160

Int. J. Services Operations and Informatics, Vol. 6, Nos. 1/2, 2011

Decision-making process for project portfolio

management
Fateh Belaid
CNRS/UMR 7218 LAVUE,
ENSA PARIS,
3-15 Quai Panhard et Levassor,
75013 Paris, France
Email: fateh.belaid@paris-valdeseine.archi.fr
Abstract: The purpose of this paper is a quantitative study of the risk
surrounding the main problem of investment decision making in project
portfolio selection. The primary objective is to provide managers with a
decision support tool allowing them to choose carefully their investment
strategies and reduce risk of failure. The developed computer model consists of
three major modules. The first module calculates projects cash-flow using a
deterministic method. The second module calculates expected after tax net cash
flows and estimates performance indicators for each realisation, thus yielding
distribution of return for each project. The third module selects a set of projects
(portfolio) using their covariance and semi-covariance matrix. In summary,
we will define a selection model for portfolio management of investment
projects that will not only take into account risk, but also the effect of the
interdependence of projects. The model will be applied to a portfolio of
projects in petroleum upstream.
Keywords: project management; decision making; portfolio optimisation;
risk analysis; Monte Carlo simulation.
Reference to this paper should be made as follows: Belaid, F. (2011)
Decision-making process for project portfolio management, Int. J. Services
Operations and Informatics, Vol. 6, Nos. 1/2, pp.160181.
Biographical notes: Fateh Belaid is currently a postdoctoral fellow at the
Habitat Research Center, part of National Center for Scientific Research
(CNRS), UMR 7218. He received his PhD in economics and management
from the University of Littoral Cte dOpale. His research focus is on decision
theory, risk analysis, and portfolio project management.

Introduction

1.1 Context
In the capital-intensive industries, a firm will normally invest in a portfolio of investment
projects rather than in a single project. The problem with investing all available funds in
a single project is, of course, that an unfavourable outcome could have disastrous
consequences for the company. In general, the funds are not sufficient to support all
available investment opportunities. So the selection of portfolio projects is important.
Copyright 2011 Inderscience Enterprises Ltd.

Decision-making process for project portfolio management

161

The selection process objective is to choose a subset of projects that maximises

profits (objective) of the company while respecting the budget restriction (constraints).
However, in addition to all the above considerations, the company should follow a
strategy to ensure better returns with minimal risk.
Premium evaluation criteria in investment are necessary in each step of the decision.
However, the important question that needs to be answered in this research is the
following: how shall we use the portfolio optimisation approach to make the strategic
investment decision as easy as possible from a practical point of view?
Turner (1992) defines investment as follows: An endeavour in which human,
material and financial resources are organised in a novel way, to undertake a unique
scope of work of given specification, within constraints of cost and time, so as to achieve
unitary, beneficial change, through the delivery of quantified and qualitative objectives.
This definition highlights the changes brought about by the nature of projects, the
need to organise a variety of resources subject to significant constraints, and the central
role given to defining the objectives of the project. Turner also suggests paying special
attention to uncertainties inherent to the new organisation as a central element of
effective project management. The competitiveness of a firm especially in the capitalintensive industries is highly dependent on a stream of successful and profitable projects.
Economic analysis of the potential profitability of projects is thus an important task
that demands efficient methods for evaluation and selection of projects.
For example, in the petroleum industry, the exploration and development of an oil
field face many unknowns uncertainties associated with yields and costs throughout the life
cycle of the project: capital expenditure (Capex), the operating costs (Opex), the production
rate, the oil price (and gas), the rate of geological success and train of expenditure,
particularly for sub-sea wells (the offshore projects). With all these uncertainties it is
extraordinarily difficult to forecast profits and cash flow, for even the simplest prospects.
The economic risk of petroleum projects is essentially linked to the economic environment.
In particular, the evaluation of the profitability of investments is based primarily on
scenarios of oil prices, so that the latter is the main determinant of income.

