Portfolio Optimization: Part 2—An Application of Oil Projects with Inter- and Intra-dependencies

Abstract

The first part of the portfolio optimization was intended to present the concepts and the modeling approach of how both inter- and intra-dependencies can be integrated. In this article we use the concepts and modeling approaches introduced before and show how these models could be applied for a mix of five hypothetical offshore oil field development projects.

This article applied the concepts introduced in the first part by comparing the integration of the sequential approach with portfolio and the integration of the systems approach with portfolio.

The results show that the two approaches yield substantially different efficient frontiers. As expected the difference between the systems and sequential approach increases with increasing standard deviation of the portfolio net present value (NPV) with the expected value of portfolio being greater in the systems approach. In our example, the difference in the computed expected NPV ranged from 8% at lower level of risk to 15% at higher level.

In conclusion, the system approach is superior in capturing intra-project dependence and its impact on the portfolio level is significant compared to the sequential approach. Both the systems approach and the portfolio methodology complement each other in capturing both intra-project and inter-project dependence at the portfolio level.

Keywords:

• dependencies
• oil and gas
• portfolio optimization
• stochastic integrated models
• uncertainty