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Reservoir Management XI

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You are on page 1of 52

Know the basic concepts around risk measurement

Know the basic concepts around Optimization and Uncertainty

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Pre-test Review

1. What is an uncertainty?

2. Name 3 classic uncertainties in the upstream

3. What is risk?

4. Name 3 classic risks in the upstream

5. What is a decision?

6. Name 3 classic decisions in the upstream

7. What is optimization?

8. What do we usually try to optimize?

9. What are constraints?

10. Name 3 classic constraints in the upstream

11. What is optimization under uncertainty?

12. What can we do about uncertainties?

13. What can we do about risk?

14. What can we do about decisions?

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Economics

Economics Overview

Hard Factors Affecting Project Economics

Field Operating Expenses Capital Expenditure Operating Income

Well intervention Well Cost Oil Price

Energy to run operation Pipelines Volume

Injected and produced water Surface Facilities Crude & Gas Quality

Supervisory & Maintenance Time to market

Petroleum Treatment and Transport

Information Technology

Corporate Overhead

Research & Development

Marketing, Legal, Finance

Discounted Material Procurement

Cash Flow

Outcome

Activation Index: US$/STB/D

Production Cost: $/STB

Time Rate of Return: IRR

Payback Time: [years]

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Economic Evaluation

Cash Flow Model

Net Cash Flow = Profit

Tax Model

Includes taxes

Tangibles/Intangibles

Financial Model

Capitalization of costs

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Time Value of Money

F

Time Value of Money P=

(1 + i )n

P - Present value

i - Interest rate

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Net Present Value

L NCF j

Net Present Value NPV =

j =0 (1 + i ) j

L - project life

NCFj - net cash flow for period j

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Rate of return

L INV j L NOI j

Rate of Return =

j =0 (1 + i ) j

j =1 (1 + i ) j

INVj = investment during period j

NOIj - net operating income during period j

i - interest rate

ROR = i when summations are equal

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Discounted Cash Flow Example

F

P=

(1 + i )n

Present Value using discount factor i

0 -60000 -60000 -60000 -60000

1 37100 33727 30917 32053

2 16800 13844 11667 12540

3 12200 9166 7060 7868

4 8640 5901 4167 4814

5 5440 3378 2186 2618

6 250 141 84 104

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example Problem

0 -30000

1 15000

2 10500

3 7500

4 5000

5 3200

6 1600

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Net Present Value for a Petroleum Production System

k

C q wi wi )

k

C T I k

C F (

k

1 r k

)

NPV = wp k T

k Tk

k =1

(1 + i ) 365

q k

g

= daily production of water [STB/D], at time k

q k

wp

= daily production of gas [SCF/D], at time k Without loss of generality, the

q k

= daily injection of water [STB/D], at time k

wi objective function, for a

Po = net selling revenues of oil [$/STB], calculated as

selling price minus the associated production hydrocarbon production

costs: operational budget (payroll, supplies,

maintenance, treatment and transport) and minus

system may be expressed as

the production royalties. the finite sum of discounted

Pg = net selling revenues of gas [$/MSCF]. Idem

C wp = cost of treatment and disposal of produced water

cash flows during the project

per unit barrel, [$/STB]; horizon

Cwi = cost of treatment and compression of injected

water per unit barrel, [$/STB];

ITk = the total capital investment [$] on field assets

(wells, surface facilities) at time interval k

CFk = fixed costs (overhead, leases, capital cost) at time

interval k

rk = tax rate at time interval k

Tk = size in days of the time interval

i = annual discount factor

k = time interval number

N = number of time intervals

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Risk Measurement

Risk Measurement

Given risk, the uncertainty of a future outcome, the realized (or actual) return on

an asset may be different from what was expected (or anticipated).

Being able to measure and determine the past volatility of a security provides

some insight into the riskiness of that security as an investment.

Increased volatility, or price fluctuations, can be associated with increased risk.

To deal with uncertainty of returns, investors need to think explicitly about a

securitys distribution of probable total returns.

With the possibility of two or more possible outcomes, which is not unusual,

investors must consider each possible likely outcome and assess the probability

of its occurrence.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Probability Distributions

Probability distributions provides a range of the likelihood of certain outcomes or

returns from an investment, as opposed to a point estimate. The sum of all

probabilities must equal 1.

