Determining the impacts of price uncertainty is relevant as the market expects and rewards consistent performance, or more specifically consistently good performance. These performance measures are often driven by product pricing. But, pricing may represent one of the most significant uncertainties for many producers.

1. Consistent performance:
Reducing the impacts of price uncertainty through
portfolio management practices
Paul D. Allan
PORTFOLIO DECISIONS, INC.
SPE Paper # 82001
SPE Hydrocarbon Economics and Evaluation Symposium
Dallas, Texas, U.S.A., 5–8 April 2003.
Copyright 2003, Portfolio Decisions,Inc.

2. Overview
•
•
•
•
Background
Portfolio Model Description
Methodology
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

3. Background
•
•
•
•
Background: Why relevant? Why now?
Portfolio Model Description
Methodology
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

4. Background
• Business Climate
– Market expects (rewards) consistent performance
… as long as consistently good performance
– Performance measures often driven by product
pricing (Operating income, NCF, ROCE…)
– Pricing may represent one of the most significant
uncertainties for many producers
Copyright 2003, Portfolio Decisions,Inc.

5. Background
WTI Average Monthly Prices
A
$30
Earnings = ?
B NCF = ?
ROCE = ?
$20
C
$10
’90
Copyright 2003, Portfolio Decisions,Inc.
’95
’00
PRICE may represent
the most significant
factor in a company’s
ability to meet its
performance GOALS…

6. Background
• Business Climate: How are the impacts of
price uncertainty managed?
– Financial hedges (options, collars, swaps…)
allow producers to lock in results… at a cost
– Ignored - can’t control it and market expects
exposure to price…at a cost…
– Portfolio Management – Exploiting the natural
‘hedging’ of certain fiscal structures or opportunity
timing…at a cost
Copyright 2003, Portfolio Decisions,Inc.

7. Background
• What is required for portfolio management?
– Understanding of portfolio opportunities, goals,
and constraints necessary to effectively balance
trade-offs (value the costs of the hedge benefit)
– Complexity of business (project interactions,
scale, uncertainties, options) makes ‘intuitive’
portfolio management difficult
Ø Need quantitative approach to exploiting hedging
effects of portfolio interactions
Copyright 2003, Portfolio Decisions,Inc.

8. Portfolio Model Description
•
•
•
•
Background
Portfolio Model Description: Components
Methodology
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

9. Portfolio Model Description
Opportunities – Goals - Constraints
Type I
Type II
EXPLORATION
Vision
Type III
Projects
Projects
Goals
Opportunities
Constraints
Copyright 2003, Portfolio Decisions,Inc.
Strategy

10. Portfolio Model Description
Opportunities
• Actual E&P Economic cases used (domestic &
international)
• Consolidated cases into 95 unique ‘Type’ projects
• Simple stochastic descriptions (P10, P50, P90, Fail)
for each project
• Each case evaluated at High, Reference, and Low
price scenario (WTI Pricing) – used individual pricing
offsets as appropriate
Copyright 2003, Portfolio Decisions,Inc.

11. Portfolio Model Description
Opportunities: Pricing assumptions
• High Price scenario: WTI = $25.00 per bbl (flat)
• Reference scenario: WTI = $19.50 per bbl (flat)
• Low Price scenario: WTI = $17.00 per bbl (flat)
Ø Flat pricing used for simplicity / demonstration.
Ø These techniques would equally apply with time
variable pricing assumptions.
Copyright 2003, Portfolio Decisions,Inc.

12. Portfolio Model Description
Goals, Constraints
Initial Reference Portfolio
Reference Price (WTI = $19.50)
Capital ($MM)
ROCE (%)
Op Income ($MM)
0.0
0
Staff Reqd
20
11
20
09
20
11
20
09
20
07
20
05
20
03
20
11
20
09
20
07
Copyright 2003, Portfolio Decisions,Inc.
20
07
250
200
150
100
50
0
2,500
2,000
1,500
1,000
500
0
20
05
20
03
250
200
150
100
50
0
Reserves (MMBOE)
20
05
Production (MMBO)
20
03
20
11
20
09
20
07
20
05
20
03
0
20
11
500
20
09
5.0
20
07
1,000
20
05
10.0
500
20
03
1,500
20
11
15.0
20
09
1,000
20
07
2,000
20
05
20.0
20
03
1,500

13. Portfolio Model Description
Goals, Constraints
Initial Reference Portfolio
Reference Price (WTI = $19.50)
Capital ($MM)
ROCE (%)
Op Income ($MM)
0.0
0
Staff Reqd
20
11
20
09
20
11
20
09
20
07
20
05
20
03
20
11
20
09
20
07
Copyright 2003, Portfolio Decisions,Inc.
20
07
250
200
150
100
50
0
2,500
2,000
1,500
1,000
500
0
20
05
20
03
250
200
150
100
50
0
Reserves (MMBOE)
20
05
Production (MMBO)
20
03
20
11
20
09
20
07
20
05
20
03
0
20
11
500
20
09
5.0
20
07
1,000
20
05
10.0
500
20
03
1,500
20
11
15.0
20
09
1,000
20
07
2,000
20
05
20.0
20
03
1,500

14. Methodology
•
•
•
•
Background
Portfolio Model Description
Methodology – Applied Portfolio Analyses
Conclusions
Copyright 2003, Portfolio Decisions,Inc.

