Basic Principles of Probability

and Statistics

Lecture notes for PET 472

Spring 2012
Prepared by: Thomas W. Engler, Ph.D., P.E
Definitions

Risk Analysis
Assessing probabilities of occurrence for each possible
outcome
Risk Analysis
Probabilities and prob. distributions
Representing judgments about chance
events

Modeling
Geologic, reservoir, drilling
Operations, Economics

Decision criteria
EV, profit, IRR

Present to management for decision

Definitions

Sample Space
Complete set of outcomes
(52 cards)

Outcome
Subset of the sample space
(drawing a 5 of any suit)

Probability
Likelihood of drawing a 5
P(A) = 4/52
Definitions

Equally likely outcomes

Have same probability to occur

Mutually exclusive outcomes

The occurrence of any given outcome excludes the
occurrence of other outcomes

Independent events
The occurrence of one outcome does not influence the
occurrence of another

Conditional probability
The probability of an outcome is dependent upon one or
more events that have previously occurred.
Rules of Operation

Symbol Definition Expression

P(A) Probability of outcome A occurring

P(A+B) Probability of outcome A and/or B P(A+B)=P(A)+P(B)-P(AB)

occurring
P(AB) Probability of A and B occurring P(AB) = P(A) P(B|A)
P(A|B) Probability of A given B has
occurred.
Rules of Operation Addition Theorem

P(A+B)=P(A)+P(B)-P(AB)

Example
12
outcome A drawing 4, 5, 6 of any suit P ( A )
52

outcome B J or Q of any suit 8

P(B)
52
20
P(A B)
52 P(AB) 0

Mutually
A Exclusive
B events

Venn Diagram
Rules of Operation Addition Theorem

P(A+B)=P(A)+P(B)-P(AB)

Example
12
outcome A drawing 4, 5, 6 of any suit P ( A )
52

outcome B drawing a diamond 13

P(B)
52
22
P(A B) 3
52 P(AB)
52

A
B

Venn Diagram
Rules of Operation Multiplication Theorem

P(AB)=P(A)P(A|B)

Example
4
outcome A drawing any jack P( A)
52

outcome B drawing a four of hearts P(B | A) 1

on the second draw 51

4 1 1
P(AB) conditional
52 51 663

Sampling without replacement

- observed outcome is not returned
- series of dependent events
Rules of Operation Multiplication Theorem

P(AB)=P(A)P(B)

Example
4
outcome A drawing any jack, return P( A)
52

outcome B drawing a four of hearts 1

P(B)
on the second draw 52

4 1 1
P(AB)
52 52 676

Sampling with replacement

- observed outcome is returned to sample space
- series of independent events
Example
Example: Exploration example involving conditional probabilities
Decision: drill prospect or farmout and retain an override

Tabulated gross per-well reserves for existing wells

Percent of wells
EUR Number having these
Bcf of wells reserves
2 7 35% P(B|A)
3 7 35% These are conditional probabilities. That is,
4 4 20% given a well is productive there is a 35%
5 2 10% chance of producing 2 Bcf.
20

NPV for alternatives

EUR Drill option Farmout option

Bcf NPV, $ EMV, $ NPV, $ EMV, $
2 40000 14000 9000 3150
3 90000 31500 12500 4375
4 130000 26000 15000 3000
5 200000 20000 18000 1800
91500 12325
Example
Dry hole cost = 70000

Probability of finding gas, P(A) = 0.25

Apply multiplication theorem

Probability of finding gas and that reserves are 2 Bcf? P(AB)

Possible
outcome P(A) P(B|A) P(AB)
dry hole 0.25 0.7500
2 Bcf 0.25 0.35 0.0875 P(AB) = P(A) P(B|A)
3 Bcf 0.25 0.35 0.0875
4 Bcf 0.25 0.20 0.0500
5 Bcf 0.25 0.10 0.0250
1.0000

