4 - Portfolio Balancing and Risk-Adjusted Values under Constrained Budget Conditions

Abstract

The exploration for hydrocarbon reserves is a high-risk game in terms of the probability of finding success. Therefore, procedures for limiting corporate economic exposure are always involved in the decision to pursue the particular available opportunities and in the decisions concerning the working interest fraction (W) that a particular corporation would prefer to take in a given opportunity. Cozzolino's formula is the most widely used in terms of assessing the risk-adjusted value (RAV) of an opportunity for a given risk tolerance (RT) of a corporation, when the probability of success (Ps), value (V)—(present-day currency)—and costs (C)—(present-day currency)—are evaluated. Cozzolino's formula permits a determination of the optimal working interest (OWI) that maximizes RAV. All references to C are considered to be positive, with adjustment of formulas to include the appropriate negative signs for all calculations involving costs. This chapter provides an analytic technique, which can be solved with a small calculator, for determining portfolio balancing with a fixed total cost exposure (or cost expenditure) limit for predetermined input parameter values for each opportunity. In addition, if the individual input variables for each opportunity are themselves uncertain, then it is possible to generalize the procedure to yield a probabilistic interpretation, which illustrates how to determine the probability for optimizing the total RAV, and the probable range of working interest for each opportunity.