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-
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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
361Normal 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 + SPR2
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
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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 «PEForecast: 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 attentiongiven 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
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‘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