15. Methodology
Developed Efficient Frontier for Reference Strategy
Evaluated portfolio trade-offs for this strategy
Initial Reference Strategy
Reference Price (WTI = $19.50)
Efficient Frontier
Reference Price Assumption
Risk (Value Variability)
700
600
Every point represents a unique
portfolio combination:
•Same inventory of opportunities
•Same goals
•Same constraints
500
400
300
200
100
0
3,500
3,700
3,900
4,100
4,300
4,500
Portfolio Value ($MM)
Copyright 2003, Portfolio Decisions,Inc.
4,700
4,900

16. Methodology
Evaluated specific portfolios
Probability of Achieving
Expected Value
Reference Price (WTI = $19.50)
1,000
500
20
11
20
09
20
11
20
09
1.00
0.80
0.60
0.40
0.20
0.00
20
07
250
200
150
100
50
0
20
05
20
11
20
07
0
20
03
20
11
20
09
1,500
Staff Reqd
1.00
0.80
0.60
0.40
0.20
0.00
20
09
2,500
2,000
1,500
1,000
500
0
20
03
20
11
20
09
20
07
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1.00
0.80
0.60
0.40
0.20
0.00
Reserves (MMBOE)
1.00
0.80
0.60
0.40
0.20
0.00
20
05
250
200
150
100
50
0
2,000
20
03
Production (MMBO)
20
07
20
11
20
09
20
07
20
05
20
03
0
20
07
500
1.00
0.80
0.60
0.40
0.20
0.00
20
05
1,000
Op Income ($MM)
20.0
15.0
10.0
5.0
0.0
20
05
1.00
0.80
0.60
0.40
0.20
0.00
20
03
1,500
ROCE (%)
20
05
Capital ($MM)
20
03
Reference Portfolio

17. Methodology
Evaluated specific portfolios
Probability of Achieving
Expected Value
Reference Price (WTI = $19.50)
1,000
500
20
11
20
09
20
11
20
09
1.00
0.80
0.60
0.40
0.20
0.00
20
07
250
200
150
100
50
0
20
05
20
11
20
07
0
20
03
20
11
20
09
1,500
Staff Reqd
1.00
0.80
0.60
0.40
0.20
0.00
20
09
2,500
2,000
1,500
1,000
500
0
20
03
20
11
20
09
20
07
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1.00
0.80
0.60
0.40
0.20
0.00
Reserves (MMBOE)
1.00
0.80
0.60
0.40
0.20
0.00
20
05
250
200
150
100
50
0
2,000
20
03
Production (MMBO)
20
07
20
11
20
09
20
07
20
05
20
03
0
20
07
500
1.00
0.80
0.60
0.40
0.20
0.00
20
05
1,000
Op Income ($MM)
20.0
15.0
10.0
5.0
0.0
20
05
1.00
0.80
0.60
0.40
0.20
0.00
20
03
1,500
ROCE (%)
20
05
Capital ($MM)
20
03
Reference Portfolio

18. Methodology
Reference Portfolio:
Unacceptable when Low Price applied
Reference Portfolio
Probability < 10%
Low Price (WTI = $17.00)
1,000
500
20
11
20
09
20
11
20
09
1.00
0.80
0.60
0.40
0.20
0.00
20
07
250
200
150
100
50
0
20
05
20
11
20
07
0
20
03
20
11
20
09
1,500
Staff Reqd
1.00
0.80
0.60
0.40
0.20
0.00
20
09
2,500
2,000
1,500
1,000
500
0
20
03
20
11
20
09
20
07
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1.00
0.80
0.60
0.40
0.20
0.00
Reserves (MMBOE)
1.00
0.80
0.60
0.40
0.20
0.00
20
05
20
03
250
200
150
100
50
0
2,000
20
03
Production (MMBO)
20
07
20
11
20
09
20
07
20
05
20
03
0
20
07
500
1.00
0.80
0.60
0.40
0.20
0.00
20
05
1,000
Op Income ($MM)
20.0
15.0
10.0
5.0
0.0
20
05
1.00
0.80
0.60
0.40
0.20
0.00
20
03
1,500
ROCE (%)
20
05
Capital ($MM)

