Tutorial Juniper Field

[Decision Tree & Value of Information]

Questions [jfq]

Tweedie Industrial Gas Ltd [TWIG] has completed its evaluation of the Juniper structure and
is satisfied that reserves of oil are sufficient to justify the installation of a floating production
facility costing £150 million. Furthermore, management is keen to proceed immediately in
order to absorb available cash flow from the company’s Aspen Field, which has recently achieved
peak production.

A further, adjacent structure, named the Rowan prospect, was discovered last year and has been
the target for further seismic investigation. The Exploration Department is optimistic that
commercial reserves will be demonstrated in the near future. Management accepts the current
assessment that the probability of commercial reserves being identified in the Rowan structure is
40%; P [Rowan commercial] :- 0.40.

If this oil does exist, the floating facility currently planned for Juniper would be inadequate for
both reservoirs and, consequently, a second floating facility would be required. Alternatively,
TWIG could decide now to install a larger floater or a fixed steel jacket, with capacity for both
reservoirs. This option is estimated to cost £225 million.

The semi-submersible rig, Arbor 1, has been leased to drill a single appraisal well on Rowan this
year and these results will certainly provide a better indication of the economic potential of the
structure. The reliability of this appraisal well is predicted by TWIG to be around 0.8, meaning
that whatever the prognosis, there is an 80% probability that it is correct.

If the development decision is delayed until this appraisal result is available, the Juniper
programme would slip by a year and TWIG would face a larger short-term tax liability,
equivalent to an additional current payment of £25 million. One further well is planned for the
Rowan structure next year, but management is not prepared to delay the Juniper decision beyond
the result of the first appraisal well.

1. TWIG management has decided to proceed with the Juniper Field development no later

than the completion of the well currently being drilled by Arbor 1. There is, however a
problem deciding whether to install a small floater or whether to use a larger facility.

Advise the management of TWIG as to the optimum strategy in order to minimise the
expected cost of the Juniper / Rowan Field development.

Note that this requires the construction of a decision tree incorporating the logic of the
problem, relevant cost information and probabilities. No revenue information is
presented or required.

2. There is some disagreement within the company regarding the probability that Rowan is
commercial and management would like advice on the sensitivity of its decision to
variation in estimates of P [ Rowan commercial ].

Investigate the impact of changing this assumption in order to establish the range of
values for which the determined optimum strategy remains optimum.
3. A second semi-submersible rig, Arbor 2, may be available now at a very high spot rate.
The opportunity therefore exists to bring forward the well planned for next year and to
have the information available in time to contribute to the Juniper decision.

If the two appraisal wells together on Rowan were considered to provide a reliable
assessment, how much extra should TWIG be prepared to spend to have this well drilled
now rather than next year?

Note that “reliable” in this context means that no matter what the result of the appraisal
well, the interpretation provides an accurate assessment of the economic viability of the
structure.

30/10/14