Improving Exploration Investment through

Risk Management,
Uncertainty Recognition &
Decision Analysis
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Materials Created & Presented by
Ian Tchacos

Decision Analysis

Sensitivity Analysis

Decision Trees
 Decision Analysis
A disciplined approach to decision making

o Recognizes value as a function of both decisions & uncertainties:

Value
Alternatives &
Options Uncertainties
(Decisions)
o Helps teams:
 Quickly sort through issues to define the problem / opportunity
 Develop alternative approaches to consider
 Identify key risks and uncertainties to either control or monitor

o Facilitates informed decision making and coordinated action via:

 Stronger contracts and strategies
 Aligned teams monitoring and managing risks
 Increased value

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Decision Analysis
Reduces costly rework and poor decisions

o The problem is framed (set up) correctly

o Multiple, realistic alternatives are considered

o Information included is realistic

o Decision criteria & constraints are understood

o The evaluation is appropriate and insightful

o There is commitment to implementation

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There are three primary aspects of
Decision Analysis

o Framing:
Properly characterizing the problem & alternative solutions

o Analysis:
Gaining insight from the realistic evaluation of alternatives, considering
risks and uncertainties

o Communication with Decision Makers:

Coordinating action through dialogue with decision makers

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A Integrated Decision Framework encompasses the key elements of
Decision Analysis
It is a fit for purpose approach:

DECISION BOARD
FRAME INSIGHT

Define Create Perform Generate

Quantify
the Alternatives Sensitivity Range of
Uncertainties
Problem Analysis Outcomes

Implement & Monitor Make Decision

COORDINATED ACTION

PROJECT TEAM Decision Board Meeting

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Various framing tools help structure the
problem and alternative solutions

Issues

Business Strategy Table Decision Hierarchy

Assessment

Decision & Risk Influence Diagram Strategy Table

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Timeline
 The decision makers role during framing
involves two key responsibilities, at two key times

o Prior to the team meeting to “frame the problem”, decision makers should provide:

 Their top (3 - 5) issues regarding the problem

• An issue being anything of concern (a fact, decision or uncertainty)
 Their top (3 – 5) questions that need to be answered in order for them to make a decision

o After the team has “framed the problem” and before any material analysis has been performed, the
DECISION BOARD should meet with the team:

 To “improve the frame”:

• Agree on the problem focus
• Alternative solutions to be evaluated
• Risks and uncertainties to be incorporated
• Experts to be included for the assessments of uncertainties
• Project schedule

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A variety of analysis tools bring insight
to decision making with uncertainty

Tornado Plot Decision Tree

EMV = Σ Pn x NPVn

Cumulative Probability Curve Expected Monetary Value

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 The decision makers role during the analysis
involves two key responsibilities, at two key times

o Once the uncertainties have been assessed, decision makers should approve the
assessments of key uncertainties:

• May be done in one off meetings, via trusted managers or as a Decision Board
• Needs to be done prior to the final results of the uncertainty analysis modeling

- Before telling us what we might not want to hear and lending the analysis open for
revisit of the input numbers, based on emotion rather than objectivity

o After the uncertainty analysis is complete, Decision Boards should meet to derive insight
from the evaluation, discuss hybrid strategies and make a decision:

 Understand the key risks and uncertainties

 Understand the impact of the key risks and uncertainties on the courses of action considered
 Understand ways to better manage or control the key risks and uncertainties
 Approve a hybrid approach with commitment to implementation

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Decision Analysis
Addresses difficult questions by:

o Focusing on what we don’t know, as

opposed to what we do know

o Applying a logical, consistent approach to

evaluate alternatives

o Gaining insight into the risk and value

drivers of decision problems

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Fundamentals of Risk Analysis
The quantitative component of Decision Analysis
DECISION ANALYSIS
Roll the Dice
The basic principles of risk analysis may be
illustrated using a simple game

o Investment decision

o Uncertain outcomes

o Potential financial gain or loss

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The Funky Die Game

UNCERTAINTY PRIZE

Even or Odd Number Call correct $20

That Will Face Up in Die Call incorrect $0

o Play once

o How does this differ from calling a coin toss?

