In Brazil, for the last four decades, Petrobras, a state-owned company, had retained a monopolistic concession for the exploration of Oil & Gas prospects, when, in 1998, the law was changed and a broad range of opportunities were created. Since then, Petrobras has been offering a series of Join Venture opportunities for foreign oil companies to farm in.

Presently, a number of international oil companies installed offices locally and started to participate in the upstream sector. ANP, the National Petroleum Agency, is offering for tender various blocks both offshore and onshore. The first bid round was a major success, in mid 1999, the second bid round being scheduled for the third quarter of year 2000.

Blocks leased in the first bid round are now being explored by means of 2D and 3D seismic, and the first exploratory wells will be soon drilled. This article presents a framework to perform an economic evaluation of oil & gas prospects, taking into account the risk factor. The Net Present Value of each block is first computed based upon an average value. Following that, Monte Carlo simulation is used to compute the downside risk. The inputs are determined by means of probability distributions. Reservoir parameters, capital and operating costs and oil prices are fed into the program, revealing the NPV sensitivity to each factor.

The problem is further structured by means of decision trees. The Expected Monetary Value, based upon perceived probabilities of success, is estimated, utility functions being used to account for risk aversion. The optimum level of participation in each prospect is determined, using the so- called Certainty Equivalent concept. Finally, the formation of an optimum portfolio is discussed, so that any oil company can establish its strategy in joint bids and farm ins.

Four hypothetical prospects are evaluated; with different levels of investment and risk profiles, namely, from higher probability of success to new frontier, lower probability of success. The correspondence with real life may be, respectively, the Campos Basin, where 70% of Brazilian oil production comes from, and basins like Pelotas, where there are no producing wells, with little seismic available.

The framework suggested in this work could be useful for any company that is currently involved with exploration activities. Additionally, it may be used for analyzing any investment with a certain degree of uncertainty or volatility.


The contemporary Brazilian scenario offers opportunities of investments to foreign petroleum companies, normally in the upstream sector that until recently, was restricted to Petrobras.

This article shows the methodology to take decisions that involve risk. When there is no such thing as a variety of results, uncertainty or risk, the decision criteria can be based upon the net present value only.

We will work on an example that has four different prospects, with different internal rates of return and four standard deviations for these rates. Prospect A has an internal rate of return of 23% per annum, and a standard deviation of 13% per year. Prospect B has an IRR of 29% and deviation of 24%. The alternative C has an IRR of 37%, and a standard deviation of 41% and finally, prospect D has an IRR of 19% and a deviation of 7% per annum. The probability of success for each prospect also varies.

We will analyze these different options, coming to some results that will be a basis for building up the optimized investment portfolio.

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