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Stochastic Modeling of Exploration Assets/Projects

Komlosi, Zsolt *1
(1) Tatu bt., Budapest, Hungary.

Quantitative evaluation of an asset for an investor is estimating growth of Shareholder Value (SV) of the entity generated by the investment to be evaluated. Generally it meant developing and running of a deterministic discounted cash flow model and performing some sensitivity analyses. This solution can be accepted at evaluation of projects having normal risk. Although in case of exploration assets with probability of risk is extremely high, application of stochastic modeling (as a combination of Monte Carlo simulation and portfolio optimization) and building a portfolio is a must. Unique exploration project is not comparable with other projects of the entity.

The procedure is as follows. Firstly, net present value (NPV) probability distribution of each asset should be determined with running Monte Carlo simulation on successful-case cash flow model having main drivers as future (crude oil) price and reserve probability distributions. Each asset is characterized with risked NPV probability distribution showing influence of exploration expenditures and probability of success (being lower than geological probability) on successful NPV.

Secondly, select the optimum portfolio with risk optimizer software. Running of optimization is beginning with the portfolio containing all assets available at entity. The software calculating various combinations of assets searches the combination of highest value (that can be expected NPV or Risk Adjusted Value). The results of optimization should be displayed on NPV vs. VaR plot. The preferred solutions can be found on the efficient portfolio curve containing portfolios having maximum NPV at given risk (VaR), or in other approach, having minimum risk (VaR) at given NPV. Main feature of the optimum exploration portfolio is the expected NPV giving the growth in SV due to the exploration projects performance. Simultaneously a measure of risk as Value at Risk (VaR) can be derived for the optimum portfolio as well. It gives the threat of decrease in SV. The optimum exploration portfolio derived is comparable with other projects of the entity.

In this portfolio optimization system evaluation a new asset (exploration project) can be done in the “mirror” of the portfolio. Analyst should reevaluate entire portfolio including the new asset. The location of new portfolio’s symbol on NPV vs. VaR plot qualifies the new asset. Favorable asset is expected to move portfolio into direction of higher NPV and/or lower VaR values.


AAPG Search and Discovery Article #90141©2012, GEO-2012, 10th Middle East Geosciences Conference and Exhibition, 4-7 March 2012, Manama, Bahrain