Eien eal Monte Carlo Simulation: Its Status and Future 4.A. Murtha, SPE, Consultant Introduction Monte Carlo simulation isa sttistes-based analysis too that yields probability-vs-value relationships fo key parameters including oi and gas reserves, capital exposure, and various economic yar sticks, such as net present value (NPV) and return on investment (RON). These probability relationships help the user answer Such {questions as "What isthe probability thatthe NPV of this prospect Will exceed the target of $1,500,007" or "How likey i it that the reserves added from this year’s exploration program wil fll shost ‘of our planned production?” Monte Carl simulation ia par of risk analysis and is sometimes performed in conjunction with or as an lteative to decision [tee] analysis, Pating aside for the momenta deserption of Monte Carlo sila tion, the method has artracted its share of ers ove the yeas, Their ‘comments include“ did this in FORTRAN in 1964. T just never caught (0a; "Why not just ad or subtract 10% to the base case”; “The a Sve is whatever you want it to be."; "The answer depends on who is doing the simulaiion.", "Garbage in, garbage out"; “You never have ‘enough dats". "A black box, hocus-pocus, tha'sallit";and Itakes too Tong to run enough cases.” To some deeee, the ccs have been silenced by the evolution of virwally universal spreadsheet programs, much aster computes, and eatively simple sohwave to rin simul tion and process data. Noneteles, we will dress some ofthe under= lying concems, but it is necessary to ky some foundation Fis. ‘Our objectives are (1) to define Monte Carlo simulation in 2 mor general context of risk and decision analysis: (2) to provide some Specific applications, which ean be interrelated: (3) to respond t0 some of the eritiisms; 4) 10 offer some cautions about abuses ofthe ‘method and recommend ow to avoid the pitfalls; and (5) to predict ‘what the future has instore ‘What Is Risk Analysis? hough the word “risk” occurs with great regularity these day in the petroleum Titerature, i has not always boen Fashionable, In is b60.page Subject Index, the 1989 printing ofthe 1,727-page Peto eum Engineering Handbook contains jus one reference 10 risk HMactorin an ariel about property evaluation, "Among the namerous words nd phrases associated with isk anal ysis are decision analysis sk assessment, sk management, porto Tio management and optimization, and strategic planning. In some contexts, these words are used only ina ualttive sense, but our fo cus s quantitative. Decision analysis, in ts broadest form, includes problem identi cation, specification of objectives and constrains, modeling, uncer- tainty analysis, sensitivity analysis, and rules tha lead toa decision, Generally speaking, risk analysisandassessmenteferto the quanti fication of uncertainty, slmost always inthe context of possible in vestments. Inthe oil and gas business, although much ofthe analysis ‘might perain 10 reserve size, capital cost, production forecasting, and the like, the bottom line universally is monetary value. ‘Risk management connotes a second stage, where the investors seek protection from unfavorable situations; they work to miti- eimiareaenotamsrtewnanecetecnacgr roe ‘tecoandar ners naan nueearicn pay meatal Solsnfrces sc mesh hse Puen rine Seca Str cs eft na an ES IPT « Api 1997 gate the risks. Thus, tumkey contracts, guarantees, insurance, Tocked-in prices, and hedges are instruments of risk management. ‘A pontolio isan aggregation of investments, Portfolio managers ‘mix their prospect to reduce collective risk and enhance ROL. Opt rmiration is often taken as maximizing some measure of reward, such as NPV o¢ profito-investment ratio, subject to constraints on isk. Strategic planning involves portfolio management but may i clude more intangible aspects of investments, such as the advantage fof having a presence in a count. For purposes ofthis paper, risk analysis i any form of analysis that sis and henee attempts to quantify risks associated with an invest ment. So that we do not beg the question, we need to define risk. By risk, we mean a potential loss, and, more generally, loss or gain (i.e, sachange in assets associated with Some chance occurrences). To use the term analysis, we surely suggest thatthe risk is quantifiable. The risks in drilings well include the direct costs ofthe rig and of other ‘goods and services, the possibilities of unscheduled events and thea Sessient of their consequences, the possiblity of failure (ue. a dry hole, missed target, oF an unsuccessful completion), the range of possibilities of success, and the chance of a