1.2 Motivations
Project portfolio management is a complex decision-making process involving the
unrelenting pressures of time in cost. This decision-making process is affected by many
critical factors such as the market conditions, raw materials availability, probability of
technical success and government regulations. The problem of project selection was
first developed in the field of engineering economy (DeGarmo and Canada, 1973). The
problem has been given full attention in engineering management (Martino, 1995;
Jafarizadeh and Khorshid, 2008; Wang et al., 2009).
The traditional approach considers corporate projects as being independent of each
other. Yet, the relations and correlation between projects within the uncertain environment
have been recognised as a major issue for corporations. Therefore, research in this field
has recently shifted towards project portfolio management (Jonas, 2010; Laslo, 2010).
The present paper focuses on the new project management approach.
For the petroleum industry, the development of the collection and analysis of seismic
data significantly reduced the risk of undiscovered oil. The geology and geophysics
resultant (G&G) have revolutionised oil and gas exploration. Decision analysis has
traditionally been applied to information derived from G&G for ranking projects hole by

162

F. Belaid

hole, determining on an individual basis whether they should be explored and developed.
This hole-istic approach is being challenged by a holistic one that takes into account the
entire portfolio of potential projects as well as current holdings. For Ball and Savage
(1999), this portfolio analysis starts with representations of the local uncertainties of the
individual projects provided by geology and geophysics. It then takes into account global
uncertainties by adding two additional Gs: geo-economics and geopolitics, thereby
reducing risks associated with price fluctuations and political events in addition to those
addressed by traditional G&G analysis.
This paper presents comments and some background on the use of risk analysis
methods in the selection of investment projects. We apply variant models of Modern
Portfolio Theory to determine the efficient project portfolio that maximise the expected
profit while simultaneously minimising risk. Our approach is generic while particular
attention is given to applications developed for exploration and production projects
selection.
Portfolio optimisation is a methodology from finance theory for determining the
investment programme that gives the maximum expected value for a given level of risk
or the minimum level of risk for a given expected value. In his seminal paper published
in 1952 in the Journal of Finance, Nobel laureate Harry Markowitz laid down the basis
for modern portfolio theory (Markowitz, 1952a). Markowitz focused the investment
professions attention on mean-variance efficient portfolios and opened the area of
modern investment theory. The methodology of the model presented in this paper is
derived from two sources: decision analysis and portfolio theory.

1.3 Contributions
The main contributions of this paper are as follows:
1

The model proposed illustrates how modern portfolio theory provides management
with a superior setting for allocating capital by illuminating risk at the portfolio
level. This method, contrary to the classical selection methods, analyses the projects
by considering the various aspects of the risk and the various correlations existing
between the projects.

The scenario method is proposed for the assessment of crude oil price volatility.

The proposed method is flexible in terms of input data and output results and simple
to implement.

The rest of the paper is organised as follows: Section 2 presents the state of the art
dealing with project selection and portfolio management. Section 3 details the proposed
model. Section 4 presents the details of the model with an illustrative example. Section 5
deals with the results of the proposed project selection example. Section 6 concludes the
paper.

Literature review

The problem of project selection was first introduced in the field of engineering
economy. According to Bussey (1978), the early practitioners had to consider the
problem of selecting the economic choice between executable alternative solutions. This

Decision-making process for project portfolio management

163

approach considers corporate projects as being independent of each other. Jafarizadeh

