Verdell Production Flow Test to Determine Reserves Size

Verdell Production Flow Test to Determine Reserves Size An Appraisal Value of Information Case Study

Background 1 Simon Oil recently discovered a high-rate gas zone, while exploring for oil in the Verdell field. The Verdell-1 well discovered oil in the deeper, target zone. Logs also revealed a prospected uphole gas zone that, when tested, flowed at 35 mmcf/d. Unfortunately, the test was only a few hours long. Simon Oil is uncertain whether the discovered gas in Verdell is associated with significant gas reserves or whether it is merely a small, high-pressure gas pocket. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 2 The Carole Field to the south of Verdell had numerous uneconomic high rate gas pocket reservoirs which, when new gas wells were drilled, came on like gang busters and fizzled out quickly… never paying out the cost of the wells and tie-backs. The team has produced three different geologic maps of the gas discovery, each of which has vastly different reserve estimates. The maps are displayed on the next slide.

Background 2 Gas Discovery Medium Reservoir Gas Discovery Small Reservoir Large Reservoir © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 3

Background 3 Simon Oil currently plans to drill two appraisal wells in Verdell to further delineate the oil discovery. This potential provides an opportunity to test the gas discovery, at the same time. If the gas is significant, it will be developed in the east, close to the gas export market. The oil, however, will be transported to the west, to the nearby Udall Field, where an oil transport line already exists. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 4 Gas Reserves P 10 Chance NPV (M$) 0. 30 41. 0 P 50 0. 40 21. 0 P 90 0. 30 -36. 0 The Simon team has estimated the probability of the Verdell gas discovery being a large (P 10), medium (P 50) and small (P 90), as displayed in the table above.

Background 4 The Simon Oil team would like to test the Verdell gas zone in the next appraisal well. They believe that an extended test would allow them to observe pressure and any decline in the production rate and, from that, they could better discern the size of the gas reservoir. The problem is that gas from an extended test can only be flared if the well is flowed at a lower rate than the zone is capable of and, even then, only about two weeks. This may not lead to enough gas being produced to reveal the true reservoir size. However, this form of test would be fairly inexpensive at about 0. 50 M$. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 5 A second well test is also being considered, which may yield more reliable results, but would be more expensive. The second test involves flowing the Verdell gas to the Udall Field for two months by laying the oil pipeline to the Udall field early. The cost of the two-month test would be approximately 3. 0 M$, which is the additional cost of strengthening the oil pipeline to be able to accommodate the anticipated high gas rate and higher pressure. The estimated reliabilities of both the two-week and two-month test are displayed in the next slide.

Background 5 Two-Week Test Reliability © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. Two-Month Test Reliability 6

Background 6 The team has already started debating the order in which the oil and gas zones will be produced. The oil is expected to be higher value and it is down-hole, so most expect it to be produced first usingle zone completions, produced in series. Others argue that dual completions have been proven to be effective and should be tested in this case. Dual completions would eliminate the ability to use horizontal wells, which are expected to be more effective in recovering the oil. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 7 Management is pushing for the two-week test, if any, though the reservoir engineers are doubtful whether it will be long enough. They have asked the team to use Expected Net Present Value as the primary decision criterion for the evaluation. Which test, if any, should the Simon Oil team recommend? Are there any hybrid strategies the team should consider?

Problem Frame Verdell Case Study

Valuing Information Process © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 9

Problem Statement What kind of well test, if any, should be run prior to developing the Verdell gas discovery? Key questions for the evaluation: Does the increased reliability of the two-month test justify the added cost? n How confident can we be in our estimate of the reserves from both tests? n © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 10

Issues © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 11

Decision Focus (Decision Hierarchy) © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 12

Evaluation Alternatives (Uncertainty Table) © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 13

Evaluation Focus Isolate the first evaluation getting information on one uncertainty, from one information source, to potentially change one future decision at a time. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 14

Evaluation Structure (Decision & Risk Timeline) © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 15

Problem Analysis Verdell Case Study

Verdell Gas Value, with no More Information Without further appraisal of the Verdell gas: We would choose to develop the gas, with an n Expected value of 9. 9 M$, and a n 30% chance of a -36. 0 M$ outcome. n © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 17

Verdell Gas Value, with Perfect Information With perfectly reliable information, we avoid a 36 M$ loss, 30% of the time. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 18

Function of Reliability of Interpretation The reliability of interpretation assessment gives us: A glimpse of the possible new interpretations of a particular variable that we may have in the future, given we get new information. n A means to estimate how much we might upgrade or downgrade the probabilities we assign to uncertainty ranges, after we collect new information on that uncertainty. n The possible new interpretations depend on the: Probabilities we assign to a particular uncertainty today, and the n Reliability of the information sources and our ability to correctly interpret the true state of nature for the given uncertainty. n © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 19

Result of Reliability of Interpretation – Two-week Test Original distribution, given current information… 100% 0 Sm Med Lg 100% 0 Three possible new distributions of the variable, post getting the information… © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 20 Sm Med Lg

Reliability of Interpretation – Two-week Test This is the team’s current view of the state of nature. In this case, they believe that there is a 30. 0% chance of encountering large reserves. This is the team’s assessment of their reliability to correctly interpret the reserves size from the two-week test. In this case, they believe there is a 75. 0% chance of correctly interpreting small reserves. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 21

