:s~ 0.80
1.00~ practical range of approximately 600 to 5,000 acres. Fig. 2 identifies
.
!'
and shows similar distributions for each of the other input parameters.
11 0.60  ~ti~tetj A trial consists of randomly selecting one value for each input
o. 40ft and calculating the output. Thus, we might select A = 3,127 acres,
h = 48 ft, = 18%, S'" = 43%, and Bo = 1.42. This combination of
~ 0 . 2aL.._B<=;~'L..L. __ '_~ values would represent a particular realization of the prospect yield
(j o. 00 ing 63.5 million bbl of oil. A simulation is a succession of hundreds
a 200 400 600 800 or thousands of repeated trials, during which the output values are
stored in a file in the computer memory. Afterward, the output val
x ues are diagnosed and usually grouped into a histogram or cu~u~a
PDF Normal Distribution tive distribution function. Fig. 3 shows the output and the sensItIvity
chart for this model.
0.004 T
~0.003t PP~
Selecting Input Distributions. Lognormal distributions are often
used for many of the volumetric model inputs, although nettogross
.CI I
ratio and hydrocarbon saturation are seldom skewed right and al
as 0.002 T )Zl
Fig. 1CDF and PDF for normal distribution having mean of 450
Shape of Outputs. In this example, regardless of the distributi?n
and a standard deviation of 117 (P10 =300, Pgo=600). Also types of the inputs, the output is approximately lognormal. That IS,
shown is a Monte Carlo sample. the reserves distribution is always skewed right and "looks" lognor
mal. In. fact, a product of any kind of distributions, even with
function (CDF), which is a nondecreasing (or non increasing, depend skewedleft factors, has the approximate shape of a lognormal dis
tribution. Fig. 3 displays the bestfitting lognormal curve overlaying
ing on preference) function whose y values range from 0 to I. It is sim
the output histogram for our first example.
plest to think of a random variable as a graph of cumulative probabili
ty (on the V axis) vs. value. The companion plot, called a probability
density fu'nction (PDF) is simply the derivative of the CDF. Fig. 1 Sensitivity Analysis. One of the byproducts of the simulation is a
sensitivity chart (Fig 3). A measure of significance toward a given
shows both these plots for a normal distribution. Although the CDF
output variable is calculated for each input variable, namely the (rank
presentation is ultimately more useful, the PDF may be more familiar.
order) correlation coefficient between the two parameters. When the
Once a variable, X, is described by its CDF, we can obtain a Monte
correlation coefficient is close to 0 (as in the case of Bo ), the output
Carlo sample (Fig. I) by first generating a random value, Y, uniform
(reserves) can achieve a value near the upper limit of its range with
ly distributed between 0 and I, then by taking the inverse function
a small Bo and vice versa. The fact that it is negative here is trivial;
of that value from the CDF curve to get X. Simulation software 2.3
there is essentially no correlation between Bo and N. These coeffi
does all this behind the scenes; the user's job is to specify appropri
cients can range from  1.0 to 1.0. Area is identified as the most sig
ate probability distributions.
nificant parameter, and the others are ranked accordingly. As models
become more complex, sensitivity analysis identifies the "driving
Percentiles
variables" that merit additional scrutiny and, by contrast, helps reduce
Common use of a CDF is to specify certain values of a variable. X. The
effort wasted on worrying about the wrong things. Unlike the tradi
expression, PIO, meaning the 10th percentile, is the value of X corre
tional tornado chart or spider diagrams obtained by tracking the
sponding to 0.10 on the cumulativeprobability axis. Experienced users
changes in an output caused by allowing exactly one model input to
often describe distributions by specifying two or three percentiles. Of
vary while holding the others fixed, this sensitivity analysis from
particular interest is Pso, which is called the median and is one of the
Monte Carlo simulation is far more versatile because it permits func
common "measures of central tendency," like the mode (most popular
tional or correlationtype relationships among the inputs.
range; most likely category) and mean (arithmetic average value).