and Khorshid (2008) stated that the field of industrial project selection was born by
the introduction of the question: What is the best for the firm, overall?. This field is
concerned with the act of project selection in the context of firm. Now, the problem has
been given full attention in engineering management. Featured as a process of strategic
significance, Dey (2006), Corvellec and Macheridis (2010) and Mantel et al. (2008)
defined project selection as the process of evaluating individual projects or groups of
projects and then choosing to implement a set of them so that the objectives of the parent
organisation are achieved.
Mohanty (1992) classified the criteria influencing project selection into two categories:
intrinsic and extrinsic. Kaplan and Norton (2001) confirmed the importance of project
selection by stating that a critical component for linking strategy to short-term actions is
opting for new initiatives. Several methods have been proposed to help organisations
make good decisions for project selection problem (Anadalingam and Olsson, 1989;
Wang et al., 2009).
In the field of the petroleum industry, decision analysis was first applied to E&P
projects by Allais (1956) with his study of the economic feasibility of exploration in the
south of Algeria. There were several further attempts to apply decision analysis to
petroleum upstream by Grayson (1960), Krumbein and Graybill (1965) and Drew (1967).
These concepts have been popularised by Cozzolino (1977), Harbaugh and McDonald
(1984), Harris (1984, 1990), Newendorp and Schuyler (2000), etc. Cozzolino (1977)
used an exponential utility function in the determination of future cash flows of an oil
exploration project to express the certainty equivalent, which is equal to the expected
value less compensation risk, called risk premium. Another important contribution was
made by Walls and Dyer (1996). Walls incorporated the Multi-Attribute Utility Theory
Approach in the selection process for upstream projects. This approach provides a rich
insight into the effects of the integration objectives of the oil companies and the analysis
of risk in investment choices. Walls and Dyer (1996) used this approach to study changes
in the propensity of risk depending on the size of companies in the oil industry.
The evolution of quantitative analysis of the portfolio began in the 1950s, with the
revolutionary work of Markowitz (1952a), who popularised the idea that increasing
returns implies increased risk. Markowitz developed the mathematical basis and
consequences of this analysis in his thesis in 1954. Sharpe (1964) extended and
developed the work of Markowitz, with his model of asset pricing (CAPM: Capital Asset
Pricing Model), while Modigliani and Merton (1958) presented another important
contribution to the theory of values assessment. In the early 1970s, Black and Scholes
(1972) and Merton (1973) determined the principle of rational evaluation of stock
options. Since then, several studies have been conducted in this area.
Hertz (1968) discussed the application of the portfolio theory model to risky
industrial projects with respect to the way it is used in the financial market. In 1983, Ball
and Savage presented an application of decision analysis to the management of risk and
return in petroleum exploration. Since 1990, these two authors have collaborated on a set
of models to meet the needs of certain companies. This has helped to refine the method
and to facilitate its application to E&P projects (exploration and production). In addition,
in 1997, the Earth Observatory Lamont-Doherty of Columbia University has founded a
consortium of oil companies to share knowledge in E&P project portfolio analysis based
on Ball and Savage (1999) models, Holistic vs. Hole-istic E&P Strategies. This model
remains one of the most popular in the area of E&P project management. Since then,
several studies have been conducted in this direction (e.g. Walls, 2004; Erdogan et al.,

164

F. Belaid

2001). The original idea is that a portfolio may be worth more or less than the sum of its
component projects, and there is not a better portfolio, but a family of optimal portfolios
that allow for achieving a balance between risk and return. Jafarizadeh and Khorshid
(2008) proposed a method of project selection based on capital asset pricing theories in
framework of mean semi-deviation behaviour.
The research work presented in this paper shows the importance of the use of the
Modern Portfolio Theory in project portfolio management. The proposed model includes
a methodology to improve the quality and efficiency of the decision-making process of
project portfolio management.

Proposed model

The process we use to optimise the exploration or production projects portfolio is an

integrated economic model. Implementation of this process involves three basic steps
focused on three main stages:
1

Individual evaluation of each project by using the deterministic method to evaluate

the cash flows of oil exploration projects or production projects.

Applying Monte Carlo simulations for the assessment of projects economic risk.

Building a portfolio optimisation model for the selection of the optimal portfolios.

The construction and operation of the model are summarised in Figure 1.

Figure 1

Model flow of optimisation process

Project Evaluation

Evaluation of every individual project using

deterministic approach for the determination of the
main decision criteria: NPV.

Monte Carlo Simulation

A Monte Carlo simulation of the joint economic

outcomes of the projects is run for risk
assessment, based on the local uncertainties (geoscience), and the global uncertainties (geoeconomics and geo-politics). The statistical
dependence between projects must be preserved.

Optimisation Process

An optimisation of linear/quadratic program for all

the projects to find the optimal capital allocation to
each project. In such ways that return is
maximised for a certain level of risk.

The aim is to obtain an optimal rate of investment for each project to maximise the total
return of the portfolio taking into account the various risks and the constraints of the
company. To do this, we compare two methods: a model inspired by Modern Portfolio
Theory method with the variance as a risk measure and a model inspired by Modern
Portfolio Theory method with the semi-variance as risk measure.

Decision-making process for project portfolio management

165

We apply this process to a real problem of project evaluation and selection. The
selected projects for our problem are a group of 14 real petroleum projects. The decision
problem is: which ones of the mutually exclusive projects are the best for the company
considering their risk and return?

