Nontechnical Distortions in the Analysis and Management of Petroleum Investments
Authors: Campbell J.M. 
Published: December 2007

The oil industry has suffered hard times in recent years, and prospects for continued tough times remain for the near future. Some conditions arise from problems beyond the control of an individual company, but others result directly from problems inherent in the way petroleum investments are analyzed and managed. This paper outlines some of the major problems that have crept into the investment process. In almost every case, the cure requires nothing more than sound, professional judgment and prudence. It is even more important, however, to control the tendency to go to excess in practicing business. The excessive optimism of the boom years has probably given way to the excessive pessimism of the present.

Introduction

Investing in petroleum projects appears less inviting as oil prices continue their erratic movements up and down, as tax changes occur, and as investors take stock of historical returns. The ability of the industry to attract the necessary capital has probably never been at a lower point (although maybe as low). Some of the problems stem from the questionable track record the industry produced in recent years.

This paper examines some causes of the recent performance of oilfield investments and methods for correcting the attitudes that led to them. It should be clear to everyone that the boom days of the post-1973 embargo are gone with little chance of returning, barring another political upheaval somewhere in the world. With little chance of oil prices' bailing out current and future investments, the time is right to evaluate the problems that exist in the analysis and management of petroleum investments. Many people assume that the present state of the petroleum industry has corrected the excesses of the recent past. This is not the case, and one can argue that present practice may even be hastening the demise of our industry.

Several major problems have crept into the methods used for analyzing and managing projects. Their importance varies by the size of company (integrated vs. small independent), location (overseas vs. domestic), and activities (exploration vs. development). Every organization we observed exhibits some of these problems to various degrees. Each issue impacts the way the industry invests its increasingly smaller investment funds.

Most analyses tend to focus on methodology or terminology. While developing better methods is a useful function and should be encouraged, misapplication of any methodology produces poor investments. This paper focuses only on the limitations inherent in the identification and selection of petroleum investments.

Problems in Oil Investment Analysis

Some of the major issues in the analysis of oil investments are (1) inconsistent goals among disciplines, (2) excessive optimism, (3) loss of information, (4) management of technology, (5) the ruler method of price forecasting, and (6) poor performance in past investments. Each category encompasses a nontechnical issue that distorts investment analyses as much as, or more than, technical considerations, often reflecting attitudes that evolved in response to past economic and technical conditions. The real issue is whether these attitudes improve or obstruct sound investment decisions. The answer is not a simple yes or no; sometimes it works, but other times it does not. With the massive reorganizations of our industry and the loss of talented and experienced personnel, those with the best chance of responding to the ever-changing climate are the ones who reassess the basic premises of the way decisions are made.

A major constraint to making good investment decisions is not just the data, tools, or methodologies; it is the unwillingness to overcome the limitations in our thought processes that are begun in school and refined in the workplace; These thought processes indicate that the main objective is to practice the accepted methodology as a good member of each profession, not to make sound investment recommendations.

Inconsistent Goals Among Disciplines

One can describe the oil industry as a loose confederation of disciplines working together to make a profit. Landmen acquire land; geologists generate prospects; geophysicists locate traps and other subsurface characteristics; engineers drill and produce the reserves; and management collects information from all groups to make a decision. Because each provides the other with data and interpretations, the key phrase is "working together."

Are the various groups striving to achieve the same goals? Fig. 1 illustrates the basic differences in the goals of six of the groups involved. Given the same results from existing wells, the different perceptions of each group are presented. This cynical view does not apply in all cases but does arise frequently.