In recent years there has been a trend to increasing levels of probabilistic analysis when evaluating the expected returns from new investments in E&P assets. This trend has been most notable in the exploration area where the uncertainties and dollars at risk are large. There are many valid reasons why this trend makes sense and should lead to improved investment decisions. It is not my intention to re-examine these areas. Instead, I will focus on the reasons why probabilistic analyses are important from the portfolio perspective.
Modern portfolio theory has been around for over fifty years has been heavily applied in the financial world for at least the last thirty years. The central concept is that by a judicious choice of portfolio assets and “efficient” portfolio can be constructed in which, for a given mean portfolio return, the portfolio variance, or risk, is minimized. Over the past ten years there have been efforts to apply this concept to portfolios of E&P assets. I will show how this is done today for portfolios of E&P assets, and why the analysis and characterization of uncertainty are so important for good portfolio-level decisions to be made.