Investment Selection Under Uncertainty For Producing Operations

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This paper is to be presented at the Eastern Regional Meeting to be held in Pittsburgh, Pa., on Nov. 5–6, 1964, and is considered the property of the Society of Petroleum Engineers. Permission to publish is hereby restricted to an abstract of not more than 300 words, with no illustrations, unless the paper is specifically released to the press by the Editor of the JOURNAL OF PETROLEUM TECHNOLOGY or the Executive Secretary. Such abstract should contain conspicuous acknowledgment of where and by whom the paper is presented. Publication elsewhere after publication in JOURNAL OF PETROLEUM TECHNOLOGY or SOCIETY OF PETROLEUM ENGINEERS JOURNAL is granted on request, providing proper credit is given that publication and the original presentation of the paper.

Discussion of this paper is invited. Three copies of any discussion should be sent to the Society of Petroleum Engineers office. Such discussion may be presented at the above meeting and considered for publication in one of the two SPE magazines with the paper.

One of the notable features of the modern oil industry is the constant pressure for increased efficiency to meet the challenge of growing costs and increased competition. With increasingly large capital outlays for producing operations, it has become critical that investment be made as effective as possible. For this reason, considerable attention has been given to techniques for insuring maximum benefits from dollar expenditures. It is to our industry's credit that many quantitative methods for dealing with the myriad of assumptions and variable factors of producing operations have received wide acceptance.

One of the most serious and challenging decisions facing a producing company executive is that of selecting from the investment opportunities available the combination which will provide the highest returns. Since budget funds are usually limited, this selection must be made on the basis of economic and operational merit. The degree of merit can be determined only from the information available to the executive and from his experience.

The treatment of risk in capital budgeting Is critical since its measurement is largely subjective in evaluation assumptions and managers' preference for it is variable. Procedures for considering risk range from the simple discounting of expected values of investment returns, to the more complex determination of the utility of the investment. The main disadvantages in existing procedures are the suppression of information and the computational complexity. In brief, uncertainty is a fact of life in producing. We must live with it, and make financial plans accordingly. In dealing with risk, it is the results that should be considered. We must rule out unnecessary risks, but still aim for the high returns.