Probability distributions involve subjective estimates determined by incorporating

anticipated future changes to past outcomes.

Probability distributions can either be discreet or continuous:

with a discreet probability, a probability is assigned to each possible outcome.

with a continuous probability, an infinite number of possible outcomes exist.

The most familiar continuous probability is the normal distribution depicted by a bell-

shaped curve.

It is a two-parameter distribution because it only requires the mean and the variance

to fully describe it.

To describe the mean (or most likely outcome), it is necessary to calculate the

expected value or return.

That is, the average of all possible return outcomes, where each outcome is

weighted by its respective probability of occurrence.

The variance or standard deviation is used, at least as a first approximation, to

calculate the total risk associated with the expected return.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Variance and Standard Deviation

The variance is the expected value of the average squared differences from the

mean of the distribution.

Simply put, it is a measure of how much, on average, any particular observation

of a randomly distributed variable will differ from the average or mean value of

the distribution.

The standard deviation is the square root of the variance and is also a measure

of dispersion of outcomes around an average.

The larger the standard deviation, the more uncertain the outcome.

The standard deviation is a measure of the goodness or confidence placed in

the mean value of the outcome of a random variable.

A related concept, is the mean absolute deviation, which is the usual or average

amount by which the values observed differ from the mean of the distribution.

The standard deviation alone is only a partial or incomplete, and sometimes,

misleading measure of the riskiness of an investment relative to another one.

Risk assessment should include differences in expected values and the

downside or loss potentials of the alternative investments.

To take on any real meaning when comparing alternative investments,

investors should use standard deviations relative to the investments

expected returns to measure each investments return per unit of risk.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Variance and Standard Deviation

For example, the standard deviation of equity returns is greater than the

standard deviation of fixed-income investment returns for all investment

horizons. However, at longer investment horizons, equities dominate fixed

income investments and despite greater standard deviations, equities can be

viewed as less risky investments than bonds.

If returns are normally distributed, investors can predict that actual realized

returns will fall within one standard deviation above or below the mean about

68% of the time; and within 2 standard deviations, about 95% of the time.

Determine the arithmetic mean of all observations.

Subtract each individual observation from the average return (arithmetic

mean) of all observations.

Square each difference.

Divide the sum of the squared differences by the number of observations

less 1.

Take the square root.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Variance and Standard Deviation

To calculate the standard deviation of a portfolio, one needs to know:

a) the proportion each asset represents of the total amount invested in the

portfolio, b) the standard deviation or variance of each asset, c)the

covariance of returns of assets in each portfolio.

p= (w12 x 12) + (w22 x 22) + (2 x w1x w2x 12)

asset 1 (or of asset 2 when using subscript 2), 12 the covariance between

the assets, and w represents the weight of each asset in the portfolio;

stands for the square root.

The variance and standard deviation are a measure of total risk, including both,

systematic and unsystematic, whatever the sources of variability of returns.

Over the short run, and for certain investments (i.e., options, other derivatives,

hedge funds, etc.) the standard deviation may only provide an incomplete and

misleading measure of risk, even when used with expected returns, given that

the distributions may not be normally distributed.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Coefficient of Variation

While standard deviation is an absolute measure, to make a comparison between two

assets of different means and standard deviations, a relative measure of dispersion is

needed: the coefficient of variation.

The coefficient of variation is found by dividing the standard deviation by the mean or

expected return.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Semi-Variance

The semi-variance is a measure of downside risk: the risk of realizing an outcome

below the expected returns.

Some investors prefer it because they think that only deviations below the expected

return or below a benchmark or target return really matter.

The semi-volatility, or downside volatility, is computed in exactly the same way as the

semi-variance,except that all returns above target or benchmark, rather than the

expected return, are ignored.

The square root of the semi-variance is sometimes called the semi-deviation.

Semi-deviation is to semi-variance as standard deviation is to variance.

The downside deviation is sometimes used to refer to the square root of the semi-

variance, but more frequently to the square root of the downside volatility, which is

computed with respect to a minimal acceptable rate of return different from the

expected return.