Correlations Among Inputs (Dependency). Unless otherwise spe
Risk Analysis in the Form of Monte Carlo Simulation
cified, the samples of the various input distributions are taken inde
Monte Carlo simulation is an alternative to both singlepoint (determin pendent of one another. Thus, on a particular trial, a very large value
istic) estimation and the scenario approach that presents worst, most of Sll' may be paired with a very large value of or a small value of
likely, and bestcase scenarios. The term Monte Carlo dates back to A could bc chosen along with a large net pay. If there is a geological
the Manhattan Project in the 1940's, where it was used as a code name. argument (or empirical data) to justify a correlation between ~ pair of
The inference is to the gambling mecca, where chance rules. For an ear parameters, then the simulation software can honor that relatI<;mshlp.
ly historical review, see Ref. 4. The following paragraph, drawn largely Correlation among inputs, in this particular example (not In gen
from Ref. 5, offers a brief description of the Monte Carlo process. eral) causes the resulting output to become more dispersed. Thus,
A Monte Carlo simulation begins with a model (i.e., one or more when area and pay (often) or porosity and water saturation (nearly
equations, together with assumptions and logic relating the parame always) are correlated, the prospect appears to be riskier and the
ters in the equations). For purposes of illustration, we select one form mean value of the estimate increases somewhat when the correla
of a volumetric model for oil in place, N, in terms of area, A; net pay, tions are incorporated in the model. Sometimes, the difference is
h; porosity, ; water saturation, SI\'; and formation volume factor, Bo. slight, but the modeler should be prepared to describe at what level
N = 7, 758Ah(IS.,)/Bo . ..... , .................. (I) the correlations make a difference. 5 Imposing correlations among
inputs can also reorder the list of sensitive variables.
Think of A, h, ' SI\" and Bo as input parameters and N as the output.
Once we specify values for each input, we can calculate an output val Model Shortcomings. There is a widespread practice of extracting
ue. Each parameter is viewed as a random variable; it satisfies some one or a few numbers from the reserve distribution to "run econom
_______ =__
~.""~t':.
.000 .
___'.500
'[~:~
______2_.500
____3._500
_ _ _,_.500_
250
~
.;,e I
Fig. 2Five input distributions, with area shown in both CDF and PDF formats; STD = standard deviation.
ics," treating well productivity and capital costs as deterministic and Monte Carlo SimulationTypical Problems
thereby reducing the effectiveness of the uncertainty analysis. The In addition to the widely used volumetricreserves model, the fol
fielddevelopment model that follows picks up where the reserves ex lowing three problems serve to illustrate the breadth of Monte Carlo
ample leaves off. As engineers and geoscientists become more accus simulation. Taken as a whole, they also suggest a process of integra
tomed to integrating riskanalysis components, the explorationpros tion or consolidation.
pect model will include scoping estimates for production forecasts
and both capital and operating expenses. Without this integration, Problem 1. Drilling Authorization for Expenditure (AFE): Esti
identifying the relative importance of the various risks is difficult. mate Total Costs and Times. Drilling APE estimators are prime can
How does fieldsize uncertainty compare with the uncertainty of the didates for Monte Carlo simulation, being conceptually simple, ubiqui
capital costs or the productivity of the wells? Where should we invest tous, and essential to the overall prospect evaluation process.79 Fig. 4
additional resources to acquire information? What are the key issues shows a simple format for the AFE model, with categories of activity
when negotiating with partners or forming alliances? These questions times and costs of goods and services. One task for the user is to esti
are not easily answered, yet they should be acknowledged.
mate durations for various activities, such as drilling the hole sections,
completing, and testing. Another task is to estimate lineitem costs. In
Why Do Monte Carlo Simulation?
this model, the drilling expert provides two values for each estimate:
We do risk analysis because there is uncertainty in our estimates of
capital, reserves, and such economic yardsticks as NPY. Quantify a low and a high estimate. A preliminary calculation in the worksheet
ing that uncertainty with ranges of possible values and associated solves some simple equations 10 to obtain the mean and standard devi
probabilities (i.e., with probability distributions) helps everyone un ation for a lognormal distribution for that cost or time category. These
derstand the risks involved. There is always an underlying model, high and low estimates are treated as PIO and P90: the actual value has
such as a volumetric reserves estimate, a production forecast, a cost a 10% chance of being less than the low value and a 10% chance of
estimate, or a productionsharingeconomics analysis. As we inves exceeding the high value. One could treat the low estimate as a P5 and
tigate the model parameters and assign probability distributions and the high estimate as a P95, or variations thereof. Because the input pa
correlations, we are forced to examine the logic of the model. rameters represent times and costs, they are generally regarded as
The language of risk analysis is precise; it aids communication, skewed right; there are more extreme values to the right of the mode
reveals assumptions, and reduces mushy phrases and buzz words. than to the left, causing a tail of large values having low probability of
This language requires study and most engineers have little expo occurrence. Alternative distributions include beta, gamma. and triangu
sure to probability and statistics in undergraduate programs. lar (which would require three user estimates).

