Industry Needs Re-Education in Uncertainty Assessment

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It is clear the oil and gas industry recognizes the large uncertainty in which it operates. A search in the OnePetro technical paper database using the keywords “uncertainty” or “risk” returns more than 53,000 conference and journal papers. Yet, it is also clear that the industry does not know how to reliably assess uncertainty and that this inability negatively affects industry performance. Capen (1976) described the difficulty of assessing uncertainty. He pointed to massive capital overruns and low industry returns due to an almost universal tendency to underestimate uncertainty. Brashear et al. (2001) and Rose (2004) later documented the dismal performance of the industry in the last 10 to 20 years of the 20th century due to chronic bias and evaluation methods that do not account for the full uncertainty.

Although industry profitability may have improved in the past decade because of high oil prices, Neeraj Nandurdikar in an October 2014 JPT article, “Wanted: A New Type of Business Leader to Fix E&P Asset Developments,” showed that the oil and gas industry continues to perform significantly below estimations and expectations. He cited three ways that assets erode value, all of which relate to unreliable assessments of uncertainty: (1) production and reserves estimates are overestimated, (2) capital costs are underestimated, and (3) development times are underestimated. And these do not include price estimations; the surprising oil price slide at the time of this writing has the potential to move industry performance from below expectations to below profitability.

While project evaluations can be affected by many different types of biases, these can be reduced fundamentally to two primary biases: overconfidence and directional bias.

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Industry Needs Re-Education in Uncertainty Assessment

Duane McVay, Professor, Texas A&M University

01 February 2015

Volume: 67 | Issue: 2


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