Although the semi-variance may be conceptually superior, in practice, the standard

deviation is the measure of choice due to some difficult math problems.

Over the long run, stock returns have generally been reasonably symmetrical, so the

downside deviation and standard deviation result in exactly the same answer.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Covariance and Correlation

Covariance is a measure of the degree to which two variables move in a systematic

or predictable way, either positively or negatively.

If they move in opposite directions, they exhibit negative covariance, while moving in

the same direction reflects positive covariance.

If they are completely independent, showing no systematic relationship, their

covariance is zero.

If two variables move in perfect lockstep, up or down, they exhibit perfect positive

covariance. If they move in perfect lockstep, but in opposite directions, they exhibit

perfect negative covariance.

Correlation is a standardized version of covariance where values range from -1

(perfect negative covariance) to +1(perfect positive covariance).

Covariance is equal to the correlation times the standard deviation of the two

variables:

Letting 12 = represent the covariance between 2 variables, 1 the standard deviation of

variable 1, 2 the standard deviation of variable 2, and 12 the correlation of the two variables,

the relation between correlation and covariance is as follows:

12 = 1 x 2 x 12 or 12 = 12 / (1 x 2)

According to Markowitz, by adding stocks that do not exhibit perfect covariance to

their portfolio, the total risk of the portfolio as measured by the variance or standard

deviation, would decline.

In other words, as long as there are any classes of assets whose returns are not

perfectly correlated with the current portfolio, investors can further reduce the risk of

their portfolios by adding securities from those asset classes.

p2 = (w1 2 x 12) + (w22 x 22)+(2 x w1x w2 x 1 x 2 x 12)

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Covariance and Correlation

For each additional independent stock (covariance and correlation are equal to

0) added to the portfolio, the variance attributable to the uncorrelated risk

declines in proportion to the number of stocks and approaches zero as the

number of securities increases.

the standard deviation declines by the square root of the number of

independently distributed securities in the portfolio, assuming, for simplicity,

equal standard deviations and weights:

p = 12/n and p = 1/ n.

2

equally between the two securities completely eliminates all variability and the

variance and standard deviation are equal to 0.

There is no risk reduction advantage in adding perfectly positively correlated

assets to ones portfolio and the variance remains the same.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Beta

Beta determines the volatility, or risk, of a security or fund in relation to that of its

index or benchmark (whereas standard deviation determines the volatility of a

security or fund according to the disparity of the returns over a period of time).

In the CAPM single factor asset model, the index or benchmark is the market

portfolio, often measured by the S&P500.

When comparing funds in a category or to measure performance, the benchmark is

generally the average of the fund in the category.

A fund with a Beta close to 1 means the funds performance closely matches the

index or benchmark; if greater than one, it means greater volatility than the index or

benchmark; and if less than 1, it indicates less volatility than the index or benchmark.

Choose funds exhibiting Betas less than 1 in bearish markets because they decline

less than the market, and vice-versa.

However, Beta by itself is limited and can be skewed due to factors other than market

risk affecting the funds volatility.

To compute Betas, multiply the standard deviation of returns on a stock by the

correlation coefficient of returns on the security and the returns on the market, divided

by the standard deviation of returns on the market.

1 = 1m 1 / m

The weighted beta coefficients measures the risk of a given portfolio compared to the

overall market.

Beta coefficients are determined using historical price data of individual stocks and

the market as a whole. Regression analysis is used to compute the Betas.

Given that the past is not always an accurate predictor of the future, the beta of an

individual security has shown to be pretty unstable over time. On the other hand,

betas of individual portfolios have proved to be fairly stable over time.

Source: The Tools and Techniques of Investment Planning

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

R-Squared (Coefficient of Determination)

relationship to a benchmark/index (i.e. day-to-day fluctuations experienced by the

overall market) and how much is its independent risk unrelated to the

benchmark/index.

When used in conjunction with ratings of mutual funds or the performance of

professional managers, it indicates if the beta of the mutual fund is measured against

an appropriate benchmark.

Values range between 0 and 100, where 0 represents the least correlation and 100,

full correlation. The closer to 100, the more the Beta should be trusted and vice-versa.