serious mishap. Risks associated with building a gas-fired eletric-power generating plant include the forecasts of gos price (onthe cost sie) and electric price (onthe revenue side) aswel as capital and operating costs, downtime, and demand, Rsk associated with estimating reserves for an explora tion prospect include estimation ofthe geological chance factors Simple Risk Estimates by Use of Probability Suppose you have drilled $6 wells ina field-development program, [of which were deemed dry holes. What isthe chance thatthe next Wel will be dey? Perhaps 14/56 is a good answer. It depends on Whether there has been a rend iohave fewer or more dry holes over time. In other words, i the suecess of one well n some way depen- dent on the sucess of athers? Whatever the cas, providing an eti- mate forthe probability of a dry hole is a form of risk analysis. ‘Asa more complicated example, consider the estimate for geo- logical success based on chance Tactors whete the probability of suceess is the product of the probabilities of having a structure, @ seal, a reservoir, a source, and timing. Estimating the factorsand ob- taining the produc is a form of risk analysis. ‘As the subsequent examples illustrate, however, the specific Fisk- analysis technique called Monte Carlo simulation offers a flexible nd powerful tool 1 study complex problems. Monte Carlo analysis, serves asthe focal point for the remainder ofthis discussion. Probability Distributions and Random Variables “Muh of risk analysis consists of estimating something witha range ‘of values rather than with a single value. We report that the wildoat wel will require between 56 and 87 days to drill instead of saying it will take exactly 65 days and thatthe total cost willbe between US. $4.3 millon and U.S. $7.2 milion, not exactly U.S. $5.2 mil- lion: Instead of the single-point estimate of U.S. $34 million, we say the waterflaod prospect's NPV is a normal distribution with a mean (of US. $34 million and a standard deviation of U.S, $1.7 million, Thus, as we move oward risk analysis, itbecomes necessary to de- velop some familiarity wit the rudiments of probebility and stats tis. For our purposes, we need the paired ideas of probability dis- ‘wibutions and eandom variables. A random variable isa variable or parameter tht can be described by a probability distribution, which intum isan xy plot relating probability to value. There are two com: ‘mon formats for probability distributions: a cumulative distribution 361Normal CDF 200 400 600 800 x PDF - Normal Distribution Fig. 1—COF and PDF for normal distribution having mean of 450, and a standard deviation of 117 (Pio =800, Pyo- 600). Also ‘shown is a Monte Carlo sample. fanetion (CDF), whichis a nondeereasing (or nonincreasing, depend ingon preference) function whose y values range from to I. Liss plestto think of random variable a a graph of cumulative probabili- ty (onthe v axis) ¥s. value, The companion plo, called a probability ‘density function (PDF) is simply the derivative of the CDE. Fig. 1 shows both these plots fr # normal dstsbution. Although the CDF presentation s ultimately moce useful the PDF may be more fii ‘Oncea variable, X is described by its CDF, we can obtain a Monte Carlo sample Fig. 1)by fest generating a random vale, Yaniform- ly distributed between O and I then by taking the inverse function ofthat value fom the CDF curve to getX. Simiation software™* does allthis behind the seenes; the user's job isto specify ate probability distributions ercentiles Common wse ofa CDFiso speci consin values ofa expression, Pj meaning the 10th percentile, sth value of X core- sponding 190.100n the curulative-probility axis, Experienced users ‘often describe distributions by specifying two or thee percentiles. OF particular interest is Psp, which s elle the median ais one ofthe ‘common “measures of central tendency.” lke the made (most popular range; most likely ategory) and mean (rthmetc average vale), Risk Analysis in the Form of Monte Carlo Simulation Monte Caro simulation isan alternative ro both single-point (determin sie) estimation and the scenario approach that presents worst, most- likely, and bestcase scenarios. The term Monte Carlo dates back to the Mankatan Project in the 1940's, where it was used as acode name, The inference sto tbe gambling mecca, where chance rues. Foran ear- Iy historical review, see Ref. 4 The following paragraph, drawn largely from Ret. 5, offer bie description of the Monte Curio process ‘A Monte Carlo simulation begins with a model (i, one or moe ‘equations, together with assumptions and logie relating the parame ters inthe