19. Methodology
When optimized under the Low price:
Low Price Optimized Portfolio
Probability from < 10% to over 55%
1,000
500
20
11
20
09
20
11
20
09
1.00
0.80
0.60
0.40
0.20
0.00
20
07
250
200
150
100
50
0
20
05
20
11
20
07
0
20
03
20
11
20
09
1,500
Staff Reqd
1.00
0.80
0.60
0.40
0.20
0.00
20
09
2,500
2,000
1,500
1,000
500
0
20
03
20
11
20
09
20
07
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1.00
0.80
0.60
0.40
0.20
0.00
Reserves (MMBOE)
1.00
0.80
0.60
0.40
0.20
0.00
20
05
20
03
250
200
150
100
50
0
2,000
20
03
Production (MMBO)
20
07
20
11
20
09
20
07
20
05
20
03
0
20
07
500
1.00
0.80
0.60
0.40
0.20
0.00
20
05
1,000
Op Income ($MM)
20.0
15.0
10.0
5.0
0.0
20
05
1.00
0.80
0.60
0.40
0.20
0.00
20
03
1,500
ROCE (%)
20
05
Capital ($MM)
Low Price (WTI = $17.00)

20. Methodology
Using Low Price assumption: Compared Low price
optimized portfolio to the Reference portfolio
• Significant improvement in the probability of
achieving the ROCE and Operating Income goals
• Still met Reserves targets, but much lower growth in
reserves
Ø A negligible difference between the portfolios (Low
price and Reference price optimized) would have
indicated insufficient project variety for hedging
purposes
Copyright 2003, Portfolio Decisions,Inc.

21. Methodology
Identified strategic projects: Low price optimized portfolio
• Beneteau and Baltic project types not selected in
Reference Price optimized portfolios – But, crucial to
delivering performance in the Low price environment
• Evaluated specific characteristics that made these
projects attractive under the low price assumption
Ø These projects included PSC’s, marginal return
projects, and small production deals with low value,
but rapid development
Copyright 2003, Portfolio Decisions,Inc.

22. Methodology
Biased selection to include Low price performers
• Beneteau and Baltic projects forced into the portfolio
• Projects locked ‘on’ prior to optimizing the portfolio at
the reference price
Ø Low Price Biased portfolio delivers protection from
the impacts of the low price scenario…at a cost
Copyright 2003, Portfolio Decisions,Inc.

23. Methodology
Comparison between:
- Original Reference portfolio
- Low price biased portfolio
Reference Strategy
Reference Price (WTI = $19.50)
Total Capital (8 year Plan)
$4,034 MM
Efficient Frontier
Reference Price Assumption
Original Reference
8%
Forced: Baltic, Beneteau
Risk (Value Variability)
700
600
27%
500
65%
400
300
200
100
Increased allocation (Low Price Biased)
0
3,500
Initial Allocation (Low Price Biased)
3,700
3,900
4,100
4,300
Portfolio Value ($MM)
Copyright 2003, Portfolio Decisions,Inc.
4,500
4,700
Other Capital

24. Methodology
Reference Strategy
Difference represents the portfolio
cost of applying the project ‘hedge’
Reference Price (WTI = $19.50)
Efficient Frontier
Reference Price Assumption
Original Reference
Forced: Baltic, Beneteau
Risk (Value Variability)
700
600
500
400
300
200
100
0
3,500
Copyright 2003, Portfolio Decisions,Inc.
3,700
3,900
4,100
4,300
Portfolio Value ($MM)
4,500
4,700

25. Methodology
Performance gain when portfolio
evaluated in the Low price environment
Low Price Biased Portfolio
Low Price (WTI = $17.00)
Capital ($MM)
20
11
20
09
20
11
20
09
1.00
0.80
0.60
0.40
0.20
0.00
20
07
250
200
150
100
50
0
20
05
20
11
20
07
20
05
0
20
03
20
11
500
Staff Reqd
1.00
0.80
0.60
0.40
0.20
0.00
20
09
2,500
2,000
1,500
1,000
500
0
20
03
20
11
20
09
20
07
Copyright 2003, Portfolio Decisions,Inc.
1,000
Reserves (MMBOE)
1.00
0.80
0.60
0.40
0.20
0.00
20
05
20
03
250
200
150
100
50
0
1.00
0.80
0.60
0.40
0.20
0.00
1,500
20
03
Production (MMBO)
20
09
20
03
20
11
20
09
20
07
20
05
20
03
0
20
07
500
2,000
1.00
0.80
0.60
0.40
0.20
0.00
20
07
1,000
Op Income ($MM)
20.0
15.0
10.0
5.0
0.0
20
05
1.00
0.80
0.60
0.40
0.20
0.00
20
05
1,500
ROCE (%)

