2 Oilfield Review

For help in preparation of this article, thanks to Joe Fay,Austin, Texas, USA; Kent Burkholder and Alexander Lythell,London, England; Paige McCown, Houston, Texas; PatParry, Centrica, Slough, Berkshire, England; KennethRicard, Aker Maritime, Houston, Texas; and LaurenceWickens, AEA Technology, Didcot, Oxfordshire, England.Decision Tree and Peep are marks of Schlumberger. DPS-2000 is a mark of Aker. Excel is a mark of MicrosoftCorporation.

Decisions in the oil and gas industry determinethe direction and course of billions of dollarsevery year. The complexity of a decision canrange from simple and Shakespearean—to drillor not to drill—to elaborate. Some of the moremonumental decisions determine the maximumbid for a lease, the best development process fora given asset, the drilling priority of a company’sexploration opportunities, the timing of increas-ing facility capacity, or whether to sign a long- orshort-term supply contract.

While simpler problems may be analyzedwith a few quick calculations, reaching morecomplicated decisions can take a companymonths or years of preparation. For example, oneof the dilemmas challenging E&P companiestoday is how to develop deepwater prospects.Sometimes subsea development is best; some-times a tethered floating structure is the solution.Typically, oil companies spend 12 to 18 months inthe decision cycle—gathering information, ana-lyzing data and modeling risk and uncertainty—before selecting a production system. Streamliningthis process may increase profit by shortening thetime to first production.

Ellen CoopersmithDecision FrameworksHouston, Texas, USA

Graham DeanCentricaSlough, Berkshire, England

Jason McVeanCalgary, Alberta, Canada

Erling StorauneAker Maritime, Inc.Houston, Texas

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WIL

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L

DR

OP

AC

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GE

DR

ILL

LAR

GE

FIE

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$3

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$50,0

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$50

,00

0

$5

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The difference between a good decision and a bad one can be the difference

between success and disaster, profit and loss, or even life and death. Decision-

analysis software can help decision-makers identify factors that influence the

decision at hand and choose a path to desirable outcomes.

Making Decisions in theOil and Gas Industry

1. Newendorp PD: Decision Analysis for PetroleumExploration. Aurora, Colorado, USA: Planning Press,1996.

2. Bailey W, Couët B, Lamb F, Simpson G and Rose P:“Taking a Calculated Risk,” Oilfield Review 12, no. 3(Autumn 2000): 20-35.

3. Net present value is one possible value measure, butmany others can be used, including rate of return andprofit-to-investment ratio.

4. Newendorp, reference 1, chapter 4.

Winter 2000/2001 3

Several methods are available to help decision-makers evaluate uncertainty, reduce risk andchoose workable solutions.1 These methodsinclude net present value (NPV) calculations, dis-counted cash-flow analysis, Monte Carlo simula-tion, portfolio theory, decision-tree analysis andpreference theory—all of which were reviewedin a recent Oilfield Review article.2 Elementarysituations can be solved with basic expected-value computations, but more involved casesrequire a decision-analysis process that com-bines information from multiple disciplines,allows for uncertainty and evaluates the impactof different decisions. This article focuses ondecision-tree analysis and how it works, asdemonstrated through two case studies.

Decision-Tree AnalysisDecision-tree analysis is one way to frame andsolve complex situations that require a decision.The key to obtaining a useful solution is to clearlydefine the problem at the start and determinewhat decisions need to be made. The problem-definition stage includes identifying all knowninformation and listing any factors that may influence the final outcome. To expedite the process, decisions that can be deferred are post-poned so that future information can aid the deci-sion process.

Capturing the essence of a problem by deter-mining which are the influential factors helpsdecision-makers concentrate on only thoseissues that play a major role in the outcome.Such sensitivity analysis prioritizes the impor-tance of factors to be considered in a decision.For example, one decision may depend on six fac-tors: oil price, oil volume, gas price, gas volume,capital expenditures and operating costs—but the relative importance of these is unknown.For given uncertainties, or a range of possiblevalues, for each factor, sensitivity analysis cal-culates the net present values (sometimes writ-ten as after-tax cash) represented by those

uncertainties and ranks each factor (left).3 Thefactors that most affect project outcome are theones with the highest NPV range. The shape of thegraph, with large values on the top and small val-ues on the bottom, gives it the name “tornadoplot.” In this example, the two most importantfactors are oil price and oil volume. Operating-cost uncertainty does not significantly affect theoutcome, and so can be treated as a certaintywithout markedly affecting the results.

