03/03/2019

Expected Monitory Valve (EMV)

Koya University • Statistical Analysis
Faculty of Engineering
Department of Petroleum Engineering • Calculates average outcomes of future scenarios.
Third Stage
• Adopts a risk-neutral assumption
Petroleum Economics • Probability X Impact
• Decision Trees
Expected Value Concept
• EMV of opportunities: +ve Values
• EMV of threats: -ve values
Farhad Abdulrahman
Assistant Lecturer
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Expected Value Concept (EVC) Risk and Uncertainty

 Previously discussed measures were all “no risk”  Risk:
parameters. – Addresses discrete (separate) events (e.g. discovery or dry hole)
– Can be both: A threat or an opportunity
• Uncertainty:
 But petroleum exploration involves a high degree of
– Result depends on unknown circumstances (e.g. oil price)
risk!
– Occurrence probability of an event is not quantifiable
• Deterministic:
 Two way out:
– Calculations using exact values for their parameters are called
 Doing direct risk analysis or deterministic
 trying to consider risk and uncertainty in a logical, • Stochastic:
quantitative manner.
– Calculations which use probabilities within their model are called
stochastic.
 Expected value concept combines profitability
estimates and risk estimates
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Definitions and EVC Example 1.0 of EMV

 Expected Value (EV):  Situation in a drilling prospect evaluation:
 The EV is the probability-weighted value of all possible outcomes.
 Probability of a successful well 0.6
 Expected Monetary Value (EMV):
 The EMV is the expected value of the present values of the net  Two decision alternatives:
cashflows  Farm out: A producer is worth $50,000, a dry hole
 EMV = EV (NPV) causes no profit or loss
• “Conditional”
 Drilling the well: A dry hole costs $200,000, a hit brings
– In this context “conditional” means that a value will be received only if a
(after all costs) $600,000
particular outcome occurs.
– Often it is omitted/absent!  EMV Decision Rule:
• Simple Example:
– EV Cost of Stuck Pipe = P(Stuck Pipe) * (Cost to remedy Stuck Pipe)
 When choosing among several mutually
• More generally: exclusive decision alternatives, select the
alternative having the greatest EMV.

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Solution Characteristics of the EVC

 Mutually exclusive outcomes
 Collectively exhaustive outcomes
 The sum of probabilities for one event must be
one
 Any number of alternatives can be considered
 Normally values are expressed in monetary profit,
therefore “expected monetary value”
 The EMV does not necessarily have to be a
possible outcome

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Concerns about the EV Concept UTILITY THEORY

 Is there a need to quantify risk at all?
 No benefit seen in using the EV!
 We don’t have probabilities anyway…
 Every drilling prospect is unique,
 therefore we have no repeated trail!
• Utility theory states that each individual has a
measurable preference when faced with choices
among alternatives uncertainty, which is called his
“utility”.
– It has unit called utiles

 Isn’t EV only suitable for large companies?

– The relationship between utiles and dollars is called an
 For sure other concerns override EV! individual’s utility function (curve).
 “…EMV is not perfect. It is not an oil finding tool,
– The function is strictly personal and differs among
and it is not (…) the ‘ultimate’ decision parameter.” individuals

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Utility Key Points Example 2.0 of EMV

A company is planning to embark on a drilling
• Want satisfying power of commodity venture. The possible outcomes of the venture are
• Subjective given below and the utility curve of the company is
attached:
• Not same as usefulness
• Ethically neutral (Economy does not Alternatives
Outcomes Probability Farm Out
differentiate between ethical and unethical Drill
(1/8 RI)
Dry Hole 0.4 - 200,000 0
goods)
5 BCF 0.6 + 600,000 +50,000

• Anticipated satisfaction

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Solution of Example 2.0

Decision Factors Controlling EMV
 EMV of Drill = (0.4)(-200,000) + (0.6)(600,000) = $280,000

 EMV of Farm Out = (0.4)(0) + (0.6)(50,000) = $30,000

• In the oil industry, the decision for making
Drill is the preferred choice. investment is controlled mainly by the
 EUV of Drill = (0.4)(-8) + (0.6)(2) = -0.80 utiles following two phenomena:
 EUV of Farm Out = (0.4)(0.4) + (0.6)(0.6) = 0.28 utiles

Farm Out is the preferred choice.

1. Depreciation / Applicable to Equipment.

 The difference between the EMV and EUV decisions occurs

because the potential loss of $200,000 overrides the potential gain 2. Depletion / Applicable to Mines, Quarries
of $600,000.
and Other such wasting assets.
 Without the use utility theory, the company would have made the
wrong decision.
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Methods of Computing
Depreciation
Deoreciaition
• Straight Line
• Remember that DEPRECIATION is just an 𝐶−𝑆
𝐷=
Estimate. 𝑛

• Double Declining Balance

𝑚−1
2 2
𝐷= 𝐶 1−
Depreciation is an accounting 𝑛 𝑛
Where:
estimate of the fall in value of a D = Depreciation Allowance ($/year)
C = Original Investment ($)
fixed asset over time n = Estimated Asset life (years)
m = Life of asset up to the time of calculation (years)

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Example 1.0
• A drilling bit with an estimated life of 5
years is purchased for $33,000. Its
salvage value at the end of the fifth year is End
estimated to be $3000.

Next: Decision Tree Analysis

• Calculate the annual depreciation using
both methods (Straight-Line & DDB) .

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