Reliability of Interpretation – Two-week Test The joint probability of each combination of outcomes is calculated (e. g. , Actual Large Reserves * Interpret Large Reserves) = 0. 30 x 0. 60 = 0. 18 © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. The joint probabilities are maintained for the same combination of two outcomes (e. g. , Interpret Large Reserves * Actual Large Reserves). 22

Reliability of Interpretation – Two-week Test The remaining joint probabilities are maintained when the team puts the uncertainty nodes in the order needed for the imperfect information decision tree. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 23

Reliability of Interpretation – Two-week Test The chance of interpreting reserve size can then be calculated, by applying the laws of probabilities, as: = 0. 14 + 0. 18 + 0. 03 = 0. 35 © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 24

Reliability of Interpretation – Two-week Test The chance that the interpretation is correct (e. g. the true state of nature) is back calculated, as: = 0. 35 / 0. 18 = 0. 514 © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 25

Reliability of Interpretation – Two-week Test With the given reliabilities, we can upgrade the chance the interpreted outcome is correct: Large Reserves: n Medium Reserves: n Small Reserves: n from 30. 0% to 51. 4% from 40. 0% to 62. 5% from 30. 0% to 68. 2% © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 26

Verdell Gas Value, with Two-Week Test When we interpret medium and large reserves from the two-week test and opt to develop the gas, there remains a 8. 6% and 14. 1% chance (respectively) of developing a project that turns out to have small reserves. Are we comfortable with this? Probably. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 27

Verdell Gas Value, with Two-Week Test When we interpret small reserves from the two-week test and we opt not to develop, there remains a 31. 8% chance of walking away from a viable project. Are you comfortable with this? And, if not, want might you do next? Run a longer test? © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 28

Reliability of Interpretation, with Two-month Test © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 29

Verdell Gas Value, with Two-Month Test When we interpret small reserves from the two-week test and we opt not to develop, there remains a 18. 9% chance of walking away from a viable project. Are you comfortable with this? Probably more so than with the two-week test. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 30

Initial Results Summary Two-Week Test Two-Month Test VOI (w/o cost) 5. 0 M$ 7. 2 M$ Cost 0. 5 M$ 3. 0 M$ Net VOI 4. 5 M$ 4. 2 M$ Net VOI / Cost 9. 0 $/$ 1. 4 $/$ Which test would you choose? When we interpret small reserves from the two-week test and we opt not to develop, there remains a 31. 8% chance of walking away from a viable project. Possible Hybrid Strategy: We might consider running the two-week test and, given that we interpret small reserves, run the two-month test to confirm the results. (This is the next evaluation. ) © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 31

Hybrid Strategy Analysis Verdell Case Study

Hybrid Strategy: Two-Week Test Followed by Two. Month Test Given that we interpret small reserves from the two-week test, is there value in running a followup, two-month test to confirm the results before we decide to abandon the gas development? Note that we can anticipate interpreting small reserves from the two-week test about 33% of the time. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 33

Starting Point for the Hybrid Strategy When we interpret small reserves from the two-week test, the circled sub-tree becomes the new, updated Go Now, With No More Information decision tree (from this point forward in time). © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 34

Verdell Gas Value, with No More Information After we interpret small reserves from the two-week test, the updated expected NPV of the gas development is reduced to -15. 2 M$ and, without further information, we would choose to not to develop the gas. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 35

Reliability of Interpretation, with Two-month Test These are the updated probabilities after interpreting small reserves from the first, two-week test. This is the reliability to correctly interpret the reserves size from the two-month test. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 36

Possible Interpretations & Updated Probabilities We will interpret: n Large reserves 19. 0% of the time and, when we do, we will be correct about 53. 5% of the time. n Medium reserves 24. 0% of the time and, when we do, we will be correct about 45. 7% of the time. n Small reserves 57. 1% of the time and, when we do, we will be correct about 95. 6% of the time. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 37

Added Value of Two-Month Test After 2 -Week test Only when we interpret large reserves from the second test does the chance of large (or medium) reserves increase high enough to decide develop the gas. If we again interpret small reserves from the second test, the chance of small reserves increases to about 95. 6% and we can confidently exit the gas development. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 38

Verdell Gas, Value of Hybrid Test The hybrid strategy increases the value over the two-week test alone, from 5. 0 to 6. 3 M$. The option of the twomonth test and its added value are added to the two-week test results to evaluate the hybrid strategy. © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 39

Results Summary Two-Week Test Two-Month Test Hybrid Test VOI (w/o cost) 5. 0 M$ 7. 2 M$ 6. 3 M$ Cost 0. 5 M$ 3. 0 M$ 1. 5 M$ Net VOI 4. 5 M$ 4. 2 M$ 4. 8 M$ Net VOI / Cost 9. 0 $/$ 1. 4 $/$ 3. 2 $/$ If we opt for the hybrid strategy, there is only a 33% chance that we will need to incur the additional 3. 0 M$ cost of the two-month test (after the two-week test). Budgeting for information plans (or strategies) will lower the expected cost of information gathering. Which test would you choose? © 2007 Decision Frameworks Inc. All rights reserved. Do not copy. 40