Rules of the Die Game

o Class bids on opportunity to play (“ticket” in)

o Highest bid wins the opportunity to play

o Player pays for opportunity to play (cash)

o Player calls even or odd # for die to land on

o If player calls die correctly, wins $20

o Calls incorrectly, player gets nothing

o Play only once

The money paid to play, or the
“ticket in” is a sunk cost

o Important concept

o All decisions are “sunk costs”

o Definition:

Decision = irrevocable allocation of resources

o Monetary
o Human

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Decision problems are compromised
of a few basic elements

o Choices are to be made The alternatives in the

funky die game are to
Decisions  Can be controlled invest or not invest.
 Have alternatives

o Uncertain outcomes The player will either

call the die correctly
Uncertainties or chance events or not.
cannot be controlled

o Value measures What we care about

in this game is profit.
Value  Decision criteria
 NPV or profit

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INFLUENCE DIAGRAMS identify key elements
& their relationships in decision problems.

Decisions

Profit

Even or Odd
# Call
of the Die

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Probabilities quantify the likelihood
of an occurrence
p = probability of the die landing on an odd or even #.
Call odd
p=

Call Even
1–p=
Probability is a state of knowledge & subjective judgment:
o Only uncertainties have probabilities associated with them.
o At any uncertainty node, probabilities must sum to 1.

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 A DECISION TREE organizes the important
factors of a decision in chronological order
Investment Call of Die Roll of Die Profit
Decision
p = _____
Odd $20
Call odd

1 - p = _____ Even $0
Play
Odd $0
p = _____

Call even
1 - p = _____ Even $20
Don’t play game
$0

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Basic Rules of
Risk Analysis

1) Expected Net Present Value (ENPV)

= Σ Pn x NPVn

2) For decisions, we choose the highest

value course of action.

3) Decisions do not have probabilities

associated with them.

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 Value of the Opportunity

Decision Risk Timeline

Call Roll ENPV = .6 ($20) + .4 ($ 0) = $12

Decision Tree
.6 Odd $20
$12
Call odd Roll
Even $0
.4
Call
.6 Odd
$0
$8

Call even
Roll
.4 Even $20
ENPV = .6 ($0) + .4 ($ 20) = $8

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Value of Information
o The value of information = value of the opportunity with information –
value of the opportunity without information

o We can not change our view of a given uncertainty, until new information is
obtained on that uncertainty.

o In order for information to have value, it must have the potential to change a
future monetary impact decision.
 In this case: whether to call odd, or call even
 Perfect information enables decision makers not to invest when there would
have been a bad outcome, thereby assuring good outcomes.

o The value of perfect information is the maximum amount one should pay
for information, (e.g. It’s as good as it gets).

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 Value of information, Real Options or
Embedded Decisions depend on:

1) Reliability of the information

2) Potential Impact of the Future Decision

(How painful it is when you’re wrong)

3) The Extent of the Uncertainty

(How much of the time you might be wrong)

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 Key Concepts of Risk Analysis
o The language of probability provides a quantitative language to deal with
uncertainty.

o A decision is an irrevocable allocation of resources.

o The expected value of an opportunity captures the potential outcomes weighted by

their probabilities.

o The value of an opportunity is either the expected value of that opportunity or its
certain equivalent (minimum selling price).
• Depending on the decision makers risk attitude

o The value of gathering more information can be assessed prior to making a decision.

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 Good decisions do not guarantee
good outcomes

o Good decisions incorporate:

 Logically consistent preferences
 Logically consistent information, which recognizes uncertainty
 Alternatives

o Where there is certainty, a good decision guarantees a good outcome.

 This is the case with perfect information

o Where there is uncertainty, a good decision does not guarantee a good outcome.

o The goal of Decision Analysis is to increase the likelihood of good outcomes through
a good decision approach.

