Inverted Hockey Stick Method Reveals Greater Uncertainty in Petroleum Investment Evaluations
Conference Paper
Overview
Identity
Additional Document Info
Other
View All
Overview
abstract
AbstractConventional oil price forecasting methods in the petroleum industry typically consider uncertainty by incorporating optimistic, pessimistic, and most-likely cases. Commonly, these price projections are "hockey stick" forecasts, i.e., forecasts that are initially flat or decline for some period of time and then increase monotonically. Review of historical forecasts by industry and governmental organizations show that conventional forecasting methods often fail to capture the true uncertainty associated with oil and gas prices. Performing discounted cash flow calculations using conventional oil and gas price forecasts will therefore underestimate the uncertainty associated with project economic performance indicators. Akilu et al. developed the Inverted Hockey Stick (IHS) Method to address these shortcomings. This new method for quantifying the uncertainty of price forecasts honors the historical extremes of oil and gas prices (on a constant dollar basis) along with the maximum positive and negative historical rates of change. To investigate the uncertainty associated with economic indicators (e.g., net present value, investment efficiency, and internal rate of return), we applied the IHS method to 23 completed or proposed projects from 12 operators. We found the P50 IHS value for these economic indicators is comparable to the most-likely value from conventional price forecasts. Across all 23 cases, however, the IHS method predicted a wider range of economic indicator values than conventional forecasts. The IHS method may be preferable over conventional methods due to its ability to quantify more realistic upside and/or downside risk associated with projects in the upstream petroleum industry.