Once the problem is framed, decision treeshelp find a route to an advantageous solution.Decision trees are diagrams that portray the flowof a decision-making process as a sequence ofevents and possible outcomes (below). Eventsare represented as points, or nodes, and out-comes are depicted as branches issuing fromeach node. Nodes are either decision nodes—atwhich the decision-maker determines whatbranch to take—or uncertainty nodes, wherechance rules the outcome.4 Associated with eachbranch is the expected monetary value of the out-come. Additionally, branches emanating fromuncertainty nodes are weighted by the probabilityof that outcome occurring. In common notation,decision nodes plot as squares and uncertaintynodes as circles.

Sensitivity Analysis

Influence, %

Oil price

Oil volume

Capital expenditures

Gas volume

Gas price

Operating costs

51

31

09

05

03

01

30,000

31,538

36,068

42,083

41,776

42,862

43,643

Factors45,010 60,000

59,937

57,873

54,004

50,956

50,157

46,181

Net present value dollars, thousands

> Tornado plot showing factors that most influence a decision. Of the six factors selected for analysis,oil price and oil volume have the highest range in net present value (NPV), making the outcome mostsensitive to those factors.

Dry hole_ $50,000

2 Bcf+ $100,000

5 Bcf+ $250,000

$0

+ $100,000

Drill

Don’t drill

0.7

0.1

0.2A

B

> Simple decision tree showing one decisionnode (square) and possible outcomes. Outcomesare labeled with their expected value multipliedby the probability of that outcome occurring. The path with the highest expected value is high-lighted in yellow. (Adapted from Newendorp, reference 1.)

In this simple example, the decision nodemarks where the decision-maker elects to drill ornot to drill. The expected value associated with adecision not to drill is $0; that is, no money isspent or gained. The value expected from thedecision to drill depends on what is encountereddownhole: there is a 10% chance of 5 Bcf of gas,a 20% chance of 2 Bcf, and a 70% chance of adry hole. The expected reservoir size is in fact acontinuous distribution rather than three-valued,but for the purpose of this example, three sizesare examined (above). Ideally, branches of theuncertainty node try to capture the most impor-tant aspects of this continuous distribution.

The expected value of an uncertainty node isthe sum of all probability-weighted expected val-ues of the outcomes stemming from that node. Inthis way, working back from the end, or right-hand side of the tree, expected values can be cal-culated for every outcome. Once all the expectedvalues have been calculated, the optimal deci-sion route—the one along maximum expectedvalue—can be taken.

The same method works for more compli-cated decisions (next page). In this example, thedecision to buy acreage or not depends on under-standing the possible outcomes of a succession

of decisions, including to run a seismic survey ornot, to drill or not, and to drill a second well ornot. The possible final outcomes—large field,marginal field and dry hole—are the sameregardless of the decision route. However, theyhave different probabilities of occurrence at dif-ferent stages of the decision tree because as thetree grows, more information becomes available.For this decision tree, the solution that deliversthe highest expected monetary value traces thefollowing branches: Buy acreage, run seismicsurvey, seismic survey confirms lead, drill—andif the first hole is dry, drill a second wildcat.

Assigning probabilities to the tree branchesrequires technical expertise and, in this case,relies on prior knowledge of the region. The like-lihood and value of the various outcomes alsocan be based on the result of more detailedMonte Carlo simulations. For example, the cutoffvalue for what constitutes a large field could bethe high side of a probability distribution that isthe result of Monte Carlo simulation of the reser-voir volume parameter.

Depending on the type of decision to bemade, specialists from many oilfield disciplinesmay be called upon to supply information for

decision-tree analysis. In addition to the unknownreservoir size and content, outcomes that need tobe predicted include the following:

• price of oil and gas• quality and reliability of seismic imaging or

logging data• cost and risk versus value of additional

information• likelihood of drillpipe or logging tools get-

ting stuck, and other nonproductive rig time• reservoir compartmentalization, or number

of wells• reservoir fluid properties and performance• completion complexity• cost of transport to market• improvement gain from stimulation,

workover or enhanced-recovery methods.Less obvious to many oilfield professionals,

perhaps, but also important to estimate in casesthat lend themselves to decision-tree analyses,are eventualities such as government legislationand stability, company mergers, court cases andhealth, safety and environment (HSE) issues.

