Abstract
One of the most important investment decisions that exploration and production (E&P) organizations make is allocating limited capital amongst the myriad projects in the corporate portfolio. The importance of making more effective capital allocation has become more apparent with the prevailing depressed oil price environment. This paper enumerates the methods used in deciding which projects to fund and puts them in the context of prevailing market conditions. It then identifies shortcomings in the most common methods used and suggests an optimal alternative.
In the prevailing depressed market conditions, most E&P organizations face significant capital spend cuts. More often than not, capital is allocated to projects based on a net present value (NPV) optimized portfolio. This sometimes results in the unintended consequence of sanctioning relatively capital inefficient projects that return less value per capital spend. A case study of a hypothetical portfolio of 12 projects including exploration, development, and production assets is used here to demonstrate this issue. Three methods—a rank and cut, NPV-optimized, and discounted profitability index (DPI) optimized—were used to determine projects to fund.
Results and insights from this analysis show that optimizing a portfolio based on NPV to allocate capital results in the unintended consequence of funding lower DPI projects, especially in an era of deep capital spend cuts, when prudence and corporate survival take precedence over production and reserves replacement targets. This paper highlights the value of expected value thinking in decision making and concludes that a DPI-optimized portfolio for capital allocation ensures E&P organizations obtain better value for capital spend and helps identify divestiture candidates when the need to raise capital ensues.
This paper leverages the effective use of cloud-enabled integrated solutions to evaluate prospects in a timely manner with minimal information and fewer resources, delivering results in a matter of minutes that would hitherto have taken a team of professionals several months to achieve.