3.1 Deterministic evaluation

The first step in evaluating a project is to create a scenario of the baseline situation and
calculate the indices of efficiency. The main indices used to estimate the investment
projects are described in Table 1.
Table 1

Main indices of project profitability

Index
Net present
value
(NPV)

Meaning of index
Excess of the total cash
income over the total
expenditures for the
given project with
regard for discounting
Internal rate Positive number IRR
of return
such that for the
(IRR)
discount rate E=IRR the
net discount income of
the project vanishes, for
E>IRR is negative, for
E<IRR is positive
Payback
Time from the beginning
period
of project realization to the
(PB)
instant when the current
discounted net income
becomes nonnegative
and remains so

Profit index
(PI)

Criterion for positive

estimation of the index Calculation algorithm
T
NPV > 0
R ( t ) C (T )
NPV = K +
t
t =1
(1 + E )

IRR > E

K +

R ( t ) C (T )

(1 + IRR )

t =1

=0

IRR is the positive root

of equation
PB T, T is the time
of diversion of
investment resources
acceptable for investor

Ratio of the sum of

PI > 1
discounted cash inflows
to the sum of discounted
cash runoffs, shows the
relative increment of NPV

Minimum time T beginning

from which observed in the
equality
T

t =1

R ( t ) C (T )

(1 + E )

t =1

Kt

(1 + E )

T R ( t ) C (T )
t =1

(1 + E )

PI =
K

Source: Karibskii et al. (2003)

In our case we use Net Present Value (NPV), the most popular index used in discount
cash flow project evaluation. This assumes that the values of input parameters are known,
namely:

the nature of oil in place

the production of year t, noted Pit

oil prices for year t, noted Pricet

the capital expenditure, noted Capexi

the operating cost, noted Opexi

the tax of year t, noted Taxest.

166

F. Belaid

In our case we used the following formula:

( P Price Capex Opex Taxes )

=
n

NPVi

t =1

it

1 + ( r + p ) + ( r p )

with r = the discount rate and p = inflation rate.

A positive Net Present Value means that the investment increases the companys
value. A negative Net Present Value means that the investment reduces the value of the
company, and the productivity is lower than the cost of capital. A positive NPV will lead
to the acceptance of the project and a negative NPV will cause its dismissal.
To calculate the NPV, we need to know the cost of the capital. The determination of
the discount rate is a critical element of economic calculation. The estimation of a
suitable discount rate is often the most difficult and uncertain part of a DCF (Discount
Cash Flow). This is only worsened by the fact that the final result is very sensitive to the
choice of discount rate a small change in the discount rate causes a large change in the
value.
The concept behind the cost of capital is simple: the compensation of providers of
capital for (a) the time value of money and (b) the risk that they agree on the expected
cash flows (not materialised as expected). Obtaining an estimation of a necessary
compensation is not so simple. This is because to estimate the cost of capital, we have to
estimate the risk of the project and necessary performance to offset this risk.

3.2 Stochastic evaluation

The simulation allows analysts to describe the risk and the uncertainty of variables that
influence the profitability of the project with the help of probability distributions.
Examples of uncertain variables in petroleum industry are the reserves, the drilling costs,
the crude oil price, etc.
The first objective of the use of simulation in the evaluation of investment project
is to determine the distribution of the NPV from the variables that affect project
performance, resulting in its average or the Expected Net Present Value.
The current situation in the oil industry is that we do not know the exact values of the
parameters. But if we can describe the interval and the possible values of each random
variable, we can use simulation to generate the distribution of the resultant NPV. The
idea is that, from a simple equation, we can use the model of the project as an equation
for the NPV.
We performed a stochastic assessment for each project using the Monte Carlo
simulation. First, we determine the distributions of input parameters (Production, Capex
and Opex) and secondly we estimate the distribution of the output parameter which is
the NPV for our case, from the Monte Carlo simulation. From this we calculate the NPV
and average variance. Finally, we retrieve the data from the simulation to calculate the
correlation between projects, then the matrices of variance-covariance and semicovariance which can be used in an optimisation model.
We can summarise the process of Monte Carlo simulation conducted in three main
steps, as follows:

Decision-making process for project portfolio management

167

Step a: Creation of a distribution for each input parameter: first we must identify the
main risk factors, which are here production, opex, capex and assess their distributions
using the historical values and the expert judgements. In our example distributions
allocated to the main variables are:
1

Production: log-normal distribution (see Figure 2).

Capex (investment): triangular distribution (see Figure 3).

Opex (operating costs): triangular distribution (see Figure 4).

