A Player in the Emergence of E&P Risk Analysis

By the time they are drilled, almost all exploratory ventures today will have been geotechnically, statistically and economically analyzed to estimate – probabilistically – their ultimate recovery of oil or natural gas, or its EUR, and its present monetary value, or PV, given discovery.

The probability of discovering commercial hydrocarbons, or Pc, will also have been estimated, as well as the project cost through the stages of discovery and testing, or I, for “investment.” These three elements – PV, Pc and I – are necessary to generate the project’s expected net present value, or ENPV – its chance-weighted value – the basic metric required to consider the project within the firm’s exploration portfolio.

ENPV = Pc x NPV - (1-Pc) x I (NPV includes project costs [=I])

This process is generally known as “exploration risk analysis,” or ERA, and it evolved mostly during the period from 1975 to 2000, primarily as a response to declining global exploration performance. BP’s deep offshore campaigns of the 1980s and ‘90s illustrate what was recognized as an endemic problem: explorers were discovering less than half of the EURs they forecast for their investors.

It wasn’t as if explorers weren’t trying to estimate project ENPVs during the 1960s and ‘70s. The problem was that they hadn’t learned to apply probabilities to uncertain exploration parameters, such as gross rock volume, average net-to-gross, net pay, reservoir porosity and production rates. Monte Carlo simulation (and computers) were in the infancy of their exploration use. Explorers didn’t know how to avoid cognitive bias in estimating. Moreover, exploration itself was transitioning from a historical focus on “The Deal” to “The Business.”

The Course

In 1983, AAPG’s Education Department wanted to establish a course on prospect evaluation. They persuaded Bob Megill, Exxon’s exploration economics guru, and Ed Capen, Arco’s guru on statistics and economics, to design one. Megill and Capen recognized that neither had much practical experience in prospecting: a third instructor was needed to translate their economics and statistics into practical applications that working geoscientists could grasp and apply to real-life prospects.

That turned out to be me – an independent geologist with more than 10 years’ experience with Shell, three years as chief of the United States Geological Survey’s oil and gas branch and four years as chief geologist for Energy Reserves Group, Inc. I had overseen the first USGS work on probabilistic estimates of remaining U. S. oil and gas resources. I had attended the first two Hedberg Conferences on probabilistic resource assessment, where I met early seminal workers such as R. G. McCrossan and K. J. Roy of the Geological Survey of Canada; G. M. Kaufman of MIT; R, A. Baker, H. M. Gehman and D. A. White of Exxon; Gerard Demaison and R. W. Jones from Chevron, among others. Megill and Capen were also familiar with work I had done, measuring ERG’s exploration and production performance (I compared prospect EURs and Pc versus actual results).

Bob and Ed were the recognized experts; I was just the working geologist who provided the geotechnical applications – the “bridge” from concept to implementation in the workplace. From the beginning, I soaked up their knowledge like a blotter, melding it with my own geological experience: they provided the theory, I provided the application. I welcomed the opportunity to learn new skills; besides, any new work was attractive – I was barely surviving the prolonged slump of 1984-90.

We offered our first course, a four-day affair, in Houston in the spring of 1984. It was fully subscribed. The course featured innovative teaching methods utilized by three experienced, articulate instructors who enjoyed teaching as a team. It focused intensively on the connections between geoscience, decision-making and profitability. The course concluded with a realistic exercise in which competing teams of students worked out the geology of a hypothetical exploration area, identified and assessed drilling prospects using course techniques and determined appropriate bidding strategies for obtaining acreage over the prospects – all before the age of personal computers. Each team backed its assessment with its own pocket money, generally $3 -$12 per team member.

The first course was a resounding success, so we offered it again the following fall in New Orleans, where it was again sold out and enthusiastically received. We had a winner, but we continually refined and revised the course, which we offered through AAPG several times per year for about 15 years, reaching about a thousand prospectors.

Image Caption

From left to right: Bob Megill, Ed Capen, Debbi Boonstra (AAPG staff) and Pete Rose, Calgary, 1989.