equations). For purposes of illustration, we select one form ofa volumetric model for olin place, N, i terms of are, A net pay, ‘porosity, water saturation, 5,; and formation volume factor, By N= 1,158AKGI-S,)/B, ® Thinkor A... Sand, as input parameters and Nase ouput Once we specify valves foreach input we can aut an cpt val ue Bach prams is viewed as random variable tas some 62 probability vs, cumulative-value relationship, Thus, we may assume thatthe are, A, ean be deseribed by a lognormal distribution with a ‘mean of 2,000 acres and a standard deviation of 800 acres, having & practical range of approximately 600 to 5,000 acres. Fig, 2 identifies §nd shows similar distribution foreach of te cthe inp parameters ‘Atrial consists of randomly selecting one value foreach input and calculating the output. Thus, we might select A=3,127 acres, h=48 fh, = 18%, 5, =43%, and B, = 142, This combination of ‘Values would representa pariular realization ofthe prospet yield. ng 635 million bbl of ol. A simularion isa succession of hundreds lor thousands of ropested cals, during which the output values are sored in ile inthe computer memory. Afterward, the output Val les are diagnosed and usually grouped into a histogram or cumula- tive distribution function, Fig. shows the output andthe sensitivity chart fr this model. Seleeting Input Distributions. Lognormal distributions ate often used formany ofthe volumetric model inputs, although ne-to-eross ratio and hydrocarbon saturation are seldom skewed right and al ways sharply runeated. Triangles are also fairly common and are easy to adapt because they can be symmetric or skewed either lft forsight® Sometimes, the distributions are truncated to account for natura Hits (porosity euofs, wel spacing). When all the inputs are assumed tobe lognormal, with no truncation, and independent of one another, the product can be obtained analytically ‘Shape of Outputs In this example, regardless ofthe distribution types ofthe inputs, the output is approximately lognormal, That i, the reserves distribution is always skewed right and "looks" lognor- ral. Infact, a product of any Kind of distributions, even with skevedl-left factors, has the approximate shape of a lognormal dis tribution. Fig. 3 displays the bes-fiting lognormal curve overlaying ‘he output histogram for our fst example Sensitivity Analysis. One of the byproducts ofthe simulation isa sensitivity chart (Fig 3). A measure of significance toward a given ‘output variable iscalculated foreach input variable, namely the (rank ‘order cotelaton coeficien between the two parameters. When the correlation coefficient is close to 0 (as in the case of), the output (eserves) can achieve 2 value neat the upper limit ofits range with ‘small and vice versa, The fat that i is negative here is iva, there is essentially no comeation between By and N. These coefli- cients can range from = 1.010 1.0. Areas identified asthe most sig nificant paraieter, and ihe others are ranked accordingly. As models ‘become more comple, sensitivity analysis identifies the “diving Variables" that merit additional sertiny and, by contrast, helps reduce cffore wasted on worrying about the wrong things. Unlike the tradi tional tomado chart or spider diagrams obtained by tracking the {changes in an output caused by allowing exactly one model np ‘ary while holding the oters fixed this sensitivity analysis from ‘Monte Carlo simulation i far more versatile because it permis func sional or correlaion-ype relationships among the inputs. Correlations Among Inputs (Dependency). Unless othervise spe cified, the samples of the various input distributions ae taken inde pendent of one another. Thus, ons particular tala very large value (of Sy may’be paired with avery large value of g ora small value of ‘Acauld be chosen along with large net pay here is goological argument (or empirical data) o justify a correlation beeween a pair of parameters, then the simulation software can honor that relationship. Correlation among inputs, in this particular example (notin gen- ral) causes the resulting output to Become more dispersed. Thus, When area and pay often) or porosity and water saturation (nearly always) are correlated, the prospect appears to be riskier and the mean value ofthe estimate increases somewhat when the correla- tions are incomporsted in the model. Sometimes, the difference is slight, but the modeler shouldbe prepared to describe at what level the correlations make a difference. Imposing corelations among, inputs can also reorder thelist of sensitive variables, “Model Shortcomings. Thee is « widespread practice of extracting ‘one