Recall that these distributions are frequently used in the petroleum industry, e.g. (Rose,
1987; Orman and Duggan, 1998; Rodriguez and Oliveira, 2005).
Step b: Generation of a Monte Carlo simulation with 5000 trials.
Step c: Recording the results of the simulation (the distribution of the expected NPV, the
average of the NPV, its variance). Figure 5 shows the results of one particular projects
Monte Carlo simulation.
Figure 2

Distribution of production

Figure 3

Distribution of investment costs

168

F. Belaid

Figure 4

Distribution of operating costs

Figure 5

Probability distribution of project 1 and its statistics

In the current context (the high volatility of crude prices), it is difficult to detect a longterm relationship that can describe the evolution of prices. Consequently, the forecasting
model will fail, knowing that petroleum projects have a long duration (530 years). To
overcome this problem, in calculating the NPV, the ideal would be to imagine a few price
scenarios (three) taking into account all factors of the current economic climate, and
possible future changes (continuously increasing the global demand, possible depletion
of reserves, discovery of new deposits, possible arrival of a new energy, etc.).

Decision-making process for project portfolio management

169

For our problem of the project portfolio evaluation, we use three different scenarios
for the crude price: a low price, an average price and a high price scenario. From these
scenarios, we build four models:
Model 1: This model corresponds to the low price scenario. This scenario assumes a
soft landing. The growth of world oil demand is slowing sharply because of
the transition to alternative energy, and oil prices fall to an average price of
$25/barrel.
Model 2: This model corresponds to the scenario of an average price. This scenario is
based on a continuity of supply of crude oil. Global demand remains strong
but begins to slow down. The price of a barrel of crude sells at around
$100/barrel.
Model 3: This model corresponds to the scenario of a high price. This crisis scenario
provides that the supply will be disrupted by terrorist attacks or political
unrest, and it will no longer be able to meet demand. Crude price increases to
$200 per barrel.
Model 4: a mixed model where we assign a subjective probability of occurrence of the
three price scenarios:

the price $25 per barrel with a probability of 0.2

the price $100 per barrel with a probability of 0.4

the price $200 per barrel with a probability of 0.4.

In the latter scenario, we calculate, for each project, the NPV for the three price scenarios.
Then, we calculate the expectation of NPV taking into account the probabilities of occurrence
of the three scenarios.

Optimisation and selection of optimal portfolio

Since the seminal work of Markowitz (1952a, 1952b), mathematical analysis on portfolio
management has grown considerably. Variance has become the most popular mathematical
definition for the risk of portfolio selection. Markowitz shows how rational investors can
construct optimal portfolios under conditions of uncertainty. The mean and variance of a
portfolios return represent the benefit and risk associated with the investment. Several
researchers have developed a variety of models to handle risk using variance as risk
measure, e.g. Chopra and Ziemba (1998), Chow and Denning (1994) and Hlouskova (2000).
Variance is a useful measure of risk. In calculating variance, positive and negative
deviations from the mean are equally weighted. In fact, decision-makers are often more
pre-occupied with downside risk the risk of failure. A solution to this problem is to
determine the efficient set of portfolios by using another risk measure. Semi-variance
overcomes this problem by measuring the probability and distribution below the mean
return. Several models have been developed by using semi-variance as risk measure, e.g.
Homaifar and Graddy (1990), Huang (2008), Grootveld and Hallerbach (1999),
Markowitz et al. (1993), etc. In the mean downside risk investment models the variance
is replaced by a downside risk measure, then only outcomes below a certain point
contribute to risk.

170

F. Belaid

For our problem, a portfolio optimisation was conducted for our group of 14 petroleum
upstream projects under risk consideration, resulting in an efficient frontier. In this case,
risk was measured by the variance as calculated across Monte Carlo simulation. In this
model the objective function is a linear combination of net present value against risk
(variance).

