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Many exploration and production companies impose a risk threshold on major capital projects (one common such hurdle is a maximum acceptable probability of negative NPV). Projects which fail to meet the threshold are not usually rejected outright; rather, the project team is instructed to gather more information and perform more analyses, so as to reduce the range of economic uncertainty associated with the project. This wastes capital and decreases economic efficiency.

The usual stage at which risk tolerance is applied is the development phase of a project.Companies are comfortable with the notion of failed exploration wells, but not failed developments. Stringent probability-of-success hurdles often result.

Unless the failure of a single project could put a firm into financial distress, companies should be risk neutral when making decisions at the project level – i.e., they should make decisions based on the mean values of the economic metrics of interest (NPV, P/I, etc.) with no further consideration taken of the probability of success. Value-of-information (VOI) analyses should be used to determine when additional information or analysis adds value to a project and when it does not.

Risk tolerance should be applied at the portfolio level, not the project level. Projects are routinely delayed while unnecessary appraisal wells are drilled and analyses are conducted, thus eroding millions of dollars from the NPV of these projects. Correcting this issue will require a change in the way many project managers are evaluated and compensated, but the potential benefit to the companies – and the industry – is huge.

In a nutshell, the appropriate question is not, “Am I comfortable with the risk associated with this project?”; rather, it is, “Am I comfortable with the risk associated with my portfolio of projects when this project is included?”

Most decisions fall into one of four categories:

• Routine business decisions
• Non-routine business decisions
• Routine personal decisions
• Non-routine personal decisions

Routine decisions – whether business or personal – are easy. We make them without a lot of thought. Kahneman and Klein identified four criteria to be met in order to make a decision by instinct:

1. We have been in the situation numerous times before;
2. We got quick, reliable feedback on how good or bad our decisions were;
3. There are no strong emotions overriding our logic, and;
4. We’re relatively unbiased – i.e., our information is unbiased and our incentives align with those of the team or company.

If even one of these criteria is not met in a business situation, intuition needs help from a more structured decision-making process. This structure can be achieved by framing the problem correctly, generating creative alternative courses of action, and then evaluating those alternatives against one’s objectives while fully accounting for the uncertainty in the situation. Analysis of this type does not tell you what to do; rather, it gives you non-intuitive insight into the situation. Such insight can make the difference between success and failure in complex business decisions.

In complex personal decisions, David Brooks of the NY Times suggests a novel approach: flip a coin, but don’t simply follow the result of the coin flip. Rather, pay attention to how you feel when you look at the coin. Happy? Relieved? Distressed? This can tell you a lot about what your subconscious thinks about the situation. In emotional, personal decisions, your subconscious has often processed more information than your conscious mind has. Discovering these subconscious preferences can be very revealing and insightful.

In any situation where you need to make a critical decision, there is always some level of risk – whether you’re working on an internal reorganization or considering a multi-billion dollar acquisition – something unexpected can happen that significantly changes the course of events and the final outcome. But there are tactics that can be taken to minimize the potential downside, no matter how grand or simple the task at hand. Which leads to the question -- are you confident that you are prepared and have played out enough “What If” scenarios in your decision-making analysis? If not, consider these critical questions:

• Did you compile all the necessary data and conduct a proper analysis of what was presented?
• Did you and your team brainstorm and troubleshoot all the possible outcomes?
• Have you carefully considered all the possible unknowns?
• Do you have real experts involved – people that are truly knowledgeable about the potential events and conditions?
• Is your company using valid and reliable decision-management techniques?
• Are you just going with your gut or using general rules of thumb, rather than strategic analysis of the data, scenarios, and potential risks that have been determined?

These are just a few of the areas where it’s critical to dig, probe, ask questions, gather more data, and thoroughly consider every possible outcome and roadblock before making a decision and charting a path forward. But once you do, you will have the confidence and conviction that your decision – and your strategy – is tight, and the course of action selected is the right one.