The Value of Flexibility in Managing Uncertainty in Oil and Gas Investments

Abstract

Abstract This paper deals with improving the oil and gas industry's ability to manage the impacts of uncertainty on investment evaluations. We first review the economic performance of the industry and conclude that it is not good. Under-performance is attributed largely to poor investment decision-making, which is in turn due to inaccurate evaluation of the economic impacts of uncertainty. We describe how undue focus on Value of Information (VoI) and classical DCF techniques can prevent full value creation from an investment opportunity, by not encouraging exploration of the use of flexibility to manage, or even exploit, uncertainty. A Real Options (RO) approach has considerable appeal in overcoming this problem. However, its widespread application has yet to occur due to unfamiliarity, issues around its robust implementation and a focus on valuation rather than value creation. Here, the VoI concept is extended to assessing the Value of Flexibility (VoF). Building on a previously published framework (SPE 71414), we show how VoI and VoF analyses can be performed using a Stochastic Integrated Asset Model and thus offer a practical means to capture some of the benefits of a real options approach. The VoI concept is reviewed and illustrated by the example of executing a seismic study to reduce OOIP uncertainty. VoF is illustrated by planning extra slots on a platform to manage residual OOIP uncertainty and by estimating the value of incremental water injection facilities to manage uncertainty in aquifer strength. Value creation from flexibility is illustrated by considering the potential to change production rate as oil price changes.

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