4.1 Notations
For indices, we use, i and j to denote the different E&P projects and t for the years.
We used the following two sets:
N: the total number of projects (14 in our application)
E: the set of specific projects (5 in our application)
ENPVi: the expected return of project i
ij = coefficients of the covariance matrix defined for the NPV of projects i and j
(given by the Monte Carlo simulation)
ij = coefficients of the semi-covariance matrix for the NPV of projects i and j
(given by the Monte Carlo simulation)
Ri = reserves of project i for year t
Pit = production of project i
Ii = investment of project i
Pmin t = minimum targeted production for year t
Rmin = minimum reserves required from the selected portfolio (500 million barrels
in our example)
Imax = total capital available to investment (5000 $MM in our example)
= capital enrichment for the selected portfolio
min = the desired level of return for the selected portfolio (900 $MM in our example)
= coefficient reflecting the risk aversion factor of the investor (0 1)
= the minimal fraction of the total investment allocated to exploration product (20%)

4.2 Optimisation model with variance as risk measure

The decision variables are simply Xi, i = 1, 2,, n; the fractions of the project i
invested in the portfolio. We suppose that we can participate in all projects at any level
(thus 0 Xi 1). The model of optimisation with variance as risk measure is written
below:
Model: Max (NPVVAR)
N

Max Z1 = (1 ) X i ENPVi X i X j ij
i =1

i =1 j =1

Decision-making process for project portfolio management

171

Under the constraints: i = 1...N ; t = 2013...2017

0 Xi 1
N

X
i =1

I i I max

Ri Rmin

ENPVi min

X
i =1
N

X
i =1

X i Ii X i Ii 0
i =1

i =1,iE

X
i =1

Pit Pmin t

Its a quadratic model maximising the objective function (return risk). For each value
of , we determine the value Xi (fraction of each project invested in the portfolio) and the
corresponding portfolio return and risk. The latter are elements of the efficient frontier.
We get the efficient frontier point by point by solving this problem for different values of
. The values of are shown in Table 2.
Table 2

Risk aversion coefficients used in the optimisation process

10

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

11

12

13

14

15

16

17

18

19

20

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

4.3 Optimisation model with semi-variance as risk measure

Variance penalises both extreme gains and extreme losses. In contrast, semi-variance
stimulates the selection of projects with a probability of returns below a critical value like
the expected return. Therefore, we propose a new portfolio optimisation model with
semi-variance as risk measure. Each portfolio in the frontier represents a set of projects
satisfying minimum levels of production, tolerable operational and maintenance costs,
precedence relations between projects, and a limited budget.
Likewise, according to prospect theory (Tversky and Kahneman, 1991), investors see
a loss as riskier than a gain of the same amount, which contradicts the use of variance
when extreme potential gains and losses are equivalent (Choobineh and Branting, 1986).
Semi-variance overcomes this problem by measuring the probability and dispersion
below the mean value. In accordance, the optimisation framework is now modified to
minimise semi-variance (instead of variance) for a given expected NPV.

172

F. Belaid

The model of optimisation with semi-variance as risk measure is written below:

Model: Max (NPVSVAR)
N

Max Z1 = (1 ) X i ENPVi X i X j ij
i =1

i =1 j =1

Under the constraints: i = 1...N ; t = 2013...2017

0 Xi 1
N

X
i =1

I i I max

Ri Rmin

ENPVi min

X
i =1
N

X
i =1

X i Ii X i Ii 0
i =1

i =1,iE

X
i =1

Pit Pmin t

Computational results and analysis

Economic evaluation models were created for each project in Excel file models and
evaluated under concession contracts. For simulation, we use the latest version of Crystal
Ball software version 7.3 (Charnes, 2007). The resolution of the different quadratic
optimisation models under Markowitzs method is obtained using GAMS software
(Brook et al., 1992).
As in Markowitz et al. (1993), we compute the portfolios semi-variance as follows:
N

SVi =
t =1

( NPVi ENPVi )

Si NPVi < ENPVi

The semi-covariance between projects is defined as follows:

N N min ( NPV ENPV , 0 ) min ( NPV ENPV , 0 )
i
i
j
j

S ij =
N
i =1 j =1

We only present the results of semi-variance model.

Scenario 1 (oil price of $25/barrel): By using the semi-variance as a risk measure, we
get 8 optimal portfolios. The portfolio P1 is the riskiest with a semi-variance of
1950.16 and a return of $1 336.04 million. P8 is the safest portfolio with a
semi-variance of 908.11, a return of $1000 million, and an investment of
$3874.90 million. The efficient frontier is presented in Figure 6. We notice that

