The three basic types of risks for projects are market risk, country/political risk and business risk. While the former and the latter should be evaluated simultaneously, the country risk is applied with a special opportunity cost (discount rate) weighted with a country risk factor.
The basis of risk evaluation is the net present value calculated with a cash flow model showing the breakdown in discounted differences of all future costs and revenues throughout on entire project. The simulation model will be programmed to handle the main incoming data, which define the market and business risk (e.g., oil price, inflation, foreign exchange, reserves, ultimate recovery, specific costs, taxes and similar payables, etc.) as stochastic variables.
For defining the distribution functions as variables that reflect market risks, the basis will be the variance of values in the past and the expected figures planned in the company's premises. Some parameters are not independent (e.g., under identical circumstances lower unit costs are associated with larger reserves), therefore analysts can define a correlation between the specific parameters by historical data Those co-efficient will be applied by the utilised software during the simulation.
After running all the cycles a frequency function is compiled from the results and this will serve as the basis for defining data relating to cash flow (e.g., expected value, standard deviation, values relating to 5% or other cumulative frequency, etc.). The main indicator (borrowed from the field of financial risk management) is Value at Risk (VaR) which is the difference of the expected NPV and the NPV value at, generally, 5% cumulative frequency. Another important index is the Reward per Risk ratio of expected NPV and VaR.