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Using actuarial science for reservoirs

Thursday, October 22, 2015

Actuarial Science, the discipline of assessing, forecasting and valuing risk developed for insurance and investment, could also be applied to the oil and gas industry to price the risk of not getting the production you hope for. We spoke to expert Iain Poole.

Actuarial Science, an established discipline for working out risk in the finance and insurance sector using statistical and mathematical methods, may have something to offer the oil and gas industry.

The actuarial profession is established, regulated, and acknowledged by the financial world as having the foremost body of knowledge in understanding risk. The oil and gas industry has many experts in maths and statistics, but actuarial practice has distinctive processes and philosophy behind it, says Iain Poole, head of oil and gas consultancy with UK actuarial service company Barnett Waddingham.

Mr Poole has experience in both geology and actuarial science.

When comparing standard oil and gas procedures with an actuarial equivalent, 'there's an element of commonality in the mathematics and an element of difference,' Mr Poole says. 'The financial and upstream worlds speak different languages.'

To explain the actuarial approach is probably beyond the scope of an article in this magazine; it may be enough to comment on an actuarial view of the cost of uncertainty. To value a risk, you have to estimate the expected value of losses. The price of insurance cover reflects the level of uncertainty in your numbers, Mr Poole says.

A typical insurance pricing process is to value the P50 risk (where the outcome will be better than estimate 50% of the time and worse 50% of the time.) Then you have to add a margin so that the insurer is more likely than not to be able to meet its claims, to some agreed level of confidence.

Then you add a small margin for the insurance company's expenses and profit, and a further margin to cover the possibility that your assessment is slightly wrong, 'which it probably will be,' Mr Poole says.

So the more sure you are, the less risk premium you need to add.

To put it another way, actuaries can come up with a value for any risk, whether insurable or not. Similar approaches can apply to valuing the risk of not achieving some production or revenue target.

From the client's point of view, 'the more you can clarify and describe all the uncertainties in terms that the financial community understands, rather than in industry terms, the cheaper your insurance or capital is likely to be.'

Actuarial methods could be used in many decision analysis and risk assessment tasks in exploration and production, including appraising reservoirs, production forecasting and economics, Mr Poole says. The scope can include geological uncertainty, and risk associated with new projects.

This is the first time actuarial principles have been applied to oil and gas exploration, the company believes. The service is offered to anyone looking to value an oil and gas asset share, project or company, or answer questions such as 'How much appraisal is enough?'

When a bank or equity investor is asked to finance an oil and gas project, to some degree they need to trust what the oil company is telling them, since banks do not always employ oil and gas experts, Mr Poole says.

But the bank will maintain a precautionary element of scepticism; the amount of caution will be reflected in the availability and cost of any capital the bank may provide, he said.

For example, an actuarial specialist assessing a production forecast might allow for increased uncertainty if it was made using analogy only, or without history matching, or using a 'proxy model', where some of the resolution had been removed to make computation faster.

This basically means removing knowledge, as does 'upscaling'. 'In the financial world you always pay for uncertainty or lack of knowledge,' he says.

'I've been looking at gas forecasts in Southern North Sea, where you can see the proxy model and a fuller reservoir model yield different results, especially for P10 and P90.'

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» Barnett Waddingham
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