ora few numbers from the reserve distribution to “run econom- Apri 1997 + SPR2 2 a | a ‘Lognormal, mean 2000, STD 800 acres i 2 | 3 | & i | ‘Normal, Mean 45, STD 3 feet Triangular, 0.20, 0.30, 0.45 fraction Probab Normal, mean 0.14, STD 0.02 Normal, mean 1.34, STD 0.06 Fig. 2—Five input distributions, with area shown in both CDF and PDF formats; STO standard deviation. ies” teating well productivity and capital eosts as deterministic and thereby reducing the effectiveness ofthe uncertainty analysis. The {ieid-development model ha follows picks up where tho eserves ex ample leaves off. As engineers and geoscientists become more aus. ‘tomed to integrating rsk-analysis components, the exploration-peos. pect mode! will include seoping estimates for production forecasts and both capital and operating expenses. Without this integration, idemtilying the relative importance ofthe various risks is dificult, How does feldsize unceninty compare withthe uncertainty of the capital costs or the productivity ofthe wells? Where should we invest additonal resources to acquire information? What are the Key issues ‘when negotiating with partners or forming alliances? These questions are not easily answered, yet they should be acknowledged Why Do Monte Carlo Simulation? We do risk analysis because there is uncertainty in our estimates of capital, reserves, and such economie yardsticks as NPV. Quantity ing that uncertainty with ranges of possible values and associated probabilities (.c., with probability distributions) helps everyone un derstand the risks involved. There is always an underlying mode, such asa volumetric reserves estimate, a production forecast, a cost «estimate, ora production-sharing-economics analysis, As we inves tigate the model parameters and assign probability distributions and correlations, we ae forced to examine the logic of the model. “The language of risk analysis i precise: t aids communication, reveals assumptions, and reduces mushy phrases and buzz words ‘This language requires study and most engineers have lite expo: Sure to probability and statistics in undergraduate programs, a Monte Carlo Simulation—Typical Problems In addition to the widely used volumetrc-reserves model, the fol lowing three problems serve tillasrate the breadth of Monte Carlo simulation. Taken asa whole they also suggest a process of integra tion oF consolidation, Problem 1. Driling Authorization for Expenditure (AFE): Esti- te Total Costs and Times. Drilling APE estimators are prime can Aidates for Monte Carlo simulation, being coocepraly simple, bigui- ‘ous, and essential to the overall prospect evaluation process.” Fig. 4 shows a simple format for the APE move, with categories of activity times and coss of gods and services. One task forthe user iso et: ‘mate durations for various atvities, such as dling the hoe sections, completing, and testing. Anather ask iso estimate line-item costs, fn this model, the dling expert provides two values for each estimate: 2 low and a high estimate. A preliminary calculation inthe worksheet solves some simple equstions! o obain the mean and standard devi ation fora lognormal distribution for that eos or time category. These high and iow estimates ae ueated as Pyq and Poo: the actu value has 410% chance of eing less than the low value and a 109 chance of| exceeding the high value, One could teat the low estimate asa Ps and the high estimate asa P35 oF variations thereof. Because the input p> rameters represent times and coss, they are generally regarded as skewed right there ae more extreme values tothe right of the mode than tothe Ff, causing aa of large values having low probability of occurrence. Ateratve distribution include beta, gamma, andtriangu- lar (which would require three user estimates). Apt 1997 «IPT‘ey Ce ‘et Foncat:Reao nya Fig. 3-Output distribution (histogram) with fitted lognormal ‘Acknowledging Historical Data. When data are asilale from amalogous projets one can fit parila dibs to specific in put parameter. There isa tendency for enginees to want 10 Lan evil on dat sommes athe isk of including inappropriate data Cental in time, moze and beter data may be available. One must often sete for eattully designed sensitivity analysis to quay the rivers and the impact of changing dsthtion 1ypes and ranges ‘Warning, Do not epor partial esults, Too often, the results ofa sim: ulation are reduced toa mean value ora Psp, Sometimes two or hee values, such as Po, mode, and Psp. re passed along tothe next level, ‘where they ae used t “run economics" Such practices are ne inthe Spirit of Monte Carlo simulation, As described ltr. the economies