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By the time they are drilled, almost all exploratory ventures today will have been geotechnically, statistically and economically analyzed to estimate – probabilistically – their ultimate recovery of oil or natural gas, or its EUR, and its present monetary value, or PV, given discovery.

The probability of discovering commercial hydrocarbons, or Pc, will also have been estimated, as well as the project cost through the stages of discovery and testing, or I, for “investment.” These three elements – PV, Pc and I – are necessary to generate the project’s expected net present value, or ENPV – its chance-weighted value – the basic metric required to consider the project within the firm’s exploration portfolio.

ENPV = Pc x NPV - (1-Pc) x I (NPV includes project costs [=I])

This process is generally known as “exploration risk analysis,” or ERA, and it evolved mostly during the period from 1975 to 2000, primarily as a response to declining global exploration performance. BP’s deep offshore campaigns of the 1980s and ‘90s illustrate what was recognized as an endemic problem: explorers were discovering less than half of the EURs they forecast for their investors.

It wasn’t as if explorers weren’t trying to estimate project ENPVs during the 1960s and ‘70s. The problem was that they hadn’t learned to apply probabilities to uncertain exploration parameters, such as gross rock volume, average net-to-gross, net pay, reservoir porosity and production rates. Monte Carlo simulation (and computers) were in the infancy of their exploration use. Explorers didn’t know how to avoid cognitive bias in estimating. Moreover, exploration itself was transitioning from a historical focus on “The Deal” to “The Business.”

The Course

In 1983, AAPG’s Education Department wanted to establish a course on prospect evaluation. They persuaded Bob Megill, Exxon’s exploration economics guru, and Ed Capen, Arco’s guru on statistics and economics, to design one. Megill and Capen recognized that neither had much practical experience in prospecting: a third instructor was needed to translate their economics and statistics into practical applications that working geoscientists could grasp and apply to real-life prospects.

That turned out to be me – an independent geologist with more than 10 years’ experience with Shell, three years as chief of the United States Geological Survey’s oil and gas branch and four years as chief geologist for Energy Reserves Group, Inc. I had overseen the first USGS work on probabilistic estimates of remaining U. S. oil and gas resources. I had attended the first two Hedberg Conferences on probabilistic resource assessment, where I met early seminal workers such as R. G. McCrossan and K. J. Roy of the Geological Survey of Canada; G. M. Kaufman of MIT; R, A. Baker, H. M. Gehman and D. A. White of Exxon; Gerard Demaison and R. W. Jones from Chevron, among others. Megill and Capen were also familiar with work I had done, measuring ERG’s exploration and production performance (I compared prospect EURs and Pc versus actual results).

Bob and Ed were the recognized experts; I was just the working geologist who provided the geotechnical applications – the “bridge” from concept to implementation in the workplace. From the beginning, I soaked up their knowledge like a blotter, melding it with my own geological experience: they provided the theory, I provided the application. I welcomed the opportunity to learn new skills; besides, any new work was attractive – I was barely surviving the prolonged slump of 1984-90.

We offered our first course, a four-day affair, in Houston in the spring of 1984. It was fully subscribed. The course featured innovative teaching methods utilized by three experienced, articulate instructors who enjoyed teaching as a team. It focused intensively on the connections between geoscience, decision-making and profitability. The course concluded with a realistic exercise in which competing teams of students worked out the geology of a hypothetical exploration area, identified and assessed drilling prospects using course techniques and determined appropriate bidding strategies for obtaining acreage over the prospects – all before the age of personal computers. Each team backed its assessment with its own pocket money, generally $3 -$12 per team member.

The first course was a resounding success, so we offered it again the following fall in New Orleans, where it was again sold out and enthusiastically received. We had a winner, but we continually refined and revised the course, which we offered through AAPG several times per year for about 15 years, reaching about a thousand prospectors.