Numerous software products are availablethat facilitate decision-tree analysis for oil andgas E&P and other industries. These includePrecision Tree by Palisade, Decision Program-ming Language (DPL) by ADA (Applied DecisionAnalysis) and the Decision Tree package devel-oped by Merak, a Schlumberger company. Thesesystems link to calculation engines that computenet present values for each branch of the tree.Broadly speaking, decision-tree software pack-ages link to Excel as the calculation engine. Onlythe Merak Decision Tree software also linksdirectly to the Peep economic analysis program,which is a standard asset-management packagein the petroleum industry.

Decision trees can be helpful for analyzingmany types of oilfield decisions. Examplesinclude deciding whether to replace wireline logswith logs acquired while drilling, evaluatingwaterflood programs, optimizing workovers, andchoosing the best offshore platform topsidesconfiguration.5 The next section describes howdecision trees can help evaluate a deepwaterproduction system.

4 Oilfield Review

Maximum possiblereserves

Mean reserves

Minimum possiblereserves (dry hole )

> Continuous distribution of expected reservoir size. Although theexpected value of the reservoir size can fall anywhere in the contin-uous distribution, the most likely values should be selected for thedecision-tree branches. (Adapted from Newendorp, reference 1.)

Winter 2000/2001 5

Choosing a Production SystemAker Maritime, Inc., a maker of offshore platformsand spars, was approached by an operator prepar-ing to select a deepwater production system for adevelopment offshore West Africa.6 The client hadto decide whether to act early and buy a produc-tion system that could be adapted in case thereservoir turned out to be larger than expected, orwait for more information and optimize the size ofthe system. An early decision could mean quickerproduction of first oil. And an adaptive system hasthe flexibility to allow for future additions of fluid-processing modules or wells. However, such adecision would be based on minimal information.The alternative was to drill more wells, acquire

more information and buy a production systemoptimized for the reservoir size, but at additionalexpense and production delay.

Aker Maritime worked with DecisionFrameworks, a decision analysis and facilitationconsulting firm, to structure the decision andmodel development alternatives. The DecisionFrameworks approach relies on technical andcommercial petroleum-industry expertisepaired with Merak software, specifically theDecision Tree product and Peep economicdatabase application.

The first steps in the decision analysis wereto structure the problem, understand issues associated with the deepwater discovery andreview alternative development solutions.

> More complicated decision tree for buying acreage. In this example, the decision depends on a succession of decisions (highlighted in yellow) including running a seismic survey and drilling one or two wells. (Adapted from Newendorp, reference 1.)

5. Beck GF: “Examination of MWD (Measuring WhileDrilling) Wireline Replacement by Decision AnalysisMethods: Two Case Studies,” Transactions of theSPWLA 37th Annual Logging Symposium, New Orleans,Louisiana, USA, June 16-19, 1996, paper U.Martinsen R, Kjelstadli RM, Ross C and Rostad H: “TheValhall Waterflood Evaluation: A Decision Analysis CaseStudy,” paper SPE 38926, presented at the SPE TechnicalConference and Exhibition, San Antonio, Texas, USA,October 5-8, 1997.Macary S and El-Haddad A: “Decision Trees OptimizeWorkover Program,” Oil & Gas Journal 96, no. 51(December 21, 1998): 93-97, 100.MacDonald JJ and Smith RS: “Decision Trees ClarifyNovel Technology Applications,” Oil & Gas Journal 95,no. 8 (February 24, 1997): 69-71, 74-76.

6. A spar, sometimes called a dry-tree unit, is a floating vertical cylinder that is moored to the seafloor. Sparsallow production from deepwater fields to “dry” surfacefacilities as opposed to subsea facilities.

B

C

A

IH

GF

J

DE

Large field+$36 MM

Marginal field+$11 MM

Dry hole

Drill second

wildcat

Large field+$35 MM

Marginal field+$10 MM

Drill

Don’t buy acreage$0

Buy acreageRun seismicsurvey

Seismic survey

confirms lead

Large field+$33 MM

Marginal field+$8 MM

Dry hole,drop acreage

–$7 MMDrop acreage

–$6 MM

Drill secondwildcat

Large field+$34 MM

Marginal field+$9 MM

Dry hole

Drill

0.90

0.05 0.05

0.075

0.075

0.85

0.50

0.50

0.15

0.15

0.700.20

0.200.60

Dry hole,drop acreage

–$5 MM

Seismic shows nostructure, drop acreage

–$5 MM

Drop acreage–$4 MM

Drop acreage–$5 MM

Decision Frameworks worked with Aker and theiroil company client to define parameters of thediscovery, such as reservoir size, productionrates, number of wells and drilling schedule.Then, high-level decision trees were constructedfor the four development concepts under consid-eration. Two concepts were adaptive structures,the Aker adaptive spar and DPS-2000 (above andnext page, top). The other two were designs that

could be optimized to suit the reservoir size: afloating production, storage and offloading(FPSO) system and an optimized spar. All fourconcepts allowed oil storage.