EMV calculations

Possible Drill well Farmout

outcome P(AB) NPV, $ EMV, $ NPV, $ EMV, $
dry hole 0.7500 -70000 -52500 0 0
2 Bcf 0.0875 40000 3500 9000 788
3 Bcf 0.0875 90000 7875 12500 1094
4 Bcf 0.0500 130000 6500 15000 750
5 Bcf 0.0250 200000 5000 18000 450
1.0000 -29625 3081
Example
Find minimum probability required to justify drilling, (ps)min

ps EMV EMV
drill farmout
0 -70000 0
0.25 -29625 3081

50000 (ps)min = 0.47

30000

10000

-10000 0 0.1 0.2 0.3 0.4 0.5 ps 0.6

EMV, $

-30000

-50000

-70000

-90000
Probability Distributions

A graphical representation of the range and likelihoods of

possible values of a random variable

Probability density function

Random variable

f(x), frequency
a variable that can have more
than one possible value, also
known as stochastic or deterministic

x, random variable

Useful method to describe a range of possible values. Basis

for Monte Carlo Simulation.
Probability Distributions Frequency distributions
Data Range frequency Percent
Well No Net pay, ft Divide into intervals 50 - 80 4 20%
1 111 Or bins 81 - 110 7 35%
2 81 111 - 140 5 25%
3 142 141 - 170 3 15%
4 59 171 - 200 1 5%
5 109 20 100%
6 96
7 124
8 139
9 89 Histogram representation
10 129 Of statistical data
11 104
12 186
13 65 8 40%
14 95 7 35%
15 54 6 30%
16 72
5 25%
frequency

17 167

Percent
18 135 4 20%
19 84 3 15%
20 154
2 10%
1 5%
0 0%
50 - 80 81 - 110 111 - 140 141 - 170 171 - 200

Net Pay, feet

Probability Distributions Cumulative frequency distributions

Range frequency Percent

minimum Cumulative
50 - 80 4 20% Range Percent
81 - 110 7 35% 50 0%
111 - 140 5 25% 80 20%
141 - 170 3 15% 110 55%
171 - 200 1 5% 140 80%
20 100% 170 95%
200 100%
maximum

100%

80%
Cumulative percent

Benefits
1. Can easily read probabilities 60%

2. Necessary for Monte Carlo 40%

Simulation
20%

0%
0 50 100 150 200

Net Pay, feet

Parameters of distributions

A parameter that describes central tendency or average of the distribution

Mean, m weighted average value of the random variable
Median value of the random variable with equal likelihood above or below
Mode value most likely to occur

A parameter that describes the variability of the distribution

Variance, s2 mean of the squared deviations about the mean
Standard deviation, s square root of variancedegree of dispersion of distribution about
the mean

A
sa<sb

ma=mb
Parameters of distributions Computing mean and standard deviation

Depth k,md f, %
4807.5 2.5 17.0
1. Arithmetic average of discrete sample data set 4808.5
4809.5
59
221
20.7
19.1
4810.5 211 20.4
4811.5 275 23.3
N 4812.5
4813.5
384
108
24.0
23.3

xi 4814.5
4815.5
147
290
16.1
17.2

m i 1
4816.5 170 15.3
N number of equally-probable values 4817.5
4818.5
278
238
15.9
18.6
N 4819.5
4820.5
167
304
16.2
20.0
4821.5 98 16.9
4822.5 191 18.1

N 2 4823.5 266 20.3

( x i m)
4824.5 40 15.3
4825.5 260 15.1
4826.5 179 14.0

s i 1
4827.5 312 15.6
4828.5 272 15.5
4829.5 395 19.4

N 4830.5
4831.5
4832.5
405
275
852
17.5
16.4
17.2
4833.5 610 15.5

m 17.6 4834.5
4835.5
406
535
20.2
18.3

s
4836.5 663 19.6
2.87 4837.5
4838.5
597
434
17.7
20.0
4839.5 339 16.8
4840.5 216 13.3
4841.5 332 18.0
4842.5 295 16.1
4843.5 882 15.1
4844.5 600 18.0
4845.5 407 15.7
4847.5 479 17.8
4847.5 139 20.5
Core porosity and permeability 4847.5 135 8.4
m 17.6
s 2.87
Parameters of distributions Computing mean and standard deviation

2. Values listed as frequencies in groups

nixi
i index to denote number of intervals
m i n frequency of data points in each interval
ni x midpoint value of each interval
i
2
n i ( x i m ) Porosity ni pi xi m s2

i interval frequency prob. midpoint mean deviation variance

s i 1 7 x < 10 1 0.024 8.5 0.202 85.342 2.032
ni 2 10 x < 12 0 0.000 11.0 0.000 45.402 0.000
3 12 x < 14 1 0.024 13.0 0.310 22.450 0.535
i 4 14 x < 16 10 0.238 15.0 3.571 7.497 1.785
5 16 x < 18 12 0.286 17.0 4.857 0.545 0.156
6 18 x < 20 8 0.190 19.0 3.619 1.592 0.303
7 20 x < 22 7 0.167 21.0 3.500 10.640 1.773
8 22 x < 25 3 0.071 23.5 1.679 33.200 2.371
42 1.00 m 17.74 s2 = 8.96
s 2.993

