Where Have All the Profits Gone? Or, Evaluating Risk and Return of E&P Projects (original) (raw)

All Days, 2000

Abstract

Despite massive improvements in productivity due to technology advances, the E&P industry has averaged a disappointing 7% return on net assets (less than its cost of capital). Its market capitalization relative to the S&P 500, even at recent high oil and gas prices, is about half what it was a decade ago. A small scale, very simple case study suggests that at least part of the reason for this disappointing performance lies in the conventional way that the industry allocates capital and selects portfolios of projects. Conventional ranking of projects by deterministic estimates of value significantly overstates value, understates risk, and misallocates capital by incurring unnecessary, uncompensated risks. Suggestions for improvements in the project selection/capital allocation prices are offered. Why Change? Petroleum exploration and production is enjoying a "golden age" in technology. Over the past two decades, finding costs have fallen more than three fold and lifting cos...

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