Decision-making process for project portfolio management

173

this frontier is different from the one obtained with the use of the variance as
the measure of the risk. For a similar return we have a lower risk. It is due to
the fact that the semi-variance considers returns below the mean as risk,
contrary to the variance which does not distinguish between the returns below
and above the mean.
Scenario 2 (oil price of $100/barrel): The application of the method of Markowitz with
the semi-variance as risk measure provides 19 optimal portfolios for this
scenario. P1 is the riskiest portfolio with a semi-variance of 29,136, an output
of $13,326.95 million and an investment of $5000 million, while P19 is the
least risky portfolio with a semi-variance of 1938.45 and an expected NPV of
$3913.17 million and one investment of $1938.45 million. The efficient
frontier is presented in Figure 7.
Scenario 3 (oil price of $200 /barrel): The use of the semi-variance as the measure of
the risk on this scenario gives us 19 optimal portfolios with compositions close
to those obtained with the use of the variance. P1 is the riskiest portfolio
with a semi-variance of 97,956.37, a $29,489.20 million dollar return and a
$5000 million dollar investment. P19 is the safest portfolio, with a semivariance of 4927.53, a NPV of $8721.27 million, and an investment of
$1947.04 million. The efficient frontier is presented in Figure 8.
Scenario 4 (average NPV): This average scenario, gives us 19 optimal portfolios. Their
compositions are different from those obtained with the variance as risk
measure. On the other hand, the returns are close. P1 is the riskiest portfolio
with a semi-variance of 49,882, a NPV of $17,367 million, and an investment
of $5000 million (it is the same portfolio obtained with the classic method).
P19 is the least risky portfolio with a semi-variance of 2484, a NPV of
$5116 million, and an investment of $1952 million. This last portfolio reduces
the risk by 95% and the investment ($3047 million) by 60% with a loss of
70% return ($12,250 million). The efficient frontier with the average NPV is
presented in Figure 9. The results are presented in Table 3.
Figure 6

Efficient frontier for a price of $25/barrel

174

F. Belaid

Figure 7

Efficient frontier for a price of $100/barrel

Figure 8

Efficient frontier for a price of $200/barrel

Figure 9

Efficient frontier for the average price

5000

0.48

EXP1

EXP2

EXP3

EXP4

EXP5

EXP6

EXP7

EXP8

EXP9

EXP10

EXP11

EXP12

EXP13

EXP14

49,882.68

SV

Invest.

17,367.52

ENPV

P1

(1)

P2

0.25

0.89

0.51

5000

49,159.39

17,354.58

(2)

P3

0.87

0.84

0.84

0.56

5000

44,519.56

17,227.81

(3)

P4

0.74

0.95

0.92

0.67

5000

41,114.29

17,107.88

(4)

P5

0.67

0.9

0.98

0.76

4997.72

39,710.58

17,042.59

(5)

P6

0.62

0.89

0.84

5000

39,033.49

17,003.71

(6)

P7

0.57

0.83

0.08

0.95

0.07

0.82

5000

36,883.01

16,852.48

(7)

P8

0.52

0.78

0.17

0.89

0.96

0.17

0.79

5000

34,953.47

16,696.74

(8)

P9

0.49

0.74

0.23

0.84

0.93

0.24

0.77

4998.775

33,639.24

16,575.12

(9)

P10

0.46

0.71

0.97

0.29

0.81

0.91

0.3

0.76

5000

32,011.03

16,401.37

(10)

Table 3

Portfolio

Decision-making process for project portfolio management

175

Scenario 4 (average NPV)

5000

0.72

0.48

0.84

0.7

0.45

0.62

0.62

0.38

EXP1

EXP2

EXP3

EXP4

EXP5

EXP6

EXP7

EXP8

EXP9

EXP10

EXP11

EXP12

EXP13

EXP14

SV

Invest.

15,173.86

23,009.34

ENPV

P11

(11)

P12

0.34

0.58

0.44

0.53

0.65

0.81

0.58

0.71

0.92

5000

19,842.74

14,514.57

(12)

P13

0.26

0.47

0.89

0.26

0.51

0.88

0.52

0.67

0.56

0.6

0.66

4329.14

13,271.2

12,105.1

(13)

P14

0.17

0.3

0.58

0.17

0.32

0.97

0.57

0.33

0.43

0.36

0.38

0.43

2963.77

6060.44

8,340.04

(14)

P15

0.11

0.2

0.39

0.11

0.21

0.64

0.74

0.38

0.22

0.29

0.24

0.26

0.29

2020.513

2802.75

5721.47

(15)

P16

0.11

0.2

0.33

0.08

0.22

0.54

0.73

0.34

0.21

0.31

0.25

0.24

0.25

1986.934

2611.17

5498.01

(16)

