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Patrick Leach has thirty
years of experience in the energy industry, primarily in upstream oil
& gas. He is the Chief Executive Officer of Decision Strategies,
Inc., a leading management consulting firm in that industry. Mr. Leach
has also been an independent consultant and worked for Texaco as a
geophysicist, partner & government coordinator, and portfolio
manager. He has lived and worked all over the world, from New Orleans to
Sumatra to Aberdeen. Mr. Leach is the author of
"Why Can't You Just Give Me the Number? - An executive's guide to using
probabilistic thinking to manage risk and to make better decisions."
Mr. Leach has a B. Sci. degree from the University of
Rochester and an MBA from the University of Houston. He is a Charter
Fellow in the Society of Decision Professionals, and holds membership in
the American Association of Petroleum Geologists, the Society of
Petroleum Engineers, the Decision Analysis Affinity Group, and INFORMS.
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Many exploration and production companies impose a risk
threshold on major capital projects (one common such hurdle is a maximum
acceptable probability of negative NPV). Projects which fail to meet
the threshold are not usually rejected outright; rather, the project
team is instructed to gather more information and perform more analyses,
so as to reduce the range of economic uncertainty associated with the
project. Projects are routinely delayed while unnecessary appraisal
wells are drilled and analyses are conducted, thus eroding millions of
dollars from the NPV of these projects. The primary arena in which risk
tolerance is applied is the development stage of a project. Companies
are comfortable with the notion of failed exploration wells, but not
failed developments. Stringent probability-of-success hurdles
oftenresult.
Unless the failure of a single project could put a firm into
financial distress, companies should be risk neutral when making
decisions at the project level – i.e., they should make decisions based
on the mean values of the economic metrics of interest (NPV, P/I, etc.)
with no further consideration taken of the probability of success.
Value-of-information (VOI) analyses should be used to determine when
additional information or analysis adds value to a project and when it
does not.
The key concept is this: Risk tolerance should be applied at
the portfolio level, not the project level. The question to ask is not,
“Am I comfortable with the risk associated with this project?”; rather,
it is, “Am I comfortable with the risk associated with my portfolio of
assets when this project is included?”
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