~_: Murth:;;l994
TBIlI8I FonIcasI: Reserves
..... .84
IUgDayRate. $M 110
Cost Estimates
Sw .35
"....,~ .30
pay .15
eo .05
0.5 05
Measured bv Rank Coffelilllon
Overlay Chart
Reserves
.105' Rig=TC
e1 im
+~D~escriPttionfO'Ti,..m=ce~~SoC;tim
...a::te~~=c'~E;~  ~.~.
.078 _ _ _ _ _ _ _ lognormal DIstribution
Mob/Demob 0.5 2.1: 1.2013'2 132 
Mean .23
~1R30;';' 2.5' 2~i4 247247
SIdDev"11 ~~ __ ~~i~ ____ 4 7 5.421 596 596
Stage3 133/8 in 9 12 10.46 1150 1150
12 25 18.05, 1985
         : Reserves 7 13 9.82 1080
Stage6 0.00' o
.000 .:_
I. ,. 55
"
Fig. 30utput distribution (histogram) with fitled lognormal
curve. Fig. 4Drilling AFE estimator template.
Acknowledging Historical Data. When data are available from the capital cost of drilling and completing the well. Note that this
analogous projects, one can fit particular distributions to specific in distribution should come from the drilling engineers who model the
put parameters. There is a tendency for engineers to want to lean AFE simulators. Further assume that operating costs can be de
heavily on data, sometimes at the risk of including inappropriate data. scribed in terms of probability distributions. We might want to break
Certainly, in time, more and better data may be available. One must cost into fixed and variable components and to treat variable costs
often settle for carefully designed sensitivity analysis to quantify the as being proportional to oil production or water production. Alterna
drivers and the impact of changing distribution types and ranges. tively, we could correlate operating expense and oil production.
Generate the forecast of production and discounted cash flow for
Warning. Do not report partial results. Too often, the results of a sim
ulation are reduced to a mean value or a P50. Sometimes two or three
values, such as PIO, mode, and P90, are passed along to the next level,
where they are used to "run economics." Such practices are not in the
spirit of Monte Carlo simulation. As described later, the economics
itself must be a simulation that samples from the full distributions for
the drilling cost as well as from distributions for prices, expenses, and
production forecasts. One cannot capture PIOcase economics run by
splicing together PIO cases for the numerous ingredients.
The proper role for the drilling AFE is a preliminary step,to more
comprehensive models. The outputs (total time and costs) can be re
ported as a distribution or a series of distributions over time or for
each of several wells. In cases where there are multiple wells ordrill
ing costs along with facilities costs, care must be taken to transmit
the correlations between the relevant distributions.
some time horizon (e.g., 20 years). Calculate NPV at 10% interest. mon price and cost forecasts. The resulting simulation results would
So far, we have a singlewell exponentialdecline forecast for a yield the desired correlations.
single production stream.
This model generalizes to any number of wells. The underlying Scenario Errors
deterministic production forecast need not be exponential decline. Deterministic reserves estimates are often described in terms of
Fig. 5 illustrates a more complicated production profile with a delay low, medium, and highside possibilities. Some people think in
and rampup followed by two declines. Wells can be linked by cor terms of extremes: worst and best cases together with some base
relations or other relationships. More than one zone in a well can be case (mean, mode, or median). Others report PlO, Pso, and P90 val
modeled, and associated gas production can be accounted for in the ues. Sometimes, these cases are linked to such categories as proved,
model. Workovers, waterfloods (i.e., capital investments, with un proved' plus probable, and proved plus probable plus possible.
certainty and future changes in production streams) are possible. While there is nothing wrong with any of these notions, the logic of
Anything that can be handled deterministically can be included in obtaining the cases is often flawed.
the stochastic model.