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 Framing Decision Problems

o Overview

o Defining problem boundaries

o Creating alternative solutions

This section will focus on framing decisions and alternatives.

Framing includes building an influence diagram but this will be
covered in a separate section.

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The first step in quality decision making is
to build the appropriate frame

DECISION BOARD
FRAME INSIGHT

Define Create Perform Generate

Quantify
the Alternatives Sensitivity Range of
Uncertainties
Problem Analysis Outcomes

Implement & Monitor Make Decision

COORDINATED ACTION

PROJECT TEAM 30
Various tools help frame decision problems

Issues

Business Strategy Table Decision Hierarchy

Assessment

Decision & Risk Influence Diagram Strategy Table

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Timeline
 Begin defining the decision problem by
asking a series of questions

o What is the problem?

o What question(s) are we trying to answer?

o What decisions will we have to make in order to answer that question?

o What alternative solutions might we want to consider?

o What are the risks and uncertainties associated with the alternative solutions?

o What is the important background information associated with the question we are trying
to answer?

o What questions are we not trying to answer now?

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 Asking those questions will raise issues

An issue is anything of concern:

o Fact: a known piece of data or background information

o Uncertainty: a quantity about which you have no control

o Risk: a chance occurrence you do not know will happen or not

o Decision: a choice that may be controlled

• Value: decision criteria or outcome measure

• Objective: a desired level of performance

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Don’t cut the problem down too quickly…
you risk cutting off the path to the best solution

Use other tools to “feed the frame”:

o SWOT o PEST
 Strengths  Political
 Weaknesses  Environmental
 Opportunities  Social
 Threats  Technical

o FORWARD CASTING o SCENARIOS

 Suppose it is five years  Describe 2 -4 concepts
from now…  Who’s winning, losing, why &
indications
 What can you do to create
favourable outcomes?

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 Sorting the issues begins to convert
chaos to order

o Facts are recorded and saved as pertinent background information

o Uncertainties are noted for later structuring

• Influence Diagram
• Decision & Risk Timeline

o Decisions are prioritized in a Decision Hierarchy

which will include:

• Decision criteria
• Values
• Objectives

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Decisions are segregated in a DECISION
HIERARCHY to define the problem scope

Decisions that are taken as given &

will not be analyzed; they set
POLICY
the boundaries of the frame.
DECISIONS

Decisions to focus on to solve

the problem at hand.
STRATEGIC DECISIONS
Subordinate decisions
that will be
TACTICAL DECISIONS addressed once
decision is
implemented.

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 Focus on the strategic decisions, which
are “strategic” for the problem at hand

Decisions
POLICY
Already Made DECISIONS

Focus
Decisions STRATEGIC DECISIONS

Implementation
Decisions
TACTICAL DECISIONS

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 Keep your frame as open as
possible…

o Expand the attendee list of the framing meeting

• Decision makers
• Other valued information providers

o Gather issues ahead of meeting

• Especially from those who can not attend

o Err on the side of “strategic” if you are uncertain

of a decision’s place in the hierarchy

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Next, strategic themes are brainstormed to develop the
concept of some differing strategies for consideration

Try to use names for themes which illicit a mental picture for the various elements of the
concept that each theme is describing.

Strategic Themes Explore Develop Infrastructure

Road Runner Prospect 1 Subsea Tanker

Production
Prospect 2
Big Dog Prospect 3 New Platform Tie into 3rd
Party Pipeline
Prospect 4
Spend Thrift Used Platform
Watch Neighbour Build Own
Pipeline
FPSO

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Helpful Definitions

o Decision:
Irrevocable resource allocation of resources

o Strategy:
A coordinated set of irrevocable resource
allocation decisions
Alternative strategies are defined, using the Strategy Table,
for each strategic theme that the team would like to consider

The goal is a few (3 – 5) viable, fundamentally different strategies that span the set of
possibilities & test the impact of different uncertainties or decisions.