26. Methodology
Performance gain when portfolio
evaluated in the Low price environment
Reference Portfolio / Low Price Biased
Low Price (WTI = $17.00)
20
11
20
09
1.00
0.80
0.60
0.40
0.20
0.00
20
11
20
09
20
07
250
200
150
100
50
0
20
05
20
11
20
09
20
07
20
03
20
11
Staff Reqd
1.00
0.80
0.60
0.40
0.20
0.00
2,500
2,000
1,500
1,000
500
0
20
03
20
11
20
09
20
07
20
05
20
03
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1.00
0.80
0.60
0.40
0.20
0.00
Reserves (MMBOE)
1.00
0.80
0.60
0.40
0.20
0.00
250
200
150
100
50
0
2,000
1,500
1,000
500
0
20
03
Production (MMBO)
20
09
20
03
20
11
20
09
20
07
20
05
20
03
0
20
07
500
1.00
0.80
0.60
0.40
0.20
0.00
20
07
1,000
Op Income ($MM)
20
15
10
5
0
20
05
1.00
0.80
0.60
0.40
0.20
0.00
20
05
1,500
ROCE (%)
20
05
Capital ($MM)

27. Methodology
Evaluated the range of outcomes for the:
Reference Portfolio
Low Price (WTI = $17.00)
Capital ($MM)
ROCE (%)
Op Income ($MM)
Reserves (MMBOE)
Copyright 2003, Portfolio Decisions,Inc.
20
11
20
09
20
07
20
05
20
03
20
11
20
09
20
07
0
20
09
20
07
20
11
20
11
1,000
20
09
2,000
20
07
250
200
150
100
50
0
20
05
3,000
20
05
20
03
200
150
100
50
0
Staff Reqd
20
03
Production (MMBO)
20
05
400
20
03
0.0
20
11
0
20
09
600
20
07
5.0
20
05
500
20
03
800
20
11
10.0
20
09
1,000
20
07
1,000
20
05
15.0
20
03
1,500

28. Methodology
Evaluated the range of outcomes for the:
Reference Portfolio / Low Price Biased
Low Price (WTI = $17.00)
Capital ($MM)
ROCE (%)
Op Income ($MM)
Reserves (MMBOE)
Copyright 2003, Portfolio Decisions,Inc.
20
11
20
09
20
07
20
05
20
03
20
11
20
09
20
07
0
20
09
20
07
20
11
20
11
1,000
20
09
2,000
20
07
250
200
150
100
50
0
20
05
3,000
20
05
20
03
200
150
100
50
0
Staff Reqd
20
03
Production (MMBO)
20
05
400
20
03
0.0
20
11
0
20
09
600
20
07
5.0
20
05
500
20
03
800
20
11
10.0
20
09
1,000
20
07
1,000
20
05
15.0
20
03
1,500

29. Methodology
Reference Portfolio / Low Price Biased
SIGNIFICANT ?
Low Price (WTI = $17.00)
Capital ($MM)
ROCE (%)
Op Income ($MM)
Reserves (MMBOE)
Copyright 2003, Portfolio Decisions,Inc.
20
11
20
09
20
07
20
05
20
03
20
11
20
09
20
07
0
20
09
20
07
20
11
20
11
1,000
20
09
2,000
20
07
250
200
150
100
50
0
20
05
3,000
20
05
20
03
200
150
100
50
0
Staff Reqd
20
03
Production (MMBO)
20
05
400
20
03
0.0
20
11
0
20
09
600
20
07
5.0
20
05
500
20
03
800
20
11
10.0
20
09
1,000
20
07
1,000
20
05
15.0
20
03
1,500

30. Methodology
Also Evaluated typical hedge (forward sell)
• Applied stochastic pricing model (Monte Carlo w/
price environment as a variable)
• Production volume sold forward at Reference price to
equal project hedge impact (ROCE)?
Ø Required 50% of production sold forward at
Reference price
Ø Significant lost opportunity when stochastic price
assumption used (Reduced exposure to upside)
Copyright 2003, Portfolio Decisions,Inc.

31. Conclusions
• Portfolio analysis techniques useful in evaluating
project hedging potential.
• Biasing the portfolio selection can provide an
effective tool for mitigating the impacts of price
uncertainty.
• Thorough understanding of goals (level of confidence
required and tolerance of outcomes) needed to fully
evaluate hedging trade-offs.
• Pricing assumptions and alternative scenarios can
have a significant impact on the types of projects
selected.
Copyright 2003, Portfolio Decisions,Inc.