Henk Krijnen

Consultant decision, uncertainty and risk analysis
Last Updated: July 31, 2017
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When developing a strategy or making investment decisions, there will be many uncertainties that need assessment. These can range from cost and timing issues to broader questions at the macro level, for example political, regulatory or social developments. A way to get to grips with the latter category is by using ‘scenario analysis’, sometimes called ‘scenario thinking’ or ‘scenario planning’.

A scenario in this context is an alternative future: a coherent narrative of a set of developments, trends and events that could unfold within some defined environment space. Examples of such spaces are: a country, a group of countries, a sector, a city, the world. This is the environment space within which an entity (company, organization) anticipates operating over a predefined time frame, usually somewhere between 10 and 40 years. By articulating multiple such scenarios, each internally consistent but distinctly different, the entity is able to fathom various significant external (contextual) uncertainties that might have an impact on its future well-being or existence.

The purposes of scenarios can be multiple. They are a framework for discussion and strategy development. The entity can use them to engage with external parties. They can be a means to bridge gaps between different interests. A famous example of that are the Mont Fleur scenarios in South Africa, composed in 1991. In this article I however focus on the use of scenarios for decisions.

The question is how, once the scenarios are available and digested, the entity can use these in decision making. The common basis for investment or strategic decisions is some quantification of opportunity attractiveness coupled to various forms of risk analysis. Descriptions of alternative futures, however interesting they may be, do not easily find a place within the decision processes. For example, in most cases it is not (credibly) possible to assign probabilities to scenarios to sharpen the outlook (in another article I will discuss situations when this may nevertheless be an option). There is not a most likely future that can be used as a basis for landing the decision. The fuzziness around the scenario concept makes it difficult to appreciate its use for concrete decisions. This is the reason for the skepticism that the scenario approach encounters in many organizations. It should, however, be accepted that scenario analysis, like any quantitative modelling for that matter, does not eliminate the uncertainties. It justs helps to map them out, frame them, categorize them, discuss them. But we will see that meaningful operationalization of scenarios is certainly possible.

I distinguish three ways of incorporating scenario analysis in the decision making process.

Firstly there is the pervasive impact of the influence on senior leaders and decision makers within the organization of the insights that are brought about by the scenario analysis process. When a significant decision is taken, the underpinning data and analysis, of course, play a crucial role. However, the experience, background and intuition of decision makers is also important. In decision boards they will bring their own perceptions and judgements to the table, calibrating these against the analysis results and information presented to them. The insights from scenarios will assist shaping the perceptions of decision makers of the future contextual environment. At that level, they will have clear views of their own about themes such as the market, (geo)politics, technology and societal developments. Scenarios will enrich these perspectives and allow decision makers to adapt and adjust their thinking as appropriate. A well known characterization is that scenarios act like ‘memories of the future’. Of course it is then a great benefit if senior leaders within an organization are involved themselves in devising the scenarios to the extent practical.

Secondly there is the option of qualitatively stress testing investment decisions, but in particular strategies, against the different scenarios developed. This is what Kees van der Heijden, in his book Scenarios, The art of strategic conversation, called ‘wind tunneling’. This is about creating a matrix with the scenarios on one axis and the various strategy options on the other axis. Each box triggers a discussion of how attractive a specific strategy option will be under a particular scenario. This could result in qualitative attractiveness scoring in some form. Also here, the discussion associated with this process is more important than the resulting overview.

Thirdly, a quantitative approach is possible. The starting point is the key decision variable, for example the (aggregate) NPV of the investment or strategy. This variable is decomposed in its components (revenues, costs, tax) and the chain of influences on these components is mapped out. This is best done with an influence diagram so as to also visualize the interrelationships. In the contexts of the various scenarios, reasonings and quantitative assumptions are developed for the key influences. This is worked through to the level of the NPV: different NPVs under different scenarios (even better: NPV ranges under different scenarios). For the quantitative analysis techniques from the econometrics discipline can be useful (e.g. regressions). Sometimes a system dynamics model can be of assistance. But it does not need to be very complicated. Developing rounded estimates of some key external drivers whilst considering the interrelationships can be good enough. This is in fact what oil companies do (to some extent) when they annually consider a scenario based outlook for the oil price, link this to an assumption about cost escalation, exchange rates and a future price for carbon emissions.

There is no scheme that will allow collapsing all considerations into one number of attractiveness of an investment opportunity or strategy for the benefit of decision makers (except perhaps by judgementally assigning a ‘score’). But the earth is not flat and projecting its surface on a plane leads to substantial geometric distortions. Likewise, the richness of a scenario based analysis should not be kept away from decision makers, be it that the insights need to be adequately presented. Vice versa, decision makers should be prepared to digest the perspectives offered by the scenario approach and contrast that with their own perceptions, even though in the end the decision itself may be quantifiable by a single bit: 0 or 1.

