Abisoye Babajide Richard de Neufville Michel-Alexandre Cardin Integrated Method for Designing Valuable Flexibility In Systems Case Example: Oil Development Project Abisoye Babajide Richard de Neufville Michel-Alexandre Cardin September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin Purpose of Case To present and illustrate by example … Integrated method for designing … Flexibility (to expand, change function, or otherwise alter) “In” System (as part of technology) September 2008 © 2008 Babajide, de Neufville, Cardin

Conceptual Take-Aways from Case Traditional design based on fixed assumptions (or ‘requirements’) Evaluation of this design is unrealistic – including uncertainties gives different values – often very different Inserting proper flexibility can increase performance – often very much September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin The Case Oil recovery in Gulf of Mexico “shallow water” ~ 100 m Real case: numbers disguised for company confidentiality Two fields: “Sample” and “Rother” Reservoirs ‘fractured’ – that is, they consist of several smaller pools that each require wells to suck out oil September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin Case Characteristics September 2008 © 2008 Babajide, de Neufville, Cardin

Background to Design Process Initial exploration well was promising Later test wells confirmed promise – but gave different results Each test well expensive (cost depends – tens if not hundreds of millions) So few test wells – value of more not great, due to geological uncertainties Design starts from uncertain oil quantity September 2008 © 2008 Babajide, de Neufville, Cardin

Probability Mass Functions (PMFs) Note: “Most likely” scenarios are 150 and 100 September 2008 © 2008 Babajide, de Neufville, Cardin

Traditional Design Process An oil platform is a very complex system Analysis requires great skill, complex “Oil and Gas Models” needing days to run Time-consuming, expensive for a single set of assumptions Analysis focuses on simple scenario: “Most likely” assessment of oil Price of oil set by top management September 2008 © 2008 Babajide, de Neufville, Cardin

Deterministic Valuation Values of fields, based upon “most likely” assumption September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin Project looks good However: Is this assessment realistic? No! Properly including uncertainties gives different values Jensen’s Inequality – discussion later Can we do better? Yes! Use Flexibility to deal proactively with uncertainties September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin Analysis Method Four Steps: 1. Use traditional analysis as base case 2. Include uncertainties in base case: Exhaustive analysis or Simulation Consider distribution of possibilities (VARG) 3. Identify likely sources of flexibility 4. Value these possibilities – and confirm for detailed engineering analysis September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin Steps 1 and 2 Step 1: Done Step 2: Develop probability distributions Apply to design from traditional process Display consequence for outcomes (VARG) These done next September 2008 © 2008 Babajide, de Neufville, Cardin

© 2008 Babajide, de Neufville, Cardin Combined PMF September 2008 © 2008 Babajide, de Neufville, Cardin

Inflexible Design with Uncertainty Combined fields September 2008 © 2008 Babajide, de Neufville, Cardin

VARG for Inflexible Design Value-at-Risk-and-Gain – Cumulative Distribution of Values Note: Expected NPV ~23M very different from base case ~21M! September 2008 © 2008 Babajide, de Neufville, Cardin

Step 3 – Identify Sources of Flexibility Several Methods Available Topic of Research, best procedures not defined - presumably depend on system Detailed presentation later For now, recognize that base design does not enable exploitation of biggest possible fields Flexibility: More Direct Access, Sub-Sea wells September 2008 © 2008 Babajide, de Neufville, Cardin

Step 4 – Value Flexibilities Repeat evaluation of base case design using the variants with flexibility Find Expected Net Present Values (ENPV) … Also Maxima and Minima Compare along several dimensions Define best combinations of flexibilities Validate in detailed engineering design September 2008 © 2008 Babajide, de Neufville, Cardin

Flexible Combined Fields September 2008 © 2008 Babajide, de Neufville, Cardin

VARGs: Inflexible vs. Flexible September 2008 © 2008 Babajide, de Neufville, Cardin

Comparison of Economic Metrics CAPEX is the initial investment, the “capital expenditure” Note: In general, no alternative best on all measures. Several criteria important to decision-makers, they need to make judgment about trade-offs. September 2008 © 2008 Babajide, de Neufville, Cardin

Benefit-Cost of Flexibility Note: Absolute and Relative Value of Flexibility depends on situation September 2008 © 2008 Babajide, de Neufville, Cardin