An inappropriate Beta would skew more than just beta. Alpha is calculated using beta,

so if the R-squared is low, it is also wise not to trust the figure given for alpha.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

SKEWNESS

Skewness measures the coefficient of asymmetry of a distribution.

While in the normal distribution both tails mirror each other, skewed distributions have

one tail that is longer than the other.

A risk averse investor does not like negative skewness, given the greater

downside tail exposing the investor to low or negative returns below the worst

potential returns on an investment with positive skewness. In addition,

investments with positive skewness offer investors the potential for upside returns

far above any they could expect from the negatively skewed ones.

In symmetric distributions, such as the normal distribution, the mean and median are

equal, but not in skewed distributions.

In positively skewed distributions, the median or point where there is a 50% chance

that returns will fall below that value, is below the mean, which results in less than

50% chance of earning the mean; while in negatively skewed distributions, the median

is above the mean (more than 50% chance of earning the mean).

While a risk-averse investor will prefer a positively skewed over a negative skewed

investment when their means and standard deviations are identical, it does not mean

they will always prefer a positively skewed investment to a symmetrically distributed

one.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Kurtosis

Degree of fatness in tails of the distribution.

Risk averse investors will prefer a distribution with low kurtosis (where tails are more

likely to fall closer to the mean), since they will always weigh the potential downside

returns heavier than the potential upside returns.

Small cap stocks exhibit greater excess kurtosis and negative skewness than larger

stocks, which is not captured under CAPM and hence its failure to account for

anomalies regarding small caps excess returns.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Skewness and Kurtosis Combined

Some distributions can exhibit both, skewness and excess kurtosis.

As soon as skewness begins to be negative the impact of a high excess kurtosis is

significant for a risk-averse investor.

At a skewness of -1 and a kurtosis higher than 1, the probability of having a huge

negative return increases dramatically.

For optimization, simulation, and investment selection, the investors selection should

account for volatility, skewness and kurtosis when the return distribution over the

relevant period is likely to be significantly different than the normal distribution.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Field Development optimization example

Example of optimization

Investment to drill out Area A and/or Area B, which have different profit

expectations and constraints.

Export

Price, $/kscf 7 7

Lifting cost, $kscf 2 3

Area B Overhead, $kscf 2 2

Operators hrs./Mscf 2 1

Engineers hrs./Mscf 1 1

Export Pipeline capacity/Mscfd 40 100

Profit/$kscf 3 2

Operators limit (100 hrs/d)

Engineers limit (80 hrs/d)

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization

Area A has higher profit margin, thus should produce up to pipeline capacity

and use any left over resources for Area B.

resources for Area B to produce 20 Mscf/d.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization

TOTAL PROFIT

= $160,000 / DAY

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization

Decisions

Pipeline A Flow Rate = A

Pipeline B Flow Rate = B

Profit A = (Price - Lifting Cost A - Overhead A) Pipeline A Flow Rate = 3A

Profit B = (Price - Lifting Cost B - Overhead B) Pipeline B Flow Rate = 2B

Constraints

Pipeline A Flow Rate = A < 40

Pipeline B Flow Rate = B < 100

hr hr

Operator Hours = 2 Pipeline A Flow Rate + 1 Pipeline B Flow Rate = 2A + B < 100

MSCF MSCF

hr hr

Engineer Hours = 1 Pipeline A Flow Rate + 1 Pipeline B Flow Rate = A + B < 80

MSCF MSCF

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization

sequential thinking

Total Total Total Total Total Total Total

Profit = Profit = Profit = Profit = Profit = Profit = Profit =

A 50 100 150 200 250 300 350

0 25 50 75 100 125 150 175

5 18 43 68 93 118 143 168

10 10 35 60 85 110 135 160

15 3 28 53 78 103 128 153

20 -5 20 45 70 95 120 145

25 -13 13 38 63 88 113 138

30 -20 5 30 55 80 105 130

35 -28 -3 23 48 73 98 123

40 -35 -10 15 40 65 90 115

45 -43 -18 8 33 58 83 108

50 -50 -25 0 25 50 75 100

55 -58 -33 -8 18 43 68 93

60 -65 -40 -15 10 35 60 85

65 -73 -48 -23 3 28 53 78

70 -80 -55 -30 -5 20 45 70

75 -88 -63 -38 -13 13 38 63

80 -95 -70 -45 -20 5 30 55

85 -103 -78 -53 -28 -3 23 48

90 -110 -85 -60 -35 -10 15 40

95 -118 -93 -68 -43 -18 8 33

100 -125 -100 -75 -50 -25 0 25

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Solve optimization by graphical solution (LP)