The Decision Tree analysis for the adaptivedesigns called for selection of surface structureand topsides based on information from only twowells. This was followed by drilling of two wells,installation of the structure, development drilling

and production, then installation of additional pro-duction modules or wells as necessary (next page,bottom). The case of optimized designs starts withinformation from four wells before selecting andinstalling the production system, followed bydrilling of additional development wells and finallysome limited adjustment of the well count,depending on what production information indi-cated the size of the actual reservoir to be.

6 Oilfield Review

> Aker Maritime adaptive spar.

Winter 2000/2001 7

> Aker Maritime DPS-2000.

Limitedadjustment

of well count

Add productionmodules and

adjust well count

Development drillingand productionTwo penetrations

Four penetrationsDevelopment drilling

and production

Adaptive Designs

Optimized Designs

Decision Tree Structure

Selectstructure

and topsideequipment

Predrilltwo wells

Indicatedreservoir size

(capacity/wells)

Installstructureand drill

Installstructureand drill

Furtherindication ofreservoir size

Start withmore

information

Indicatedreservoir size

(capacity/wells)

Selectstructure

and topsideequipment

Furtherindication ofreservoir size

> Decision Tree structure for adaptive design compared to optimized design. The adaptive design (top) starts with less information and drills fewer wells. The optimized design (bottom) uses information from four wells to size thedevelopment concept.

The key uncertainty was the reservoir size,which governs the facility capacity and the num-ber of wells required to develop the reserves. Theresults of the Decision Tree analysis are the eco-nomic impacts of multiple scenarios that occur ifthe reservoir is:

• believed to be large and actually is large,medium or small;

• believed to be medium and actually islarge, medium or small;

• believed to be small and actually is large,medium or small.

A sample decision tree demonstrates the netpresent values calculated for one of the four

development concepts: the DPS-2000 adaptivesystem (above). The total NPV for this concept is$412 million. Comparing this figure to thoseobtained for the other three concepts shows theDPS-2000 to have the greatest NPV (below left).

The timing of the steps in the developmentplays a key role in investment payback. A largepart of the value in selecting an adaptive systemis in the reduced time to first oil. The DecisionTree software followed a schedule from January2001 to June 2005 that included front-end engi-neering and design (FEED), construction, deliveryand commissioning (below right). Both adaptiveconcepts could deliver first oil in 2003, compared

with the 2005 deliveries possible with the optimized systems. However, the added value ofthe adaptive systems was accompanied by added risk.

The Decision Tree software helped demon-strate the added value achievable with the earlyadaptive production systems and allowed AkerMaritime to present a full range of decisionoptions to the oil company client. It also under-scored the fact that uncertainty often exists evenafter more information is gathered. Recognizingthis during the selection of development con-cepts is important, and can add value.

8 Oilfield Review

Adaptive Concepts Optimized Concepts

Value Captured

DPS-2000

Adaptive spar

$412 MM

$350 MM

Optimized spar

FPSO

$313 MM

$182 MM

> Comparison of final NPV calculations for the four develop-ment concepts under consideration. The adaptive conceptsoffer up to $230 million higher NPV than the optimized concepts.

Jan.2001

Jun.2001

Jan.2002

Jun.2002

Jan.2003

Jun.2003

Jan.2004

Jun.2004

Jan.2005

Jun.2005

Jan.2006

Decision Tree Schedule Inputs

Aker DPS-2000

Adaptive spar

FPSO

Optimized spar

First oilDec. 2003

First oilAug. 2003

First oilFeb. 2005

First oilApr. 2005

Includes front-end engineering and design (FEED), construction, delivery and commissioning

> Schedule of Decision Tree events. The adaptive concepts start first and producefirst, while production from the optimized projects lags by about 18 months.