New Concepts and Tools

By 1989 the course content had expanded to five days, and we had developed six linked techniques to form a consistent, tested process for prospect risk analysis:

  • Log-probability graphs to display and analyze lognormal distributions
  • Forced predictions of resource components to fit the lognormal expectation
  • The P90-P10 convention, used to express probabilistic uncertainty
  • A simple graphical process duplicating Monte Carlo simulation
  • Four-component model for Chance of Geologic Success (Pg) of a Prospect
  • Defined stages of Prospect Success: Geologic (Pg), Commercial (Pc), and Economic (Pe) – the “two-step process”

New Career Directions

After his retirement from Exxon at the end of 1984, Bob Megill became a sought-after consultant. Ed Capen continued his career with ARCO, which limited his participation to three or four vacation-weeks per year. Megill and I, as consultants, began separately to include the risk analysis specialty in our consulting practices, adding elements of our own professional specialization. In late 1989, when fragile health motivated Bob to retire again, he generously suggested that I take over his client list, which I gratefully and eagerly accepted.

That led me promptly to a critical decision – rather than teach through a “middleman,” I decided to self-vend all future commercial teaching. This resulted in substantially greater income for my business, Telegraph Exploration, Inc., and made possible the eventual establishment 10 years later of a new firm specializing in exploration risk analysis: Rose & Associates, LLP.

It also meant that my dear wife Alice and I would now operate as a business team travelling to the client’s venue to put on my “version” of the evolving risk analysis course – Alice would handle all course logistics and administration and I would teach, usually about seven hours a day for four (later five) days a week. She quit her longtime job in Austin and we started a new business in January 1990.

Megill had left me a contract with Texaco. I later I signed up Unocal. Other prestigious clients followed. In 1990, Alice and I taught the risk analysis course 26 times, in the United States, Canada and the United Kingdom. The following year we taught it 24 times. At the end of 1991, after reviewing our personal financial status, it was clear that I had found my way into a pretty attractive business while waiting for the exploration prospecting game to recover. By early 1992, we were out of debt. The last prospect I generated was drilled later in 1992. It was a dry hole.

Over the next 10 years, Alice and I travelled the world, teaching exploration risk analysis in the United States, Canada, Mexico, South America, the Far East, Australia and Europe. It was intense, physically demanding, exhilarating, profitable – and the best time of our lives. I continued to refine and expand my version of “The Course” which I renamed “Exploration Economics, Risk Analysis and Prospect Evaluation,” adding several new chapters, one on play analysis (a summary of a newly developed separate four-day course), others on exploration economics and exploration portfolios.

Building the Business

Our little business continued to grow. After Bob Megill retired, I continued to teach with Ed Capen and his ARCO colleague, Bob Clapp, when they had vacation time available. After they retired in late 1992, we formed Petro-Risk Partners, teaching a handful of courses each year. The rest of the time I was free to teach and consult on my own, and I stayed extremely busy.

Starting in 1990, I began to give talks on various aspects of exploration and production risk analysis at regional, national and international meetings, mostly related to AAPG. I also took an active role in subsequent Hedberg Conferences, especially Snowbird in 1993, San Diego in 1995 and Galveston in 1998. This allowed me to share new ideas and techniques, and it provided excellent publicity for our course offerings, led to many new professional and business contacts, and substantial new business development.

Getting into the Software Business

Petro-Risk Partners had developed a formal protocol based upon the sequential procedures of our E&P risk analysis course, and we helped several major companies incorporate this protocol into software that promoted the uniform global use of such methods by their exploration staff.

In late 1996, Amerada-Hess asked me if any of our clients might be willing to license their software to a competitor. I called my contacts at those firms and relayed Hess’ question. Three client companies declined, but my Marathon contact said, “Let me get back to you.” A month later, he called me back and said, “Marathon will license their risk-analysis software. How much do you think we should charge?”

“Beats me – I’m ignorant about the software business. How about ten grand?”

“Sounds good to me. We’ll split the $10,000 with you, OK?”

So, I called my Hess guy, gave him my Marathon guy’s contact info, figuring they would close the deal, and I could feel good about helping two clients, as well as earning $5,000 in the process. A few weeks later the check arrived; it seemed like “found money” to me.

Several months later, I got another call from Marathon: “Pete, we don’t want to be in the software business – we want you to be in the software business. Because of all your contacts in the E & P business, we’ll give you exclusive rights to market and license our risk-analysis software, and we’ll split any sales contracts with you 50/50. How does that sound?”