The output distributions of this model are the requisite input dis Do Not Mulitply or Add PlO Values. When volumetric products
tributions for portfoliooptimization models. Namely, these are fore are used to obtain reserve estimates, there is a temptation to build the
casts (1) of aggregate field production by type, which sum to "re lowside reserve estimate by taking the product of low estimates for
serves"; (2) of cash flows, one of whose sums is NPV, and ROI; and the various factors. This is a dangerous business at best. The product
(3) of capital and operating expense, providing a measure of "expo of PlO estimates for area, pay, and recovery factor, for example, is
sure." The usefulness of this model is obvious. One can estimate the approximately PI. For special cases (all distributions lognormal, no
probability of achieving some hurdle rate for ROJ or of failing to meet correlations), one can find an exact answer. But if you use a different
a target NPY. The sensitivity analysis highlights the input parameters distribution type, include any correlations between inputs (larger
that drive the model and alerts investors to opportunities to mitigate
area tends to be associated with thicker pay), or change the number
the risks. ROJ is a parameter that needs special attention when doing
of factors (breaking out recovery factor into porosity, saturation,
a simulation because it relies on an iterative process to converge and
formation volume factor, and efficiency), there are no simple rules
may occasionally fail. The resulting ROJ output distribution then has
of thumb to predict just how extreme the product of PlO values is.
some missing data. There are several ways to avoid this pitfall.
Problem 3. Strategic Plan: Estimate Reserve Increases, NPV, Do Not Multiply Pso Values or Modes. Less obvious is the fact that
and Capital Exposure. The strategicplan model can be rather sim the Pso value or the modes for the inputs do not yield Pso or mode,
ple. The objective is to aggregate various capital investments (let us respectively, for the output, except in very special cases. The mean
call them ventures) making up a portfolio. Jn the upstream side of values of inputs will yield the mean of the product distribution, pro
the petroleum industry, these ventures might represent countries. vided there is no correlation among inputs. In other words, even the
Each investment is represented by distributions for capital, reserves, "basecase" reserve estimate generally should not be obtained from
and NPY. Restricting the portfolio further to an exploration portfolio a product of basecase inputs except in very special cases.
might add the number of wells planned and success rates, along with Similar arguments apply to cost models, such as a drilling AFE
the associated estimates for reserves, cost (both exploration and de model, where the principal output is a sum of inputs. One cannot
velopment), and NPY. Figs. 6 and 7 show the spreadsheet template simply add the low and high estimates for the line items and hope
and typical inputs and outputs for such a model. to obtain realistic low and high estimates for the total. Typical sums
On each trial of the simulation, samples are taken from number of of PIO values might be PI or P2, and could be much less likely (see
discoveries for each venture, along with corresponding reserves, Fig. 8). Again the exact value of the sum of PIO values depends on
NPV's, and capital exposures (both exploration and development). distribution types, relative sizes of inputs, and correlations. It is im
Outputs are the aggregations of these parameters. Aggregation mod prudent to try to generalize. Fig. 8 illustrates a postsimulation graph
els rely on good input distributions and any correlations between of the Ps and P9S curves for depth vs. time. The obviously incorrect
them. These input distributions are themselves outputs from an explo curves representing the sum of the best and worst values for the in
rationeconomics model. Correlations arise from technology changes puts are included. This is the analogy of obtaining low and high esti
(high productivity in several wells might depend on stateoftheart mates of reserves by taking products of PIO and P90 values.
drilling or completion), economic factors (changes in prices of prod
ucts and in costs of goods and services affect all projects), and estima Do Not Add Pso Values or Modes. Worse yet, one cannot simply
tor biases (capital costs estimates on various projects might be made add modes or Pso values from individual cost models to obtain the
by the same team, which tends to underestimate certain line items). mode or Pso, respectively, of an aggregation. Only means add to
Estimating the coefficients of these correlations may be difficult. One means. Yet, it is a common practice to estimate the base cost of a
can (and indeed should) run the various economic models using com drilling program by adding the base estimates for individual wells.
~ /'
....i
.1"
.1" ~1I
I
... .."""
if ~
~ j .... J
:iii .... .a I:
.a
r'
I:
"
.a
~ / ~"
~
.210 121
l /
. ,
.2M 121
~
.100
....
Forecast: Reserves
11
I'
.... ,... Forecast: NPV 
AU ".1 .....
'III
/' n.
""
~ ,n
/
/
J ,..
i" f ... '50 t
;'
Il. ~ i ... / u. ~
II
om / ... /
~
I", ''''' .... ~
"....
