Investment Efficiency
Investment Efficiency, "IE"
This is defined as the EMV divided by the expectation of exploration and production costs. But the production costs are only relevant in the case of success. The exploration costs are important in the case of failure, but also accrue to the success case. However in that case they are included in the production costs (for instance capitalized). It is a rough way of trying to go beyond the EMV and incorporate the notion of optimizing an exploration plan. It is based on the idea that there would be a fairly large number of exploration opportunities, but only a limited budget for exploration and production. Then, e.g. out of two prospects with equal EMV, the one with the smaller costs would be preferred, because that would tend to make more money available for the set of prospects with smaller EMV. Although this principle may not work very formally in the practice of exploration, the exploration manager should at least be aware of the logic behind this ranking so that it can be applied when possible.
Where:
- EMV = Expected Monetary Value
- POS = Probability of success after cutoff
- EDC = Expectation of Development and production costs,
including the exploration costs in the success case - E(AEC) = Expectation of the exploration costs in the abortive case
In the seventies, I had the opportunity to test this idea on a large portfolio of Shell International. We compared the EMV ranking and the IE ranking for some hundred opportunities. The IE result, if materialized, was more than 10% better in PV profit than the EMV.