significant challenges as to the use of new high-pressure technologies and materials that must separate the gas from the condensate for then to reinject the gas and transport the condensate to Prudhoe Bay and through a new TAPS pipeline to market. This
- 2. cycle methodology is highly uncertain, as there is no history to track previous performances under such circumstances (Bradner, 2015). Decision Tree Analysis After a license have been awarded an IOC for the right to drill. IOC’s would usually perform geological surveys, seismic and drill wildcat wells and conduct an appraisal after testing before making a final decision on a field development program. In the Point Thomson project case, and since there are not much information available on the paper, the decision tree below in figure 1 is based on highly hypothetical data ($000m): Sell rights = 300M Drill Immediately = 160M Probability of finding oil, first drilling = 50 - 50% Value of recovered oil after first drilling = 3000M Geological Surveys = 35M Probability, finding a reservoir = 2/3 Oil found, after review, sell rights = 600M or go for the drilling If recovered = 14000M (or 3.5 x invested capital of $4000M) Abandonment cost, intentionally not taken into account, exploration wells Fig. 1 Point Thomson Project Decision Tree Source: Sudenius (2016)
- 3. As we can see from the above decision tree is; even if we find a reservoir or do not find a reservoir, the decision will not change, we will still go for drilling the wells and not sell the rights even before or after discovery. Investment decisions in projects The decision tree is used in this case, but there are other analytical decision tools commonly employed in the oil and gas business domain to determine risk probabilities distribution and uncertainties in exploration activities like options pricing of the sales with “futures, call options, risk-free bonds” according to (Smith and McCardle, 1999). The Monte Carlo simulation tool performs probabilistic analysis as opposed to a deterministic analysis (Finch, Macmillan and Simpson, 2002). It is used at different stages during exploration that gives management the “expected value” (i.e. market value or value to shareholders) and where the decision tree and Monte Carlo tool provides you with the discounted rates and option pricing provides you with the “risk neutral probabilities.” However, the first step is to find net present values based on worst, median and best scenario with pre-set criteria that the project life cycle is established, and no new development are determined without regards to market price variations of the petroleum. On the other hand, in our day to day environment, management have to change these values and its variable factors due to uncertainties. Those factors must be sequences and taken into consideration over time to give multiple scenarios (Suslick, Schiozer and Rodriguez, 2009: Galli, Armstrong and Jehl, 1999). Conclusion The Point Thomson project is a significant investment of $4 billion and has a high degree of uncertainties due to its characteristics of high-pressure wells, new technologies, transportation to market with pipelines, and its delays could have an impact and may force the operator to increase the storage capacity at Prudhoe Bay. It is, therefore, crucial for management to use all decision-making procedures that is commonly available, i.e. quantitative analysis, holistic views, discounted cash flows, Monte Carlo for simulating reserves, and the decision trees (Finch, Macmillan and Simpson, 2002). References: Bradner, M. (2015) ‘Point Thomson: Alaska's big Arctic project,' Alaska Business Monthly, 31 (3), pp.124-128. Finch, J.H., Macmillan, F.E. & Simpson, G.S. (2002) ‘On the diffusion of probabilistic investment appraisal and decision-making procedures in the UK’s upstream oil and gas industry,' Research Policy, 31 (6), pp.969-988. Galli, A.G., Armstrong, M. & Jehl, B. (1999) ‘Comparison of three methods for evaluating oil projects’, Journal of Petroleum Technology, 51 (10), pp.44-49. Inkpen, A.C. & Moffett, M.H. (2011) The global oil & gas industry: management, strategy & finance. Tulsa, OK: PennWell [Online]. Available from:http://library.liv.ac.uk.ezproxy.liv.ac.uk/record=b2632439~S8 (Accessed: 5 February 2016). Loy, W. (2010) ‘First Point Thomson well reaches the target,' Petroleum News, Vol. 15, No. 7, February 14, [Online]. Available from: http://www.petroleumnews.com/pnads/611076461.shtml (Accessed: 5 February 2016).
- 4. Petroleum News. (2009) The Explorers 2009: ExxonMobil, Petroleum News, Vol. 14, No. 46, November 15, pp. 1 – 124, [Online]. Available from: http://www.petroleumnews.com/pnads/171091570.shtml (Accessed: 5 February 2016) Smith, J. E., & McCardle, K., F. (1999) Options in the Real World: Lessons Learned in Evaluating Oil and Gas Investments, Operations Research, 47(1), pp. 1 – 15. Suslick, S., Schiozer, D. & Rodriguez, M.R. (2009) ‘Uncertainty and risk analysis in petroleum exploration and production,' Terræ, 6 (1), pp.30-41 [Online]. Available from: http://www.ige.unicamp.br/terrae/V6/PDF-N6/T-a3i.pdf (Accessed: 6 February 2016).