1. Plot Objective Function:

100

100 Total Profit = 3A + 2B

B = (Total Profit - 3A) / 2

2. Plot Constraints

B=

0<A<40

10

80

35

80

0-2

0<B<100

Pipeline Flow rate from B (MSCF/D)

0

A

Operator's Limit

3A

2A+B<100 B<100-2A

30

+

0

2B

Engineer's Limit

60

60 A+B<80 B<80-A

=

25

0

3. Find Maximum in the region of

feasible constraints;

20

0

40

40

always in one of its vertices

15

0

10

20 B<

0

20 80

-A

50

00

00 20 40 60

60 80

80

are more than 2 variables or

Pipeline Flow rate from A (MSCF/D) if objective function and

constraints are non linear?

34

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Solve Optimization by Using Any Solver

S.T.R. = Subjectmax [ ( )]

f x =

to restrictions max[Total Profit ]S .T . R.

Objective

Decision

Profit model Function

Making

Evaluation

35

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Solve Optimization by Using Excel Solver

2. Set Max, min or Value of Objective

3. Set By Changing Cells Decision Variables

4. Set Subject to Constraints Constraints

5. Click Solve

36

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization

The Optimal

Answer A produces 20 Mscf/d B produces 60 Mscf/d

80

Ope Optimal

rato

70 r Co Answer

nst

rai nt $180K

60 /day

50 En

gi

ne

40 er Intuitive

C on

st Answer

30 ra

in

t $160K

20 /day

10

0

0 10 20 30 40

Area A Production, Mscf/d

37

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

So, What is Optimization?

Optimization is a process that finds a best, or optimal, solution for a model.

Optimization is the selection of the best alternative, or maximizing/minimizing a goal,

subject to a particular model, satisfying (or not) all requirements and constraints

For example, maximize IRR given that the maximum capital exposure does not

exceed $100,000

A constraint restricts the decision variables to specific combinations of values.

For example, if you can only invest $50,000 in a group of portfolio assets (your

decision variables), a constraint will ensure that the investment sum from all of

the assets will never exceed $50,000.

A requirement is a restriction on a forecast statistic such as the mean or standard

deviation. Optimization will ignore any solution that does not comply with your

requirement

For example, you could set a requirement to ensure that in any acceptable

solution, you will be 90% certain of having a final portfolio value of $1 million or

more.

Optimization is very important when you have model variables that you can control

(e.g., spending) and you want a maximum or minimum goal that relies on those

variables.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

What do we optimize in Oil & Gas Industry?

(things we can control)

to maximize profit and minimize variance

Capital allocation into separate investments

number of oil wells to drill given a certain reservoir size and specified production

rates.

Facility size, pipeline dimensions, plateau rate, artificial lift method, gas-lift quantity,

production/injection rates

Shots per foot, slots per foot, mud weight, weight-on-bit, pump strokes

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Optimization and Uncertainty

Example of uncertainty assessment

For a given decision set (A=20, B=60) there is only one Total Profit

value under certain assumptions of input parameters and resource

constraints, but

Assumes that there exists uncertainty in

Reservoir delivery

Lifting costs

Operation efficiencies

Events are uncertain if we do not have control over them in the decision

making process, but they are relevant in at least one of the objectives

Sometimes, uncertainties may be minimized before we take decisions

Sometimes, it is unpractical to eliminate uncertainties but we can

evaluate the impact on our decisions

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

We model uncertainty using Random Variables with certain

Probability Distribution

thus, can take on more than one possible value.

variable. (e.g., ultimate reserves, net pay, drilling costs, commodity

price etc.)

a random variable can take, together with the associated

probabilities of occurrence of those values.

e.g., Coin toss - Heads or Tails, each has a probability of 0.5

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization under uncertainty

Gas Price ($/kscf) Lift Cost A ($/kscf) Overhead ($/kscf)

?

