Published by Harshil Shah on
“The value of information is commonly underestimated and through a proper understanding of the true power of new information the uncertainty of major business decisions can be reduced.”
We are working with companies in the oil and gas sector to optimise risk and returns in major investment decision making using a range of quantitative techniques. These techniques can and arguably should be applied to risk management across a wide variety of businesses. The value of information is commonly underestimated and through a proper understanding of the true power of new information the uncertainty of major business decisions can be reduced.
Complex business decisions will always be difficult to make and should be approached with care and attention commensurate to the scale of risks and complexity. Consider an oil and gas company in the early stages of exploration. Initial tests suggested the area identified has a 30% chance of containing a financially attractive amount of oil.
They considered the following options:
There are many factors to be considered in making this decision. This is where a rigorous but simple to communicate methodology was used to decide on the optimal decision. Ideally, this should be illustrated in monetary terms. This involved modelling the expected outcome of each decision in financial terms and the potential cost of each decision, both of which are also subject to uncertainty.
The model must also consider:
“These methods allow us to promote evidence based decision making with auditability and accountability for decision makers.”
Using a range of statistical techniques, we established a decision tree based on each option with the expected net value. The decisions were then ranked in order of value and the the optimal decision was developed. The inputs to this decision tree were tested for sensitivity allowing further attention to be focused on the elements of the problem with the most financial significance.
In this example, without a thorough analysis of the potential value of each option it would have been difficult to determine that abandoning the project was in fact the best decision. These methods allow us to promote evidence based decision making with auditability and accountability for decision makers.
In reality, there are likely other risks and considerations above and beyond the cost and return of the project including, for example, company reputation, employee satisfaction and regulatory hurdles. These techniques are broad enough to allow these risks to be incorporated to build up a complete picture of the risk profile and best option. For significant business decisions, the marginal cost of conducting this analysis will pay for itself many times over in the long term so it seems nonsensical not to do it.