itself must bea simulation tat samples from te full istibutions for the drilling cost as well a from disrbutions for prices, expenses nd production forecasts, One cannot capture Po-ease economics rin by splicing together Pg cases for the numerous ingredients "The proper roe forthe drilling AFE isa preliminary step 10 more comprehensive models. The outputs ftal ime and costs) can ber ported asa distribution or a series of distributions overtime or for tach of several wells. Incases where there ae multiple wellsor dil ing costs along with facilities costs, care must be faken to transmit the correlations berween the relevant distibation, ‘Other Cost-Estimation Models. Aside from the willy of the AFE. ‘model in its own right, itserves asa paradigin fr other cost-estima: tion models. Many cost engineers use Monte Cari techniques for pipelines, platforms, and other facilites, Even the nations of contin- JReney can be described in useful terms. For purposes of including them in the Mente Carlo economies model, simple spreadsheet line item models, similar tothe drilling AFE. are adequate. When sched- tule details ate paramount, x projectscheduling model is necessary. In recent years, Monte Cario versions ofthe most popular schedul- ing programs have become available Problem 2. Field-Development Program: Estimate Production and Revenue Streams. San with deterministic forecast foi pro duction, possibly generated by an exponential-decline mode, 4 = gexp(= an, @ where initial rate, stock-tank barrels per year, 0 fractional de cline per year: and f= time in years. Think ofboth ana as proba- bility distributions, We do not know exactly hss much oil wall be prouced in the fest year ot how sharply the production wil decline from one year to the next. Likewise, assume some distribution for IPT + Apa 1997 Fig. &Driling AFE estimator template. the capital cost oF drilling and completing the well, Note that this tlistnbution should come from the dling engineers who model the AFE simulators. Further assume that operating costs can be de- scribed inermso probability distributions. We might want to break cost into fixed and variable components und to treat variable costs asbeing proportional tool production or water production, Alterna- tively, we could correlate operating expense and oil production Generate the forecast of production and discounted cash flow for‘Trend Chart Rate. 290% 4 2 50% Time Fig. 5—Production forecast with uncertain ramp-up, peak rate, and two decline segments, ‘ome time horizon (e.g, 20 years) Caleulate NPV at 10% interest. So far, we have a single-well exponental-decline forecast for a Single production stream. ‘This mode! generalizes to any number of wells. The underlying deterministic production forecast need not be exponential decline. Fig. Sillusirares a more complicated production profile witha delay and ramp-up followed by two declines, Wells can be linked by cor relations or other relationships. More than one zone ina wel ‘modeled, and associated gas proiction can be accounted for model. Workovers, waterfloods (ie. capital investments ith une certainty and future changes in production streams) are possible “Anything that ean be handled deterministically can be included in the stochastic model. "The output distributions of this model are the requisite input dis. uibutons for portoli-optimization medels. Namely, these ae fre- casts (1) of aggregate field production by type, which sum to “re- serves"; 2) of cashflows, oe of whose sums is NPV, and ROT, and (3) of capital and operating expense, providing a measure of "expo- ‘ure:" The usefulness ofthis model is obvious. One can estimate the probsbilily of achieving some hurdle rate for ROT of ffl to meet ‘atarget NPV. The sensitivity analysis highlights the inpu parameters thar drive the model and alerts investors to opportunites to mitigate the risks, ROT isa parameter that needs special attention when doing simulation beeause i relies onan trative process to converge and ‘may occasionally fil. The resulting ROT output dsebution then has some missing data, There are several ways to avoid this itll Problem 3. Strategic Plan: Estimate Reserve Increases, NPV, ‘and Capital Exposure. The strategic: plan model can berather sim ple. The objective is to aggregate various capital investments (let us call thom ventures) making up a portfolio. In the upstream side of the petroleum industry, these ventures might represent countries. Fach investment i represented by distributions forepital. reserves, and NPV. Restricting the portfolio further an exploration portfolio ‘might add the number of wells planned and success