Applicable for large data sets

Results are approximate
Parameters of distributions Computing mean and standard deviation

3. Discrete probability distributions

x midpoint

m pi x i drilling costs probability of range

$M $M
EV
$M
xi*pi
$M
(x i-m)2
($M) 2
p(x i)(x i-m)
($M) 2
i 100.0 0
105.2 0.007 102.6 0.7 0.7 1641.3 10.7
111.5 0.040 108.4 4.3 4.5 1208.5 48.3
2 130.6 0.229 121.1 27.7 29.9 486.8 111.5
s p i ( x i m) 136.3
148.2
0.093
0.225
133.5
142.3
12.4
32.0
12.7
33.3
93.4
0.7
8.7
0.2
i 165.2 0.278 156.7 43.6 45.9 184.6 51.3
168.7 0.035 167.0 5.8 5.9 568.2 19.9
178.5 0.066 173.6 11.5 11.8 929.5 61.3
183.7 0.021 181.1 3.8 3.9 1443.0 30.3
190.0 0.007 186.9 1.3 1.3 1912.9 13.4
m 143.1 149.9 355.6
s 15.8 s 18.9

pi is the probability of occurrence of the xith value

of the random variable
Parameters of distributions Computing mean and standard deviation

4. Cumulative frequency distribution

x midpoint
drilling costs probability of range EV xi*pi (x i-m)2 p(x i)(x i-m)
2
$M $M $M $M ($M) ($M) 2
100.0 0
105.2 0.007 102.6 0.7 0.7 1641.3 10.7
111.5 0.040 108.4 4.3 4.5 1208.5 48.3
130.6 0.229 121.1 27.7 29.9 486.8 111.5
136.3 0.093 133.5 12.4 12.7 93.4 8.7
148.2 0.225 142.3 32.0 33.3 0.7 0.2
165.2 0.278 156.7 43.6 45.9 184.6 51.3
168.7 0.035 167.0 5.8 5.9 568.2 19.9
178.5 0.066 173.6 11.5 11.8 929.5 61.3
183.7 0.021 181.1 3.8 3.9 1443.0 30.3
1.0
190.0 0.007 186.9 1.3 1.3 1912.9 13.4
0.9
m 143.1 149.9 355.6
0.8
s 15.8 s 18.9
Cumulative probability

0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
100.0 120.0 140.0 160.0 180.0 200.0

Drilling Costs, $M
Types of distributions

Normal
Lognormal
Uniform
Triangle
Binomial
Multinomial
hypergeometric
Types of distributions Normal

Characteristics m

Define by m and s f(x)

Mode=mean=median s s
Curve is symmetric
x
Cumulative frequency graph is s shaped
Can normalize and obtain area (probability) under
the curve.
x m Cumulative frequency
t
s

x
Types of distributions Normal

Given a set of data how do you know whether it

is normally distributed?
Shape of curves
median = mean
Examples: porosity, fractional flow

m
Cumulative frequency
f(x)

s s

x x
Types of distributions Lognormal

mode
Characteristics median
m
Define by m and s f(x)

Modemeanmedian
Curve is asymmetric
x
Cumulative frequency graph exhibits rapid rise
Can transform to normal
variable by y=ln(x)
Cumulative frequency

x
Types of distributions Lognormal

Examples:
permeability
thickness
oil recovery (bbls/acre-foot)
field sizes in a play mode

median
m
f(x)

x
Types of distributions Uniform

Characteristics: f(x)

all values are equi-probable

specify min and max
allows for uncertainty min max x

used in Monte Carlo simulation

Cumulative frequency
100%

min max x
Types of distributions Triangle

Characteristics: f(x)

all values are equi-probable M, most likely

specify min and max

allows for uncertainty L, low H, high x

used in Monte Carlo simulation

Cumulative frequency
100%

min max x
Types of distributions Triangle

Convert to cumulative frequency plot:

normalize to a 0 to 1 scale: x' x L f(x)
HL
Define m as: ML M, most likely
m
HL

For x m, cumulative probability is given by:

