New Approach to Capital-Allocation Modeling Improves Performance Assessment
Authors: Carpenter Chris 
Published: December 2018

This article, written by JPT Technology Editor Chris Carpenter, contains highlights of paper OTC 28685, “Redefining Capital Investment: A Steady Hand in an Unsteady Time,” by Waleed Abughazaleh, Risk and Change Management, prepared for the 2018 Offshore Technology Conference, Houston, 30 April–3 May. The paper has not been peer reviewed. Copyright 2018 Offshore Technology Conference. Reproduced by permission.

More than 57% of US industry megaprojects exceed their original budget and delivery timeline; this figure grows to more than 80% for megaprojects worldwide. These overruns translate into direct, significant reduction of capital-investment capability, often not realized until the capital is committed irreversibly. This paper presents a conceptual framework for capital-allocation management. This new framework, known as advanced risk and capital-allocation management (ARCAM), aims to synchronize risk, strategy, and capital decision modeling to provide better visibility of future performance of capital-investment opportunities.

Challenges and Analysis Boardroom Discussions. Because long-term production outlook shapes capital investment, executives are cognizant of changes that may affect capital expenditure (CAPEX) and financial capability. In current context, capital investment refers to capital allocations within projects and any capital relative to the sale of certain divisions or the purchasing of assets.

Now that companies have become leaner, strategy is shifting toward the ability to meet expected demand at a competitive cost. This can take the form of acquisition of distress assets, mergers, and targeted investments that permit flexibility in capital spending. The ability to retain control over capital requirements is paramount, and persistent cost over-runs within projects become a concern. This difficulty is compounded by delays in project completion. Companies invest in producing assets to meet short- and long-term production outlook, seeking flexibility to ensure that the only capital spent is that which will work toward meeting production requirements at the lowest cost in time to meet the forecasted demand. Although an oil company’s ability to influence oil pricing may be minimal, its entire competitive position will depend on the performance of its capital portfolio.

Capital Projects and Opportunity Assessment. From discovery of prospect wells to first oil, hydrocarbon fields have a long life cycle marked by increasing commitment of capital. At every investment milestone, a best-effort decision accounts for a probability of success, as with any business investment. At the corporate level, each entity develops a framework for assessing the economic viability of its capital-investment opportunities. Still, project-performance data reflect a wide discrepancy between funding-investment decision estimates and delivery in terms of cost and schedule.

The author’s observation of project-performance data and various project-opportunity-realization frameworks arrives at the conclusion that modifications are necessary to enhance objectivity, consistency, and continuity of opportunity analysis. These modifications form the basis of the ARCAM framework.