0.48 large

0.36 medium

0.16 small

882

NPV $MM

359

9

Actual reservoirprobability, size

0.23 large

0.46 medium

0.31 small

882

361

12

0.23 large

0.36 medium

0.41 small

882

361

14

Large reservoirindicated

Medium reservoirindicated

Small reservoirindicated

Predrill2 wells

Predrill2 wells

Predrill2 wells

InstallDPS-2000

InstallDPS-2000

InstallDPS-2000

p =0.2

8p = 0.39

p = 0.33

Two penetrations

DPS-2000

$412 MM

Decision Tree Results for Aker DPS-2000

$554 MM

$373 MM

$339 MM

26 wells, $100 M modification

14 wells, 1 dry hole

6 wells, 2 dry holes

14 wells

6 wells, 1 dry hole

14 wells

6 wells

26 wells, $100 M modification

26 wells, $100 M modification

> Decision Tree output showing NPV calculated for the DPS-2000 adaptive deepwater system.

Winter 2000/2001 9

Making a CaseThe decision-tree methodology also can beapplied to other types of E&P problems. As part ofCentrica’s strategy to acquire additional UK conti-nental shelf assets, the company can—when italready has contracts to buy the gas from theassets—often be required to consider potentiallyconflicting buyer-seller interests. In one example,Centrica needed to consider the impact of a pastdispute on the future value of an asset under con-sideration. The dispute related to the previousfailure of the sellers to meet contractual obliga-tions to provide gas and to Centrica’s applicationof the contractual remedies. The sellers objectedto this action and litigated to limit it. Centrica hadto consider the possible outcomes from a litigatedversus negotiated settlement on the future valueof the asset—the Hewett field (above).

Several conditions complicated the decisionprocess. Acquiring additional equity in the fieldor taking on operatorship could increase reservesand value, and allow Centrica to provide moregas, but the field was old and nearing expensiveabandonment. However, there also was potentialfor workover or developing neighboring fields.

So many elements were involved in the decisionthat the problem appeared quite difficult to solve.

Centrica consulted with AEA Technology plc tohelp them frame the problem. The resulting deci-sion tree was large, requiring evaluation of 7000alternatives with hours of computer runs per out-come that totalled a man-year of effort. An auto-mated solution was needed to generate and inputnumbers for the decision tree. Centrica analystsused the Merak Decision Tree product, and, byparing down some of the constraints, were ableto achieve a solution with 500 outcomes and com-puter run times of 7 minutes (above right).

The benefits of a Decision Tree solution weretwofold: first, the decision-analysis process pro-vided clear insight into the problem. In spite of thecomplexity of the situation, the Decision Treeresults clarified what was driving the decision aswell as the direction to be taken. For the first time,everyone involved was in agreement with therationale for the set of decisions. Second, theMerak tools made it easy to solve the problem andcompleted the calculations and analysis quickly.

Simplifying Decision-MakingFor large organizations like those in thepetroleum industry, it is still people, not pro-cesses, that make complex, expensive decisions.The decision-analysis technique is usually cus-tomized from one organization to the next, butthe most successful system is one of framing theproblem, understanding uncertainties, develop-ing stronger, often hybrid solutions, and balanc-ing risk against expected value.

As the petroleum E&P industry continues topursue prospects in more remote and potentiallysensitive regions, decision-making tools thatincorporate information from all sources ofexpertise will make important contributions toproject success.

Although decisions are ultimately made bypeople, computer and software solutions makethe job easier. Decision-analysis products canhelp identify how sensitive a decision is to all thefactors involved, determine the value of movingahead or gathering data, point decision-makersin the most valuable direction, and produce moreconsistent decisions.

The benefits of a consistent decision-analysisprocess are felt by decision-makers in all parts ofthe company, allowing technical staff and plan-ning organizations to increase the efficiency andvalue of their work. —LS

> Schematic decision tree created to help Centrica analysts reach a decisionon the Hewett field case. The tree uses a compact notation whereby a nodenext to the outcomes of a previous node means that node is repeated foreach input branch. In this way, the first decision node, “Acquire additionalequity,” applies to all three outcomes of the previous node, “Calculatedchange in gas initially in place.” Similarly, the decision node to settle bynegotiation applies to all Yes or No outcomes of the previous decision, andso on. This notation conveys the same information as a whole tree butkeeps the tree compact and manageable.

Calculatedchange ingas initiallyin place

Low

Middle

High

Acquireadditionalequity

Yes

No

Yes

No

Low

Middle

High

Low

Middle

High

Identityof expert

A

Settlelitigationby negotiation

Negotiatedoutcome

Expertdecision

BU K

N O R WAY

HewettField

N O R T H S E A

> Hewett field, UK North Sea, where low yields prevented Centrica and partners from meeting contracts to provide gas. Decision Tree analysishelped Centrica decide whether to proceed with the ensuing settlement.