# ArrowHead Solutions – Economic Modeling for Better Decision Making

## ArrowHead Solution Helps Clients Expand the Use of Cost-Supply Information for Improved Decision Making Using Economic Modeling under Uncertainty

The ArrowHead Solution for Probabilistic Resource Cost Quantification provides invaluable information needed by decision makers (e.g., corporate planners, investors, economists, and upstream developers) to make the right decisions – detailed knowledge of geological characteristics and uncertainties, well performance expectations, and resource cost fundamentals. This solution is a dramatic leap over what has been previously available to inform serious participants in energy markets.

To better inform decisions in the oil, gas, power, and NGL markets, decision makers want to analyze this information and carefully and completely understand what it implies for markets and in turn what those markets imply for their decisions. With a credible, accurate set of resource marginal curves spanning the continent and the world, how would you synthesize it and analyze what it implies for markets, commodity prices, basis differentials, and decisions? Ideally, you would like to have authentic, accurate **probability distributions** over oil, gas, power, and other commodity **prices** to guide your budgeting, capital investment, project and other decision making.

Decision makers’ need for a coherent and accurate probability distribution over market price is represented by the apex of the pyramid in Figure 1. To be useful and reliable, such probability distributions over price need to be derived from resource and market fundamentals, not from what is prevalent in the market place today (i.e., using arbitrary, nontransparent, judgmental, experiential, or extrapolative guesswork such as might be derived from a spreadsheet, volumetric study, or “study of studies.”) This probability distribution over price cannot be an arbitrary “smearing” of a single, reference point guess or a few sensitivity cases, nor should it be someone’s unaided volumetric guess of hydrocarbon in place (i.e., brown or tan splotches on a map). It should authentically combine and integrate the true uncertainties in the science and economics – the geology, the resource, the technology, the market, the players, their objectives, and their actions (including hedging). In terms of Figure 1, this probability distribution over price must be based on the two lower levels of the pyramid: (1) a comprehensive set of long run marginal cost curves for every resource in the world (the deliverables of the ArrowHead Solution for Probabilistic Resource Cost Quantification ) and (2) a comprehensive and accurate economic model that can process this cost curve data and other information.

ArrowHead provides the additional two elements depicted in Figure 1 – the middle and the upper part of the pyramid: a credible and time-tested model using a **methodology** backed by economic science and the science of probability that enables one to **utilize** the cost curve data of the ArrowHead Solution for Probabilistic Resource Cost Quantification to calculate bottom line price information. We are able to do this as a corollary and an add-on to the core offerings of this ArrowHead Solution (but not an intrinsic part of any offering).

Figure 1: Needs for Oil, Gas, and NGL Decision Making

The figure emphasizes two fundamental precursors to the “holy grail” of an authentic probability distribution over price, represented by the two lower levels of the pyramid in Figure 1:

**The lowest level of the pyramid is the primary focus of this solution**– assembling the fundamental probabilistic geological and cost data that drive the entire process in Figure 1. There is no substitute for comprehensive, accurate, and proper resource probabilistic data. No knowledge can be authentic or complete without the highest quality, most scientific, most knowledgeable work in the base of the pyramid – the fundamental geological and engineering cost information across the full range of the existing and prospective resource base. That is the focus of this solution.**The middle level of the pyramid (economic modeling methodology) utilizes the valuable lower-level information**in a way that credibly converts that information into probability distribution over price. This is no small feat and requires unique modeling capability:- Markets have extensive and complex structure (e.g. oil and gas wells, pipelines, storage, mines, transportation and transmission, power plants, and emissions). Our models accurately represent the full structure and the way all these elements interconnect.
- Each agent in the market seeks to maximize profit, so the market must be represented as the collection of independent agents that compose it. Agent modules must consider the investment, operation, and retirement decisions they would make under various conditions they face and select the decision that would result in the most profitable outcomes.
- Global markets are composed of myriad, interconnected regional markets and flows (e.g., gas, oil, electricity and coal). The model must therefore accurately represent existing and prospective interconnection of regions. ArrowHead does so using a global oil-refining/light duty vehicle/product model (ArrowHead Global Oil Model) for oil and a global production/field processing/pipeline/LNG/distribution/consumption model (ArrowHead Global Gas Model) for gas. Each of these models comprises a large and comprehensive representation of the world and every region that composes it.
- There are many significant market uncertainties and key events (events or changes in market structure that affect prices and volumes). As a result, our model must have (and does) the ability to easily vary potentially important assumptions. The models allow many combinations of different assumptions regarding potential drivers and allow full individual and joint consideration of probabilistic variables.
- The many different events have different probabilities. The model must enable easy application of probabilities to events, creating not just single price streams but probability distributions over price (and quantity) over the time horizon of the analysis (from 0 to 50 years).
- Fundamental economic modeling requires the application of sound economic science and probability theory. This is non-trivial given the complexity and interconnectivity of the markets. Using “junk economics” or “junk probability” simply won’t produce reliable results.
- To have confidence in the model results, decision makers must be able to see easily and understand the model methodology and be able to see easily and adjust the model structure, data, and assumptions. Transparency and customizability are absolute musts.

ArrowHead’s Global Gas and Global Oil Models uniquely meet these requirements. They are probabilistic, multiagent market models that can utilize the valuable information of this solution as input to produce the authentic probability distributions over the price for each commodity. These distributions are the key inputs to understanding and analyzing decisions.

If you are interested in processing this solution’s interim or final results, i.e., interim or final resource information, through our models, ArrowHead is able to provide these services on an individual client basis. ArrowHead can run the models using our assumptions or yours; provide you the distributions over price; and utilize them to analyze your decisions and make recommendations. Alternatively, we can make the models and data available to individual requestors. These services are not included in the deliverables of the ArrowHead Solution for Probabilistic Resource Cost Quantification but as an additional option. If you are interested in discussing these services please contact us.