L, low H, high x
2
( x )
P ( x )
m
For x > m,
2
(1 x )
P ( x ) 1
1 m

Types of distributions Triangle

Example f(x)
Estimated costs to drill a well vary from a minimum of $100,000
to a maximum of $200,000,with the most probable value at $130,000. M, 130

Convert the probability distribution to a cumulative

frequency distribution
L, 100 H, 200 x

x, random x' cumulative 1.0

variable normalized probability
(drilling costs) x 0.8
Cumulative probability

100 0.0 0.000

110 0.1 0.033 0.6
120 0.2 0.133
130 0.3 0.300 0.4
140 0.4 0.486
150 0.5 0.643
0.2
160 0.6 0.771
170 0.7 0.871
0.0
180 0.8 0.943
100 120 140 160 180 200
190 0.9 0.986
Drilling Costs, ($M)
200 1.0 1.000
Types of distributions Binomial

Describes a stochastic process characterized by:

1. Only two outcomes can occur
2. Each trial is an independent event
3. The probability of each outcomes remains constant over repeated trials
4. Binomial probability equation is given by:
n x nx
P( x ) C x p (1 p)
where
x = number of successes (0 x n)
n = total number of trials
p = probability of success on any given trial
and the combination of n things taken x at a time
n n!
Cx
x!(n x )!
Types of distributions Binomial

Example
Your company proposes to drill 5 wells in a new basin where the chance of
success is 0.15 per well
What is the probability of only one discovery in the five wells drilled?
What is the probability of at least one discovery in the 5-well drilling
program?
1.0
Number of P(x) Cumulative 0.9
0.8 Cumulative
discoveries P(x)
0.7
0 0.4437 0.4437
0.6
1 0.3915 0.8352
P(x)

0.5
2 0.1382 0.9734 0.4
0.3
3 0.0244 0.9978
0.2
4 0.0022 0.9999 0.1
5 0.0001 1.0000 0.0
0 1 2 3 4 5

Number of discoveries
Types of distributions Multinomial

Describes a stochastic process characterized by:

1. Any number of discrete outcomes
2. Each trial is an independent event
3. The probability of each outcomes remains constant over repeated trials
4. Multinomial probability equation is given by:

n! x1 x 2 xr
P( x1, x 2, ..., x r ) p1 p 2 ...p r
x1! x 2 !...x r !
where
r = number of possible outcomes
x1 = number of times outcome 1 occurs in n trials
x2 = number of times outcome 2 occurs in n trials
xr = number of times outcome r occurs in n trials
n = total number of trials
pr = probability of outcome r on any given trial
Types of distributions Multinomial

Example
Your company proposes to drill 10 wells in a new basin where the chance
of success is 15% per well
What is the probability of obtaining 7 dry holes, 2 fields in the 1-2 mmbbl
range and 1 field in the 8-12 mmbbl range?

outcome probability number of trials (wells) in program n= 10

range of
probability of dry holes x1 = 7
mmbbl outcome
1-2 0.08 probability of 1-2 mmbbl x2 = 2
2-4 0.04 probability of 2-4 mmbbl x3 = 0
4-8 0.02 probability of 4-8 mmbbl x4 = 0
8-12 0.01
0.150
probability of 8-12 mmbbl x5 = 1
probability
of dry hole 0.850 0.7%
Types of distributions Hypergeometric

Describes a stochastic process characterized by:

1. Any number of discrete outcomes
2. Each trial is dependent on the previous event (sampling without
replacement)
3. The probability of each outcomes remains constant over repeated trials
4. Hypergeometric probability equation for two possible outcomes:
d1 N d1
C C
P( x ) x n x
N
Cn
where
n=number of trials
di = number of successes in the sample space before the n trials
xi = number of successes in n trials
N = total number of elements in the sample space before the n trials
Cab = the number of combinations of a things taken b at a time.
Types of distributions Hypergeometric

Example
Our company has identified ten seismic anomalies of about equal size in a
new offshore area. In an adjacent area, 30% of the drilled structures were
oil productive.
If we drill 5 wells (test 5 anomalies) what is the probability of two
discoveries?

number_s a mpl e n= 5
number_pop N= 10
popul a ti on_s d1 = 3
s a mpl e_s x1 = 2

42%