Abstract
This paper is intended to highlight some of the misconceptions that enter decision making whether as a consequence of human bias or as statistical inaccuracies and misuse of mathematically robust equations.
There are three basic questions in the oil and gas industry: 1) How big is it? i.e.: Resources, 2) How quickly can we get it out? i.e.: Rate, and 3) How much can we make from it? i.e.: Value. All three contain risk and uncertainty. Several methods are used by oil and gas professionals to manage these variables, ranging from the simple toss of a coin, to complex mathematical algorithms and statistics. If only it were so simple to use a formula for the decision and have the confidence to trust it. However, business decisions are often more than just complex logic and the worlds of subsurface geoscience and reservoir engineering add yet more variables and uncertainty.
The paper uses real world examples in the oil and gas industry and highlights the difference between Risk Management and simple Gambling. The paper draws upon the following three themes:
Human Factors: No matter how precise the mathematics of risk analysis, ultimately decision making relies upon individuals who are subjective by definition. A group of similar but independent professionals will have a different perception of risk and their own biases depending upon the number of parameters used to calculate for example, chance of success and different biases on marking at extremes of a range.
Statistics: One solution to deal with the human variable is to attempt to take individuals out of the decision making process completely and trust mathematics instead. Unfortunately, many decision makers have forgotten what assumptions exist in Portfolio Theory and often use the methods blindly, placing too much confidence in the predictions and unaware of other equally likely outcomes.
Popular Decision tools:
Expected Monetary Value – ‘Expected’ is a subjective term and numerically tends towards the Mode of the distribution. The authors question whether EMV really has any true meaning and instils a false sense of confidence in the outcome.
Hurdle Rates - The Theory of Inevitable Disappointment highlights how a decision maker who fails to understand uncertainty can often fall short on forecasts.
Conclusion: There are no simple rules when decisions involve information which contains uncertainty and interpretation. The responsibility for decision making should rest with individuals with ‘skin in the game’. A decision maker should be aware of all assumptions and always question those assumptions. In the end, if a decision maker does not use a spectrum of tools to examine all possible outcomes, then they are simply relying on luck. Whatever the process, review, feedback and calibration are critically important.