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Nigeria’s Energy Focus Must Change From Crude Oil to Gas – Dr Chukwueloka Umeh

According to the Nigeria National Petroleum Corporation (NNPC), Nigeria has the world’s 9th largest natural gas reserves (192 TCF of gas reserves). As at 2018, Nigeria exported over 1tcf of gas as Liquefied Natural Gas (LNG) to several countries. However domestically, we produce less than 4,000MW of power for over 180million people.

Think about this – imagine every Nigerian holding a 20W light bulb, that’s how much power we generate in Nigeria. In comparison, South Africa generates 42,000MW of power for a population of 57 million. We have the capacity to produce over 2 million Metric Tonnes of fertilizer (primarily urea) per year but we still import fertilizer. The Federal Government’s initiative to rejuvenate the agriculture sector is definitely the right thing to do for our economy, but fertilizer must be readily available to support the industry. Why do we import fertilizer when we have so much gas?

I could go on and on with these statistics, but you can see where I’m going with this so I won’t belabor the point. I will leave you with this mental image: imagine a man that lives with his family on the banks of a river that has fresh, clean water. Rather than collect and use this water directly from the river, he treks over 20km each day to buy bottled water from a company that collects the same water, bottles it and sells to him at a profit. This is the tragedy on Nigeria and it should make us all very sad.

Several indigenous companies like Nestoil were born and grown by the opportunities created by the local and international oil majors – NNPC and its subsidiaries – NGC, NAPIMS, Shell, Mobil, Agip, NDPHC. Nestoil’s main focus is the Engineering Procurement Construction and Commissioning of oil and gas pipelines and flowstations, essentially, infrastructure that supports upstream companies to produce and transport oil and natural gas, as well as and downstream companies to store and move their product. In our 28 years of doing business, we have built over 300km of pipelines of various sizes through the harshest terrain, ranging from dry land to seasonal swamp, to pure swamps, as well as some of the toughest and most volatile and hostile communities in Nigeria. I would be remiss if I do not use this opportunity to say a big thank you to those companies that gave us the opportunity to serve you. The over 2,000 direct staff and over 50,000 indirect staff we employ thank you. We are very grateful for the past opportunities given to us, and look forward to future opportunities that we can get.

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July, 19 2019
Your Weekly Update: 15 - 19 July 2019

Market Watch 

Headline crude prices for the week beginning 15 July 2019 – Brent: US$66/b; WTI: US$59/b

  • Global oil prices gained as US crude inventories shrank more than expected and a hurricane in the Gulf of Mexico threatened American offshore production
  • Tropical Storm Barry – which became a hurricane on landfall in Louisiana – was in the path of up to a third of Gulf of Mexico crude output, prompting producers to shut down most of their operations; resumption of normal service has begun
  • At the same time, US crude oil stockpiles fell by almost 10 million barrels, far more than expected, with US refineries ramping up production ahead of summer demand to add some bullishness to the market
  • The ongoing tensions between the US and Iran have not escalated further yet, but Iran has vowed to continue retaliating against the British seizure of its crude tanker in the Mediterranean off Gibraltar
  • These factors have been enough to keep current crude prices trending higher, but oil producing club OPEC warns that the market will swing back into surplus next year, estimating that it is currently producing 560,000 b/d more than will be needed without even factoring in rising US shale production
  • In Venezuela, where oil production has been crippled by sanctions, Chevron is reportedly seeking a waiver to continue operating in the country after the current waiver expires in July 27
  • The US active oil and gas rig count fell once again, shedding a net five rigs (including 4 oil rigs) as merely stable prices reduced the appetite for investment; the total active rig count is now 958, 96 sites lower than this period last year
  • As the threat of Tropical Storm Barry abated, crude prices fell back in line. Without any further disruptions on the horizon, Brent should trend in the US$62-64/b range and WTI in the US$55-57 range


Headlines of the week

Upstream

  • Norway’s Equinor has bought a 16% stake in Swedish upstream firm Lundin Petroleum for US$650 million, which gains it an additional 2.6% interest in the giant Johan Sverdrup oil field bringing Equinor’s total stake up to 42.6%
  • Inpex has picked up the exploration permit for Block AC/P66 in Australia’s Northwest Shelf, which lies in the vicinity of existing promising oil fields
  • US independent Callon Petroleum Company has acquired Carrizo Oil & Gas for US$3.2 billion, deepening its holdings in the Permian and Eagle Ford shale basins, including 90,000 net acres in the prolific Delaware Basin
  • Total has agreed to divest several of its non-core assets in the UK – covering the Balloch, Dumbarton, Lochranza, Drumtochty, Flyndre, Affleck, Cawdow, GoldenEagle, Scott and Telford fields – to Petrogas NEO for US$635 million
  • CNOOC and Sinopec has signed a new agreement to collaborate on exploration activities in the Bohai Basin, Beibu Gulf, North Jiangsu and South Yellow Sea
  • Murphy Oil has completed the sale of its Malaysian upstream assets to a unit of Thailand’s PTTEP for US$2.035 billion for five offshore projects in Sabah
  • Seven upstream discoveries were made in Colombia in 2Q19, making it the market with the most discoveries during the period, leading India, Russia and Pakistan which each made three new oil and gas finds
  • Turkey has vowed to continue drilling offshore Cyprus unless a cooperation proposal between Turkish and Greek Cypriots is accepted
  • Encana is reportedly selling off its assets in eastern Oklahoma’s Arkoma Basin for US$165 million in cash to an undisclosed buyer
  • Sinopec is hunting for partners or buyers for its Buck Lake assets in Alberta’s Duvernay shale basin in Canada, to reduce its current full ownership

