The Fallacy of the Hockey Stick Projection

Abstract

Abstract Uncertainty assessment is gaining industry acceptance as an essential part of reservoir and project evaluations. Major research efforts have been undertaken and significant progress made in techniques to evaluate risks. These new techniques provide better estimates of reservoir volumes and future production performance, as well as, defining the uncertainty associated with these estimates. Unfortunately, most research efforts have focused on technical risks and few have studied the equally important risk due to economic and price uncertainty. Traditionally within the industry, price uncertainty is assessed using a range of forecasts representing the optimistic, most likely, and pessimistic cases. These forecasts are commonly represented by monotonically increasing future prices and, due to their characteristic shape, often referred to as "hockey stick" projections. While common, such projections demonstrate little resemblance to historical price performance and have proven to be poor projectors of future prices. This paper proposes a new approach based on crude price history over a fourteen-year period from 1/1/85 through 1/1/99. The method assumes that the observed price changes represent "normal price fluctuations" and that future price performance will be statistically similar to the historical data. The "bootstrap" method is used in conjunction with historical data to estimate a statistically similar set of future price forecasts. Each of these distinct forecasts has the same statistical properties and variability as the historical data. The set of price forecasts is then used to evaluate the impact of "normal price fluctuations" on project economic uncertainty. Application of the method is demonstrated with examples. The frequency distributions of key economic indicators are evaluated for the example case. These can be used to establish the economic viability and associates risk of the project. In practice, the method is easily applied and most useful in defining the sensitivity of a project's economic viability to "normal price fluctuations" irrespective of the underlying causes of the fluctuations.