rates, along with the associated estimates for reserves, cost (both exploration and de- velopment) and NPY. Figs. 6 nd 7 show the spreadsheet template and typical inputs and outputs for such a model ‘On cach tal ofthe simulation, samples are taken from number of| discoveries for each venture, along with corresponding reserves, PV's, and capital exposures (both exploration and developmen) ‘Outputs are the aggregations ofthese parameters, Aggregation mod: cls rely on good input distributions and any comlations between them, These input distributions are themselves output roman explo- ‘afion-economics model. Comelations aise from technology changes (high prodoctvity in several wells might depend on state-of the-art lling or completion), eeonomic factors (changes in prices of prod- ‘vets and in costs of goods and services affect ll projects). and estim tor biases (capital costs estimates on various projects might be made by the same feam, which tends to underestimate certain line items) Estimating the coefficients of these correlations may be dificult. One can (and indeed should) un the various economic models using com- 366 Fig. 6~Spreadsheet template for exploration portalio. ‘mon price and cost forecasts. The resulting imation results would yield the desired correlations. Scenario Errors Deterministic reserves estimates are often described in terms of low, medium, and high-side possibilities. Some people think in terms of extremes: worst and best cases together with some base case (mean, mode, or median). Others report Pg, Pso, and Pag vale ‘es. Sometimes, these cases are linked 1 such categories as proved, proved: plus probable, and proved plus probable plus possible ‘While there is nothing wrong with any of these notions, the logic of ‘obiaining the cases i often flawed, Do Not Mulitply or Add Pyo Values. When volumetric products are used to obtain reserve estimates, thee is temptation tobuild the low-side reserve estimate by taking the product of low estimates for the various factors. Thisisa dangerous businessat best The product of Pio estimates for area, pay, and recovery factor, for example, is approximately Py. For special cases (all distributions lognormal, no correlations), ane can find an exact answer. Bu if youuse adiferent distnbution type. include any corelations between inputs (larger area tends to be associated with thicker pay), or change the number fof Facors (beaking out recovery factor into porosity, saturation, formation volume factor, and efficiency), there ate no simple rules ‘of thumb co predict just how extreme th produet of Pig values is. Do Not Multiply Psp Values or Modes. Less obvious isthe fact that ‘the Psp value or the modes forthe inputs do not yield Psp oF mode, respectively, forthe output, except in very special eases. The mean ‘values of inputs will yield the mean ofthe product distribution, pro- ded there is no correlation among inputs. In other words, even the “pase-case" reserve estimate generally should not be obtained from, product of base-case inputs except in very special cases. Similar arguments apply to cost models, such as a drilling APE. ‘model. where the principal output isa sum of inputs. One cannot Simply add the low aod high estimates forthe lin items and hope to obiain realistic low and high estimates forthe total. Typical sums cof Pig values might be Por Pa. and could be much les likely (see Fig. 8) Again the exact value ofthe sum of Pio values depends on isribution types, relative sizes of inputs. and correlations. I¢isim- prudent o ty to generalize, Fig illustrates a postsimulation graph ‘ofthe Ps and Pys curves fr depth vs time. The obviously incorrect ‘eurves representing the sum of the best and worst valves for the in- putsare included. This s the analogy of obtaining low andhigh esti mates of reserves by taking products of Pig and Pyp values. ‘Do Not Add Psp Values or Modes. Worse yet, one cannot simply ‘add modes or Psp values from individual cost modes 1 obeain the mode or Pso, respectively. of an ageregation. Only means add 10 means. Yt, itis @ common practice to estimate the base cost of @ illing program by adding the base estimates for individual wells Api 1997 «PEForecast: Wells mY 7? . Forecast: Reserves . .