1. 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

2. September 2008© 2008 Babajide, de Neufville, Cardin2 of 21 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)

3. September 2008© 2008 Babajide, de Neufville, Cardin3 of 21 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

4. September 2008© 2008 Babajide, de Neufville, Cardin4 of 21 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

5. September 2008© 2008 Babajide, de Neufville, Cardin5 of 21 Case Characteristics

6. September 2008© 2008 Babajide, de Neufville, Cardin6 of 21 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

7. September 2008© 2008 Babajide, de Neufville, Cardin7 of 21 Probability Mass Functions (PMFs) Note: “Most likely” scenarios are 150 and 100

8. September 2008© 2008 Babajide, de Neufville, Cardin8 of 21 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

9. September 2008© 2008 Babajide, de Neufville, Cardin9 of 21 Deterministic Valuation Values of fields, based upon “most likely” assumption

10. September 2008© 2008 Babajide, de Neufville, Cardin10 of 21 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

11. September 2008© 2008 Babajide, de Neufville, Cardin11 of 21 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

12. September 2008© 2008 Babajide, de Neufville, Cardin12 of 21 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

13. September 2008© 2008 Babajide, de Neufville, Cardin13 of 21 Combined PMF

14. September 2008© 2008 Babajide, de Neufville, Cardin14 of 21 Inflexible Design with Uncertainty Combined fields

15. September 2008© 2008 Babajide, de Neufville, Cardin15 of 21 VARG for Inflexible Design Value-at-Risk-and-Gain – Cumulative Distribution of Values Note: Expected NPV ~23M very different from base case ~21M!

16. September 2008© 2008 Babajide, de Neufville, Cardin16 of 21 Step 3 – Identify Sources of Flexibility Step 3: –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

17. September 2008© 2008 Babajide, de Neufville, Cardin17 of 21 Step 4 – Value Flexibilities Step 4 –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

18. September 2008© 2008 Babajide, de Neufville, Cardin18 of 21 Flexible Combined Fields

19. September 2008© 2008 Babajide, de Neufville, Cardin19 of 21 VARGs: Inflexible vs. Flexible

20. September 2008© 2008 Babajide, de Neufville, Cardin20 of 21 Comparison of Economic Metrics Note: In general, no alternative best on all measures. Several criteria important to decision-makers, they need to make judgment about trade-offs. CAPEX is the initial investment, the “capital expenditure”

21. September 2008© 2008 Babajide, de Neufville, Cardin21 of 21 Benefit-Cost of Flexibility Note: Absolute and Relative Value of Flexibility depends on situation

22. September 2008© 2008 Babajide, de Neufville, Cardin22 of 21 Probability Tree

23. September 2008© 2008 Babajide, de Neufville, Cardin23 of 21 Flexible Sample Field

24. September 2008© 2008 Babajide, de Neufville, Cardin24 of 21 Flexible Rother Field

25. September 2008© 2008 Babajide, de Neufville, Cardin25 of 21 Considering Price Uncertainty