...""" '.110 '3.6111
"'M
15
Similarly, total capital cost is often estimated by adding the base been pockets of resistance. These efforts sometimes date back to the
costs for the various line items. 1970's, some even further. Since Hertz'sll widely read article, there
A simple exercise shows how far off the total cost can be. Take 10 have been the sporadic articles 12 28 and books 29 34 on Monte Carlo
identical triangular distributions, each having 100. 200, and 350 for simulation and related topics in the petroleum literature. The attention
low, mostlikely, and high values, respectively. While the mode of
each is 200, the mean is 216.7 The sum of these distributions is
approximately normal with a mean of 2, 167 and a standard deviation
of approximately 18. The sum of modes, 2,000, is well outside the 3
standarddeviation range. In other words, 10 independent line items,
each ranging in cost from 100 to 350 with most likely of 200, would
have an aggregate cost in the range 2,113 to 2,221. Do not even con
sider adding the high or low estimates. The modes themselves sum
to values outside the range of practical consideration.
Then, you make a concerted effort to acquire data in the future. The
point is this. If you can make a deterministic estimate for some param Time, day
eter, then you can make an estimate for its possible range (e.g., from
PIO to P90). Many people feel more comfortable presenting the range.
Item 3 is addressed in the guidelines in the next section. Suffice i ~;~;Pl0~P5 Sampled I
it to say, there are many abuses of Monte Carlo simulation (and of
decision trees). One example is multiple models within a company 1>< P95 "_s_um_p"_90_ _ _ _11
to estimate the same thing. There should be exactly one model for
charge assessment, one for reserves estimating, one for drilling AFE
model, and one standard facilities cost model. Like any other soft
ware tool, they should be designed carefully with input from the key
users, maintained over the long term, and reviewed periodically.
Fig. 8Timevs.depth forecast with actual Ps and P9S vs. sums
of P10 and Pgo inputs.
Some Gui~elines for Monte Carlo Simulation
I. Establish comprehensive objectives: scope, deadlines, process.
3. Some form of geostatistics interface to Monte Carlo simulation.
2. Hold awareness seminars on the language concepts of risk
4. Formalized agreements for sharing data and model description.
analysis.
5. Renewed attempts at systematic integration of risk and deci
3. Design and conduct training in Monte Carlo software.
sion analysis into companies.
4. Decide which models to build or buy.
5. Designate teams or indi viduals to design and acquire the models.
Future Developments.
6. Establish reporting procedures: forms, timing, and people.
I. Commercial Monte Carlo templates for economics, drilling!
7. Keep reports of results to a few pages and 30 minutes. However,
facilities costs, and production forecasts.
insist that they include (1) sensitivity analysis with 10 or fewer driving
2. Seamless links between components, with empirical data.
input parameters, (2) the basis of selection of all key inputs, (3) identi
calformat output distributions, and (4) signatures of reviewers. 3" Several corporations embracing the method.
8. Avoid duplication or modification of models; use periodic re 4. Several portfolio and planning models; at least two commer
view to suggest changes. cial models already exist.
9. For each model, identify two people who will be responsible 5. User groups for Monte Carlo software.
for explanations, assistance in running, review, and collection of re 6. Lookbacks; companies will formalize this process.
usable examples and who will, in general, assume responsibility for 7. Catalogs of distribution types.
the integrity of the model and its use. 8. Steady growth of technical papers.
10. Set firm guidelines for documenting all models and applica
tions religiously and thoroughly. The Perfect World. The following would be present in an ideal en
11. Establish lookback procedures that focus on improvement of vironment for engineers and scientists
estimations and of the model logic, not on reward or punishment. I. The language of basic statistics would be as common as lan
12. Always ask whether there is another model doing essentially guage of engineering economics.
the same thing and offer an incentive to one of the model builders 2. Appropriate databases would be generated, properly main
to join your company. tained, and used to guide parameter modeling.
13. Periodically have a disinterested thirdparty review the ap 3. Everyone would know the significance of their analyses and
plications. how their results plugged into the next level of model.
4. All estimates would be ranges; singlenumber requests would
Future of Monte Carlo Simulation be refused.
Is there a rebirth of simulation, and will it persevere? Here are some 5. Budgets would be built on distributions. Aggregation, properly
predictions. done, results in estimates with relatively less dispersion than the in
dividual components. We too often fool ourselves with single num
NearTerm Developments. bers and then either force spending or create reasons for missing the
1. Field testing of two commercial economics packages inter target. There would be no penalty for coming in "over budget." Per
faced to Monte Carlo spreadsheets. formance measures would be probabilistic.
2. Testing of at least two standalone comprehensive Monte Carlo Can this happen? Of course! We must assume that everyone can
economicsevaluation models. be educated. .JPI'
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