Going Beyond the Efficient Frontier Analysis Using an Integrated Portfolio Management Approach

Abstract

Proposal The main focus of most portfolio optimization tools in the E&P industry is to determine the efficient frontier by defining risk and return measures and then selecting one of the portfolios along the curve as the most appropriate portfolio for a given set of conditions for the company. While it is critical to determine the efficient frontier, this paper proposes that defining other boundaries to all feasible portfolios and establishing a solution space or envelope rather than a point on the efficient frontier curve is both beneficial and practical. This approach provides decision makers an opportunity to test multiple strategies and to analyze the impact of competing goals and constraints in a more representative environment. The paper emphasizes that creation of this more complete, representative environment requires an integrated portfolio management approach combining economic evaluation, portfolio modeling and portfolio optimization. In this paper, a collection of exploration and development projects are evaluated using stochastic simulation techniques. After all project information is consolidated in one centralized location, a multi-dimensional portfolio data cube is built. Using portfolio optimization, different strategies are then tested by analyzing the solution envelopes, and movements within the body of the solution envelopes to explore all available opportunities. Different groups of opportunities are also tested against different scenarios using portfolio optimization to identify the best project mixes. The paper also concludes that an integrated portfolio management approach – one that goes beyond efficient frontier analysis - helps decision makers to identify realistic choices in uncertain situations more effectively.