It sounded great, so I called Ed Capen, already a dedicated computer user, and relayed Marathon’s software offer, expecting my partner to jump at the opportunity for Petro-Risk Partners to begin marketing their own software to our many clients.

Instead, and instantly, he said, “That’s the dumbest idea I’ve ever heard – who in the world would pay good money for a software program they could build themselves?”

“Well, Ed, maybe there are dumb geologists like me who are more interested in applying risk-analysis to prospects than designing software to help them do it – especially if it uses a well-established, time-tested system like ours,” I answered.

Ed was unmoved.

I departed from Petro-Risk Partners at the end of 1997. Of course, Ed and Bob had been involved in the original consulting projects for our major oil company clients, so when I started receiving payments on software sales, I set up a protocol by which they each would get a small royalty on every sale of my software license.

So here I was, a computer illiterate with a software license. I needed to find a software expert who also knew something about E & P risk analysis. It took a year or so and a hiccup to get my new business off to a sound start, and it led to an outcome I hadn’t anticipated: I needed associates. My days as a sole proprietor were over.

Rose & Associates

My new software associate wasn’t working out. But I also needed seismic expertise: Dr. Gary Citron chose to leave Amoco, take a chance with me, and become my eventual first partner in Rose & Associates, LLP. He was an excellent choice who, four years later, became the firm’s second managing partner. Soon after, we added petroleum engineers Mark McLane (ex-Pioneer, ex-Exxon) and Jim Gouveia (ex-Amoco and BP), both future partners. We also added several recognized risk analysis experts such as Jim McKay (ex-Texaco), and Bob Otis (ex-Chevron).

Mark McLane took over our software business, Lognormal Solutions, Inc. After about a year, Mark wanted to return to teaching and consulting for Rose & Associates, so I brought in David Cook, a geophysicist from ExxonMobil, who proved to be a superb manager, and LSI continually grew under his direction.

Rose & Associates quickly developed a three-component business model, consisting of:

  • Teaching a variety of risk-analysis courses
  • Developing and licensing software that assured clients that all its E & P ventures were evaluated correctly and consistently using our time-tested methodology
  • Consulting with client companies about their individual projects

In 2001, AAPG published my book, “Risk Analysis and Management of Petroleum Exploration Ventures,” with the kind permission of Japan National Oil Company, which granted use of two reports I had prepared earlier for JNOC. The AAPG book was in fact an expansion of the 1999 version of “Exploration Economics, Risk Analysis and Prospect Evaluation,” the descendant of the course that had been evolving since Capen, Megill and Rose had generated its earliest predecessor in 1983. The AAPG book went through seven printings and was also published in Japanese, Chinese and Russian, and became widely known as “The Bible” for E & P risk analysis. I donated all royalties to AAPG in exchange for their agreement to reduce the price of the paperback edition, thus making them affordable to overseas geoscientists.

Stepping Down

Gary Citron became managing partner of Rose & Associates in 2003. The firm’s headquarters moved to Houston. I stuck around for a couple of years to mentor our new managing partner. My last management initiative was to start developing risk analysis and software to deal with the emerging new resource plays. The entrepreneurial phase had ended and the consolidation phase began under Gary’s fine leadership. Our management transition was timely and very successful. Rose & Associates continued to grow, gradually adding new partners and associates as demand grew. Peter Carragher, who previously worked for Amoco and BP, succeeded Gary Citron as managing partner in 2015. I sold my last share in the firm in January 2005 and prepared for a long and productive retirement, starting with the one-year presidency of AAPG.

Now, after 20 years, a software business that started from the most humble of origins has grown into a key component of Rose & Associates, along with training and consulting. Software sales and services have totaled around $30 million in profits since 1998. The firm itself is the recognized global leader in the field of E & P risk analysis, with offices in the United States, Canada, Indonesia, China and the UK. There are now seven partners, 12 associates and an office staff of five.

Not bad for a dumb geologist who knew nothing about computers and software, who didn’t know any better than to embrace the dumbest idea that a recognized guru like Ed Capen had ever heard!

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