Portfolio management is when the performance of the whole business is stressed over the performance of the projects. This can include a risk and reward analysis and often uses optimization and probabilistic analysis. This tool can be used for company 'disasters', such as any single event which results in a significant failure to meet company goals. Examples are failure or success of a very large project or the loss of key asset(s) due to political turmoil or a natural disaster.

1. SPE 82029
Disaster Insurance Using Portfolio
Management Techniques
James R. DuBois, SPE
Portfolio Decisions, Inc
Andrew Quarles PhD, SPE
Pioneer Natural Resources
SPE 82029

2. Define Portfolio Management
Definition #1: (A method to) “compare
the relative attractiveness of alternative
investments.”
Definition #2 : An application of
Markowitz’ 1952 “Portfolio Selection”
work to oil and gas investments.
SPE 82029

3. Define Portfolio Management
• Definition #3: A decision process that
seeks to address business problems by
manipulating and understanding the mix
and timing of projects undertaken
• Performance of the whole business is
stressed over performance of the projects.
• Can include risk - reward analysis
• Often uses optimization and probabilistic
analysis
SPE 82029

4. “Typical” Portfolio Analysis
Procedure
Define the
Company’s
goals
Describe the
Company’s
opportunities
“Optimize”
portfolio
selections to
meet the goals
Define
Operational
Constraints
Investigate
Risk/Reward,
Probabilities
SPE 82029

5. What do we mean by
“Disaster”?
• Any single event which results in a
significant failure to meet company
goals.
– Failure (or success?) of a very large
project (especially if it had a high chance of
success).
– Loss of a key asset due to political turmoil,
natural disaster, etc.
SPE 82029

6. How about “Insurance”?
Taking a small loss now in
order to mitigate a possible
large loss in the future.
SPE 82029

7. So….
• We are investigating ways to :
– Alter the mix and timing of projects in
such a way as to – Find a slightly “less optimum” portfolio
which – Performs better in the case of a
feared failure
SPE 82029

8. The Expected Value Trap
• Expected Value of a project is the risk
weighted average of that project’s possible
outcomes.
• EV is a useful strategy tool if there are a
number of projects roughly similar in scope,
so that the EV is realized “on average”.
• If one project is much larger or vastly
dissimilar to the rest, care must be taken in
applying expected value techniques to it.
SPE 82029

9. The Expected Value Trap
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10. The Expected Value Trap
Base (K) at 100% Ps
SPE 82029

11. The Expected Value Trap
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12. The Expected Value Trap
Base (K) at 95% Ps
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13. The Expected Value Trap
• Base 100%
• Base 95%
– Mean-
565
– Mean
537
– Median-
537
– Median
536
– STD
152
– STD
80
SPE 82029

14. So…
• When evaluating at risk projects that are
large and unique, expected value
analysis does not adequately describe
the problem.
• Probabilistic analysis does indicate the
problem, but does little to indicate a
solution.
SPE 82029

15. Analysis steps: “Insure Against
Disaster”
• Near Term Project:
– Model the portfolio with the probability of
success of the problem project set to zero.
– Can the portfolio be reoptimized in the
remaining years to meet the goals?
– If yes, what options do we need to keep
open?
– If no, what projects do we need to add, or
which goals do we need to modify?
SPE 82029

16. Example #1
Large Exploration Failure in
Year 1
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17. Example Data
• Simplified portfolio- very course
granularity.
• Goals and Projects are fictitious.
• Examples are designed to illustrate a
procedure, not to address every
eventuality.
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18. Opportunity Pool
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19. Current Portfolio Based on EV
NPV = 4007
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20. Current Portfolio Based on EV
NPV = 4007
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21. Current Portfolio Based on EV
NPV = 4007
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22. Alaska Fails
NPV = 3878
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23. Reoptimize After Alaska Fails
NPV = 3887
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24. Selection Differences
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25. Insurance “Cost”
• Keeping PSC, Shelf programs viable,
even if “unfunded”, until results from
Alaska are known.
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26. But…
What if Alaska Succeeds?
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27. Alaska Success
NPV = 4137
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28. Revised After Alaska Success
NPV = 3708
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29. Alaska Success Revision
Difference
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30. Example #2
Loss of a Producing Division
at the End of Year 2
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31. How to “Insure Against
Disaster?”
• Medium Term Project:
– Model the portfolio with the probability of success
of the problem project set to zero.
– Can the portfolio be reoptimized point forward to
meet the goals?
– If no, can the entire portfolio be reoptimized to
meet the goals both with and without the project?
– If no, what fallback goals are acceptable? What is
the cost?
SPE 82029

32. Current Portfolio Based on EV
NPV = 3942
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33. Lose Division After Year 2
NPV = 3575
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34. Fall Back Goals
• Production growth 10% to 5%
• Reserve Growth 4% to 2%
• ROCE from 5% to 3%
• Debt to Equity 10% reduction to
steady.
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35. “Optimized” with Division Lost
NPV = 3791
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36. Project Shift Base to Recovery
Lose Division here
Increased Shelf Investment
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37. “Insured” Portfolio
NPV = 3935
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38. Cost of Insurance
• Took more Shelf properties than
“Optimal”
• Laid off some of the Alaska and Deep
Water to pay for it.
• Result:
– NPV is $7 million lower
– Can recover quickly and retain more NPV if
failure occurs
SPE 82029

39. Finally
• This is an exercise in thinking about
your business plan using Portfolio
Management techniques, not in
simply “optimizing the portfolio”.
• “Gray Matter” is more critical than
the “Black Box”.
SPE 82029

40. Reoptimize After Alaska Fails
SPE 82029