Profit B = (Price - Lift Cost B - Overhead B) Pipeline B Flow Rate

Gas Price ($/kscf) Lift Cost B ($/kscf) Overhead ($/kscf)

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of a Probabilistic distribution

1 111 From 50 to 80 ft 4 4/20 = 20%

2 81 From 81 to 110 ft 7 7/20 = 35%

3 142

4 59

From 111 to 140 ft 5 5/20 = 25%

5 109 From 141 to 170 ft 3 3/20 = 15%

6 96 From 171 to 200 ft 1 1/20 = 5%

7 124

8 139

9 89 40% 7

10 129

Frequency

11 104 30% 5

12 186 4

13 65 20% 3

14 95

15 54

10% 1

16 72

17 167

18 135

0%

19 84 From 50 From 81 From 111 From 141 From 171

20 154

to 80 ft to 110 ft to 140 ft to 170 ft to 200 ft

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Uncertainty Analysis

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Uncertainties vs. Risk

There is no real consensus between risk and uncertainty

It is usually considered in the Oil and Gas Industry as:

Uncertainty

The parameter variation affecting one evaluation

without uncertainty There is no risk

Uncertainty generates risk and opportunity

Risk

It is related to the probability of failure and the cost associated

It is usually defined with a probability of an adverse scenario

Without risk there is no probability of winning

46

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Sources of Model Variations

Uncertainty

Assumptions that are uncertain because of insufficient information about a true,

but unknown, value.

Examples of uncertainty include the reserve size of an oil field or the prime

interest rate in 12 months.

Can be described as an assumption with a probability distribution.

Theoretically, uncertainty can be eliminated by gathering more information.

Practically, information can be missing because you havent gathered it or

because it is too costly to gather.

Variability

Assumptions that change because they describe a population with different

values.

Examples of variability include the individual body weights in a population or the

daily number of products sold over a year.

Variability can be described as assumption with a discrete distribution (or

approximate one with a continuous distribution).

Variability is inherent in the system, and it cannot be eliminated it by gathering

more information.

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Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Optimization under uncertainty

Gas Price ($/kscf) Lift Cost A ($/kscf) Lift Cost B ($/kscf)

Overhead ($/kscf) Operators Hours ($/kscf) Engineers Hours ($/kscf)

Then, the optimal solution is given by maximizing expected value of the objective

function:

where is the mean value of f(x) for a given number of stochastic simulations;

S.T.R. = Subject to restrictions

48

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Optimization Under Uncertainty

Then, the optimal solution is given by maximizing expected value of the objective

function:

max[E [ f ( x )]] = max[E [Total Profit ]] = max[ ]S .T . R.

where is the mean value of f(x) for a given number of stochastic simulations;

S.T.R. = Subject to restrictions

Probabilistic

Perturbation

Decision

Objective

Profit model Function

Making

Evaluation

Probabilistic

response

49

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization under uncertainty

solves for optimal Perturbation

decision making Decision

Objective

Profit model Function

One internal loop solves Making

Evaluation

for uncertainty Probabilistic

propagation response

50

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

Example of optimization under uncertainty

represent the solution :[k$/d]

(one scenario) of one

external loop

For every expected

value of Total Profit in

the Upper envelope

there is an optimal

acceptable risk

The slope of the Upper

envelope gives an idea

of the project risk and

they have constant /

= 0.55 = 0.67

:[k$/d]

51

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

What Is an Efficient Frontier?

given assets), each potential set (e.g. portfolio) has its own specific mean return and

standard deviation of return.

Plot the means on one axis and the standard deviations on another axis

Return -- E(NPV) (MM$)

30

Efficient

28

26

24 Inefficient

22

20

4 5 6 7 8 9

Risk SSD (MM$)

Points above the curve are unobtainable combinations for a particular asset.

Curve represents portfolios where we cannot obtain higher mean returns without

generating higher standard deviations

52

Halliburton-Sonatrach On-Boarding Program Reservoir Engineering Introductory Course January 2009

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