__ Forecast: NPV Forecast: Capital Probabiny 1 7 - J__________ Fig. 7—Outputs for exploration-porttolio model Similarly, total capital cost is often estimated by adding the base ‘costs forthe various line items ‘A simple exercise shows how far off he total cost can be, Take 10 identical triangular distributions, each having 100, 200, snd 350 foe low, most-likely, and high values, espeetvely, While the mode of ech is 200, the mean is 216.7 The sum of these distributions is approximately normal with a mean of 2,167 and standard deviation ‘of approximately 18. The sum of modes, 200s well side the 3 standard-deviation range, In eter words, 10 independent line items, ceach ranging in cost from 100 0 380 with most Hkely’of 200, wou have an aggrepate cost in the range 2.11310 2,221, Do nat even con: sider adding the high o low estimates. The modes themselves sum to values ouside the range of practical consideration, ‘What Monte Carlo Simulation Does Not Do In spite of its power and applicability, Monte Carlo simulation ‘does not do the folowing. Tet does not make decisions: it prepares for decision making. 2. It does not analyze dat there is companion software for that purpose 3. Irdoes no optimize fanetions the outpt distributions serve as ingrediens for optimization, 4. It does not provide ready-made models; everyone builds their (Who Does Risk Analysis in the Oil and Gas Industry? Virtually all segments of the industry operating companies, large and small service companies: consulting firms and Financial ins tutions —are engaged in some form of risk analysis, Thousands of| ‘geosciemtss and engincers have attended classes in probabilistic reserve estimation, general principles, oF hands-on Monte Carlo ‘simulation: and the pace of that traning is accelerating. Several ma {ors have organized some sortof process to darisk or decision analy ‘ison a systematic bass. They have created task forces, organized procedures, held in-house raining, molded intemal specialists and designated champions. Seldom, however, has this been attempted ata Corporate level. Rather. it may be done in the exploration group ‘or within the planning department or by the drilling engincers A this time, it appears that no oil and gas operating company has fully implemented, unified program todo probabilistic estimates of their key operating parameters: reserves, capital exposure. and NPV. {A ow have made effon in this direction: there always seems to have IPT « Ape 1997 been pockets of resistance. These efforts sometimes date ack tothe 1970's, some even further Since Hena's! widely read article, there hhave been the sporadic anicles!2¥ and books®?¥ on Monte Carlo, simulation and related topis in te petroleum literature. The attentiongiven to risk analysis in event years should begin to generate more research and broader literature. Responses to Criticisms of Monte Carlo Simulation ‘Many of the criticisms of Monte Carlo simulation fll ito the fol- lowing categories. I. It didn't work 20 yeas ago. 2. There are no adequate dat 3. Outputs depend an people running the mode's. Intesponse,onecan cite the developmentof spreadsheets and fast computers. Instant graphies and statistical analysis, simple pro ‘gramming, cow and column structure, hundreds of canned fune: ‘Hons, and an estimated 30 million official users make Excel and Lo= tus 1-2-3 natural vehicles to do Monte Caro simulation, Datacanbe a problem: but ether you have them and can easily ob tain statistical euve fis or you dont (olen the case) and you lesa how todo sensitivity testing co find out the key parameters and how they affect results when the distribution type and ranges ae alered ‘Then, you make a concerted effort to acquire data in the fture. The points this. I you can make a deterministic estimate for some param ter, then you can make an estimate fr is possible ange (eg. from Pio to Pog) Many people feel more comfortable presenting the range. Tom 3 is addressed in the guidelines in the next section. Suice itto say, there are many abuses of Monte Carlo simulation (and of ‘decision trees), One example is moliple models within a company to estimate the same thing. There should be exactly one model for ‘charge assessment, one fr reserves estimating, one for diling AFE ‘model, and one standard lucilites cost model, Like any other sof are too. they should be designed carefully with put fom the Key users, maintained over the long tes, and reviewed periodical ‘Some Guidelines for Monte Carlo Simulation 1. Establish comprehensive objectives: scope, deadlines, proces. 2. Hold awareness seminars on the language concepts of risk analysis. 4. Decide which madels to build or buy. '5. Designate teams or individual to design ad acquite the models 6. Bsablish reporting procedures: forms, timing, ad people, 7. Keep reports of ress toa few papes and 30 minutes. However, Insist that they include (1) sensitivity analysis with 10 oe fewer driving ‘input parameters, (2) the bass of selection of lke inputs, 3) ident ca-format output distributions, and (4) signatures of reviewers. 