If you’ve ever invested in a business that is based on probabilities, you know that the percentage of success isn’t always clear-cut. In fact, a 50% trade is like a coin flip: you have a 12.5% chance of making a successful trade if you make three consecutive ones. That said, it’s important to know that most investors opt for the 50% trade when the probability of success is 85% or higher.
Monte Carlo simulation is an excellent tool to illustrate risk. It involves running your financial plan through thousands of possible return paths to calculate the probability of success. Most financial advisers will incorporate this tool into your planning process. Monte Carlo simulations give you a better idea of the risks involved and prevent you from getting a false sense of security. But how do you know which investments are likely to bring you the highest returns? Here are some tips to help you calculate your probabilities.
For development wells, the probabilities of success should be 60-80% or more. This is because most operators will only drill development wells if they can generate enough production revenue to pay for the drilling, completion, and operating costs. To put it simply, the probability of success for development projects is the combination of geotechnical, operational, and economic risks. Investing in an incremental well without this minimum level of success is a waste of time.