An improved portfolio optimization model for oil and gas investment selection

For oil company decision-makers, the principal concern is how to allocate their limited resources into the most valuable opportunities. Recently a new management philosophy, “Beyond NPV”, has received more and more international attention. Economists and senior executives are seeking effective alternative analysis approaches for traditional technical and economic evaluation methods. The improved portfolio optimization model presented in this article represents an applicable technique beyond NPV for doing capital budgeting. In this proposed model, not only can oil company executives achieve trade-offs between returns and risks to their risk tolerance, but they can also employ an “operational premium” to distinguish their ability to improve the performance of the underlying projects. A simulation study based on 19 overseas upstream assets owned by a large oil company in China is conducted to compare optimized utility with non-optimized utility. The simulation results show that the petroleum optimization model including “operational premium” is more in line with the rational investors’ demand.