8, Avoid duplication or modification of models; use periodic re- View to suggest changes 9, For each model, identify wo people who will be responsible for explanations, assistance in running, review, and collection of re usable examples and who will general, assume responsibility for the integrity ofthe model and its use 10, Set frm guidelines for documenting ll models and applica tions religiously and thoroughly. 11. Establish Took: back procedures that focus on improvement of ‘estimations and ofthe model logic, not on reward or punishment. 12, Always ask whether there is another model doing essentially the same thing and offer an incentive to one of the mode! builders to join your company. 13. Periodically have a disinterested third-party review the ap- plications. Future of Monte Carlo Simulation Isthere a rebinh of simulation, and will it persevere? Here are some predictions, [Near-Term Developments. 1. Field testing of two commercial economics packages inter faced to Monte Carlo spreadsheets 2, Testing of at least two stand-alone comprehensive Monte Carlo ‘economies-evaluation models, 370 Drilling Performance: Fig. 8—Time-vs depth forecast with actual Ps and Pas vs. sums of Pioand Pag Inputs. 3. Some form of geostatistics interface to Monte Carlo simulation 4, Formalized agreements for sharing data and model description. 5. Renewed attempts at systematic integration of risk and deci- sion analysis into companies Future Developments. 1. Commercial Monte Carlo templates for economics, drilling! facilities cots, and production forecasts 2. Seamless links between components, with empirical daa 3. Several corporations embracing the method, 4. Several portfolio and planning models; atleast two commer- ial models already exist 5. Usergroups for Monte Carlo software, 6. Look-backs: companies will formalize this process. 7. Catalogs of distribution types. 8. Steady growth of technical papers. “The Perfect World. The following would be preset in an ideal en- vironmeat for engineers and scientists 1. The language of basi statistics would be as common as a guage of engineering economics, 2. Appropriate databases would be generated, properly main- ‘ained, and used ro guide parameter modeling. 3. Everyone would know the significance oftheir analyses and bow thei results plugged into the next level of model 4 Allestimates would be ranges; single-number requests would be refused, 5, Budgets would be built on distributions. Aggregation, properly done, results in estimates with relatively less dispersion than the in «vidual components, We t00 often fool ourselves with single num- bets and then either force spending or ereate reasons for missing the target, There would eno penalty for coming in“over budget." Per- formance measures would be probabilistic (Can this happen? Of course! We must assume that everyone can be educated. ser Apri 1997 «PEReferences Bradley, HIB: Perolewm Engineering Handbook, SP, Ricindson, “Teas(1987) 2. GRISK—Adanced Risk Anas for Sprasets, Users Gude, Pal ide Corp, Newfield. New York (199, 3. Crt Bll Users Mana, Deisoneting, Aurora, Colorado (196). 4. Hon, HL="A Retrospective andProspective Survey ofthe MonteCar- lo Method ta¥ Revtews (1970) 12, S. Martha, JA “Incorporating Historia Data in Monte Cato Sin tin” SPECA (Ape 194) 1 6 Dhir Dern, Rand Mavor,M.J: “Economical Reserve alae ti of Colbed Methane RescevitsJPT (December 1991) 4 7. Poterson SK, Mura, JA. and Schocder PE! “Risk Analysis and “Monte Caro Simulation Applied othe Geacatia of Daling APE Fst inate” pper SPE 26339 presente at the 1093 SPE Armia! 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Muna. 1A: Decisions Inoliing Uncertainy-—An @AISK Tutorial for the Proleu str, Palisade Corp. Newell, Now York (1993), 34 Hartaugh J, Davis, and Wendetourg, J: Computing Risk for Oi Prospect: Pergamon Pes Ine, Elmsford, New York (1999), ‘SI Metric Conversion Factors acre X4046 873 E—O1 ha bol x1.589873 E-Ol=m 13.048" E-0l=m in. 254° E+00=cm James A. Murtha isan indepencient constant Speciotng in sk analyse ond dacison-mak- ing. He holds aBA degree trom Marietta C. and IMS and PhD degrees from the U-of Wisconsin, kia matnemaries. ond on MS degree in perro: leumandnaturcai ges engineering fiom Penns). Vania Stato U. Mestha i§ on SPE Shot Course: Insictor and a member of the Forum Series Asia Pacific Steering Commitige. He was a 1995-96 Disin- {uéhed Lecturer and @ 1994 Speakers Bureau speaker. He Chaired the 1994 SPE Petroleum Computer Conference Pro rom Commities and has served on the Election's Publishing, omputet Applications, and Editorial Review committees. are