Drawing the Wrong Conclusions

Business Side of Geology

Sometimes folks who are dedicated to the status quo, or to a particular philosophy or procedure, may come up with perverse interpretations of data that challenge their existing reference-frames.

Like the prohibitionist preacher who was holding forth one afternoon out in front of the local saloon, inveighing mightily on the evils of Demon Rum. A small crowd of passers-by had gathered (including a few regular clients of the aforementioned drinking establishment), and the preacher was bent on proving to them the destructive consequences of liquor.

The preacher held up a clear glass of water and dropped an active earthworm into it, pointing out how the submerged worm continued to thrive vigorously. Then he held up a glass of whiskey, into which he dropped the wriggling earthworm, which promptly underwent three convulsive spasms, then sank to the bottom of the glass, paralyzed.

Triumphantly, he asked the assembled, "Now, brethren, what does that prove?"

Whereupon the town drunk replied from the front row:

"Proves that if you drink whiskey you won't get worms!"


Some years ago, I was introducing the concepts and procedures of exploration risk analysis to an in-house class of geoscientists and engineers in Lafayette, La. About a week later, one of the class members called me on the telephone.

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Sometimes folks who are dedicated to the status quo, or to a particular philosophy or procedure, may come up with perverse interpretations of data that challenge their existing reference-frames.

Like the prohibitionist preacher who was holding forth one afternoon out in front of the local saloon, inveighing mightily on the evils of Demon Rum. A small crowd of passers-by had gathered (including a few regular clients of the aforementioned drinking establishment), and the preacher was bent on proving to them the destructive consequences of liquor.

The preacher held up a clear glass of water and dropped an active earthworm into it, pointing out how the submerged worm continued to thrive vigorously. Then he held up a glass of whiskey, into which he dropped the wriggling earthworm, which promptly underwent three convulsive spasms, then sank to the bottom of the glass, paralyzed.

Triumphantly, he asked the assembled, "Now, brethren, what does that prove?"

Whereupon the town drunk replied from the front row:

"Proves that if you drink whiskey you won't get worms!"


Some years ago, I was introducing the concepts and procedures of exploration risk analysis to an in-house class of geoscientists and engineers in Lafayette, La. About a week later, one of the class members called me on the telephone.

He was complimentary about the course and how much he had learned, even though he openly confessed to being a skeptic. Then he said, "You know, I applied your methods to about half a dozen of my prospects, and I conclude that, just as I had suspected, the concepts just don't work here in South Louisiana."

I said, "Why do you say that?"

"Because none of my prospects ended up with a positive expected net present value!"

As diplomatically as possible, I replied, "Well, do you suppose this could be telling you something about them as business ventures?"

He was so personally vested in the existing procedure that had been leading to many of his prospects getting drilled, that he had lost sight of the fact that they were substandard business ventures!


A well-known consultant specializing in economics and petroleum exploitation had a similar experience: He set up a simple process for a group of company reservoir and production engineers by which they could compare their geotechnical forecasts of key value-driven parameters — such as drainage area, net pay, average porosity, recoverable reserves, initial production rate, drilling costs and price forecasts — with the actual outcomes that could be measured after drilling and completion.

The idea was to measure their predictive ability, and calibrate it with actual results, i.e., to learn how to make better forecasts.

In their first trial period, the actual outcomes showed discouragingly poor correspondence to the geotechnical forecasts on which the projects were approved. However, rather than accepting that their estimating skills needed substantial improvement, their response was to challenge the comparative process!

They didn't want to face the possibility that their estimating procedures had a strong over-optimistic bias, and that routinely measuring their estimating performance might force them to shift their priorities and modify their procedures.

Change is painful.


For a business that so highly prizes new technology and tries aggressively to stay on the cutting edge of new tools and concepts, it is an ongoing wonder to me that E&P people are so entrenched with regard to their business procedures.

I attribute this to the difficulty of measuring the true "value added" by E&P projects. Such difficulty naturally leads to rewarding activity rather than results — and that leads in turn to folks focusing on business procedures rather than what those procedures generate.

That takes us back to my November column, discussing what incentive systems companies set up (whatever you incent, you get more of!). When companies give bonuses based on overall company performance, it encourages cooperation within and between different business units and departments. Professional employees want the firm to invest in the best projects, no matter where they're located. Professional staffs are naturally interested in results, not just activity.

When you reward folks just for getting wells drilled, it tends to lead only to a lot of uneconomic producers.

If we really want to improve our E&P efficiency, it means having the courage to look objectively at real results, even though such data may indicate the need for different procedures and priorities.

In other words, to be willing to put aside what is familiar, and focus objectively on reality — and the right conclusions.


Recommended Reading: When Genius Failed: The Rise and Fall of Long Term Capital Management, by Roger Lowenstein, Random House, 2000.

This is a fascinating account of the collapse of Long Term Capital Management, one of the commodity mega-traders of the 1990s. Even though owned and managed by recognized commodity experts, including Robert C. Merton and Myron S. Scholes, who won the 1997 Nobel Prize in Economic Sciences for their 1973 derivation of the Black-Scholes equation to value stock options, the hubris and greed of LTCM led to severe over-extension, consequential collapse and eventual rescue in late 1998 by a group of major investment banks (with the encouragement of the U.S. Federal Reserve).

Their disastrous experience was a precursor of the Enron scandal, suggesting that some regulation (or at least increased scrutiny) of the commodities market may be worth rethinking.

Read it, you'll like it!

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