Prospect risk, pot odds and efficient drill or no-drill decision making: what the exploration business can learn from high stakes poker

Abstract

A decision to proceed with risk ventures, such as exploration wells, requires three basic estimates: the cost, if the venture fails; the reward, if the venture succeeds; and the chance of success (risk). These three estimates are combined to derive the Expected Value and Expected Rate of Return, which are important inputs to go/no-go decisions. However, while cost and reward are seen as relatively “hard” numbers, based on measurable quantities and established price forecasts, risk is commonly seen as a “soft” number, an opinion based on incomplete knowledge. Decisions may be deferred, seeking more constraint on the risk estimate; this delay can be counterproductive. An alternative approach is used by professional poker players to make an equivalent decision. In that business, too, the chance of winning is harder to constrain than the cost and reward. Instead of seeking to fine-tune the risk, players compare a rough estimate of chance against “Pot Odds”, an easily-calculated number (the chance of winning needed to break even), and use this comparison to make the right decision efficiently.

This approach can also be used in the exploration business. Pot Odds of a prospect can be calculated using expected dry hole costs and the predicted value of a discovery. comparison with the estimated chance of success may indicate whether we already have enough information to make the appropriate decision, or whether further work is justified. This may improve business decision making efficiency or provide a sense check on decisions already made.

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