Midstream/Downstream

  • The Governor of Pennsylvania Tom Wolf has ruled out using state funds to save the Philadelphia Energy Solutions refinery after it was shuttered following a massive fire that took out the entire site last month
  • Blackouts hit Venezuela’s Amuay and Cardon refineries, bringing the 955,000 b/d Paraguana refining Center to a complete halt on total lack of power
  • Chevron Phillips Chemical (CP Chem) and Qatar Petroleum have agreed to develop a new 2 mtpa petrochemical complex on the US Gulf Coast, with the US Gulf Coast II Petrochemical Project drawing on NGLs from the Permian
  • Marathon Petroleum will shut down the gasoline FCCU unit at its 585,000 b/d Galveston Bay Refinery in Texas for up to 8 weeks for repairs

Natural Gas/LNG

  • Total has agreed to buy NG from Tellurian’s Driftwood LNG facility in Lake Charles, Louisiana in two separate deals – 1 million tons per annum for Total Gas & Power North America and 1.5 mtpa for Total Gas & Power – as well as invest US$500 million in Driftwood Holdings LP
  • Mozambique has put on hold plans to raise funds for its stake in the Anadarko-led Mozambique LNG project, citing current bad market conditions
  • ExxonMobil and Lucid Energy Group have agreed to collaborate on a long-term natural gas gathering and processing project, bringing natural gas from New Mexico’s Delaware Basin to the South Carlsbad gas processing system before being delivered to ExxonMobil’s downstream facilities in the US Gulf Coast
July, 19 2019
Iran drives unplanned OPEC crude oil production outage to highest levels since late 2015

Unplanned crude oil production outages for the Organization of the Petroleum Exporting Countries (OPEC) averaged 2.5 million barrels per day (b/d) in the first half of 2019, the highest six-month average since the end of 2015. EIA estimates that in June, Iran alone accounted for more than 60% (1.7 million b/d) of all OPEC unplanned outages.

EIA differentiates among declines in production resulting from unplanned production outages, permanent losses of production capacity, and voluntary production cutbacks for OPEC members. Only the first of those categories is included in the historical unplanned production outage estimates that EIA publishes in its monthly Short-Term Energy Outlook (STEO).

Unplanned production outages include, but are not limited to, sanctions, armed conflicts, political disputes, labor actions, natural disasters, and unplanned maintenance. Unplanned outages can be short-lived or last for a number of years, but as long as the production capacity is not lost, EIA tracks these disruptions as outages rather than lost capacity.

Loss of production capacity includes natural capacity declines and declines resulting from irreparable damage that are unlikely to return within one year. This lost capacity cannot contribute to global supply without significant investment and lead time.

Voluntary cutbacks are associated with OPEC production agreements and only apply to OPEC members. Voluntary cutbacks count toward the country’s spare capacity but are not counted as unplanned production outages.

EIA defines spare crude oil production capacity—which only applies to OPEC members adhering to OPEC production agreements—as potential oil production that could be brought online within 30 days and sustained for at least 90 days, consistent with sound business practices. EIA does not include unplanned crude oil production outages in its assessment of spare production capacity.

As an example, EIA considers Iranian production declines that result from U.S. sanctions to be unplanned production outages, making Iran a significant contributor to the total OPEC unplanned crude oil production outages. During the fourth quarter of 2015, before the Joint Comprehensive Plan of Action became effective in January 2016, EIA estimated that an average 800,000 b/d of Iranian production was disrupted. In the first quarter of 2019, the first full quarter since U.S. sanctions on Iran were re-imposed in November 2018, Iranian disruptions averaged 1.2 million b/d.

Another long-term contributor to EIA’s estimate of OPEC unplanned crude oil production outages is the Partitioned Neutral Zone (PNZ) between Kuwait and Saudi Arabia. Production halted there in 2014 because of a political dispute between the two countries. EIA attributes half of the PNZ’s estimated 500,000 b/d production capacity to each country.

In the July 2019 STEO, EIA only considered about 100,000 b/d of Venezuela’s 130,000 b/d production decline from January to February as an unplanned crude oil production outage. After a series of ongoing nationwide power outages in Venezuela that began on March 7 and cut electricity to the country's oil-producing areas, EIA estimates that PdVSA, Venezuela’s national oil company, could not restart the disrupted production because of deteriorating infrastructure, and the previously disrupted 100,000 b/d became lost capacity.

July, 18 2019