Strategic Themes Explore Develop Infrastructure

Road Runner Prospect 1 Subsea Tanker

Production
Prospect 2
Big Dog Prospect 3 New Platform Tie into 3rd
Party Pipeline
Prospect 4
Spend Thrift Used Platform
Watch Neighbour Build Own
Pipeline
FPSO

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 Each strategy should have an objective
and rationale

o Objective:
Brief description of the strategy and what it is trying to achieve.

o Rationale:
Concise statement of the reasons why the strategy might be a good
one to consider.

Minimal Investment Strategy

Objective:
Spend as little as possible yet realize value

Rationale:
Frees up funds for other more demanding assets with tighter constraints

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Influence Diagrams
&
Decision and Risk
Timelines
An Influence Diagram is a graphical
representation of a decision problem
Think of it as a “map” of the probabilistic economic model
Oil
Reserves Price
Flowstream
Revenue

Development
Strategy Taxes NPV
Capital
Costs

Costs
Operating
Costs = Calculated variable
= Uncertain variable
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 Influence Diagrams (IDs) have two
primary uses
o Initially, they are a communication tool
used to structure the problem & obtain
assessment of uncertainties.

Input Experts Project Team

o Later, they are used to construct the & Decision Board
economic model from which to base
any analysis.

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There are five basic symbols used in
an influence diagram

• Decision Criteria Node

Measure upon which decision will be made.

• Calculation or Deterministic Node

Major elements which need to be calculated to determine
the decision criteria.

• Uncertainty or Chance Node

Key unknown elements or inputs to the calculation nodes.

• Influence or Relevance Arc

• Decision Node

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 An arc to an uncertainty means
“it is relevant”

D A • The expert would change his/her view of

uncertainty A based on the decision D.
Water Injection Reserves

C A • The expert would change his/her view of

uncertainty A based on uncertainty C.
Water Depth Development Costs

C A • The expert would not change his/her view of

uncertainty A based on uncertainty C.
Water Depth Oil-In-Place

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 An arc to a decision means
“it is known”
It represents the decision makers state of knowledge at the time
he or she has to make the investment decision.

• The decision maker knows the

A B outcome of uncertainty A (it’s
resolved) before having to make
Oil or Gas Discovery Appraise investment decision B.

• The decision maker knows the

B C outcome of decision B when having to
make investment decision C.
Explore Appraise

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Steps to Building Influence Diagrams

o Build the Influence Diagram for one strategy.

o Begin with the decision criteria node on the far right (usually NPV).

o Ask the team “what do we need to know to calculate or know NPV?”.

o Keep asking that question (node by node) as you build out first the revenue stream
and then the cost stream.

o Build the diagram back to the level necessary to describe the uncertainty problem.

o Note calculated (or deterministic nodes) with double lined ovals.

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Steps to Building Influence Diagrams
continued
o Add the strategic decisions and draw relevance arrows from them to uncertainties whose
ranges would change if that decision changed.

o Note independent and dependent uncertainties with an I or a D, respectively.

o Add arrows to strategic decisions if timing of the decision makers knowledge is something
you wish to express.

o Ask yourself if the other strategies could be represented by the diagram or if they would
best be represented by a new / different diagram.

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Begin the Influence Diagram with the decision
criteria (NPV) and build it from right to left

Oil
Price
Production
Stream
• Build out the revenue Revenue
stream,
then cost the stream.

Taxes NPV
Capital
• Keep asking Costs
“What do I need to know
to calculate__________? Costs
e.g. revenue
Operating
Costs

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Build the ID back to the level necessary to
describe the uncertainty in the problem

Initial Oil
Rate/w Price
Size of Production
Aquifer Stream

Reserves Revenue

#
Wells
NPV
Taxes

Facility Capital
Costs Costs

Oil Costs
Storage Operating
Note calculations as Costs
double lined ovals.
Oil = Calculated variable
Offtake
= Uncertain variable
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 THANK YOU

Contact Details

Email:
iantchacos@bigpond.com

Mobile:
+61 417 090 224

Ian Tchacos
Improving Exploration Investment Presentation 53