P17

0.11

0.19

0.3

0.05

0.22

0.46

0.73

0.31

0.2

0.34

0.25

0.24

0.22

1967.705

2536.6

5361.83

(17)

P18

0.12

0.19

0.25

0.02

0.23

0.36

0.72

0.27

0.2

0.37

0.25

0.23

0.18

1963.717

2487.6

5180.26

(18)

P19

0.12

0.19

0.23

0.23

0.32

0.72

0.26

0.19

0.38

0.26

0.22

0.17

1952.749

2484.07

5116.71

(19. 20)

Table 3

Portfolio

176
F. Belaid

Scenario 4 (average NPV) (continued)

Decision-making process for project portfolio management

177

5.1 Comparison of both resultant efficient frontiers of the maximisation

of the variance and the semi-variance
To illustrate the impact of variance and the semi-variance as risk measure, we draw the
efficient frontiers of both measures on the same graph for the various scenarios of price.
The resulting efficient frontiers are plotted in Figures 10, 11, 12 and 13. We notice
that the efficient frontiers of the models with the semi-variance as the measure of risk are
different from the frontiers obtained using variance as risk measure. We note that for
the same level of return, the semi-variance corresponds to a lower risk. However, with
the diminution of risk, the difference or the dispersal between both curves becomes
smaller.
Figure 10 Scenario 1 oil price of $25/barrel

Figure 11 Scenario 2 oil price of $100/barrel

178

F. Belaid

Figure 12 Scenario 3 oil price of $200/barrel

Figure 13 Scenario 4 average oil price

Conclusions

Analysis of obtained solutions has shown that the given optimisation model based on
the modern portfolio theory method is robust and flexible in terms of input data and
output results. However, the model allows the decision-makers to specify the best rate
of participation in every project. Its modular architecture allows further inclusion of
complementary constraints and utilises different measures (than considered) of risk and
return as well as different input data formats. This method, contrary to the classical
selection methods, analyses the projects by considering the various aspects of the risk
and the various correlations between the projects, such as places, prices, profiles, politics,
and procedures. This allows to better take into account the risk of the projects, and
limiting the investment failures. More specifically the method allows determining:

the allocation of capital as well as the distribution of the production and the returns
for each project

the adequate strategies of investment, which answer the expected objectives, and
respect the budgetary constraints of the company.

Decision-making process for project portfolio management

179

The use of variance as risk measure in the optimisation process penalises projects for
upward as well as downward potential. We can overcome the problem by using semivariance in the definition of the optimisation problem. Semi-variance concentrates only
on the reduction of losses, without taking into account risks of the extreme potential
gains. This approach allows the portfolio managers to define the risk in an adequate way
according to the objectives and the constraints which concern their portfolio. This
study demonstrates that an explicit analysis of uncertainties and interdependencies in
evaluating the risks of E&P projects improves the quality of investment decision-making.
This paper is based on static evaluation of the risk of crude oil price and on a limited
number of case studies, e.g. Rodriguez and Oliveira (2005); Jafarizadeh and Khorshid
(2008). Therefore, empirical results cannot be generalised. Future researches to develop a
dynamic model for the optimal portfolio selection incorporating the crude price
uncertainty in a dynamic way are needed. Finally, we believe that the model proposed
does not provide a certain and unique answer for the problem of project portfolio
management but gives insights into what makes a desirable project portfolio for a
company rather than an undesirable one.

References
Allais, M. (1956) Evaluation des Perspectives conomiques de la recherche minire sur de grands
espaces-application au Sahara Algrien, Revue de lIndustrie Minrale, January, pp.329383.
Anadalingam, G. and Olsson, C. (1989) A multi-stage multi-attribute decision model for project
selection, European Journal of Operational Research, Vol. 43, pp.7183.
Ball, B.C. and Savage, S.L. (1999) Holistic vs. Hole-istic E&P strategies, SPE 57701, Journal of
Petroleum Technology, Vol. 51, pp.7484.
Black, F. and Scholes, M. (1972) The evaluation of option contracts and a test of market
efficiency, Journal of Finance, Vol. 27, pp.399417.
Brook, A., Kendrick, D. and Murows, A. (1992) GAMS Users Guide Release 2.25, The Scientific
Press, San Francisco.
Bussey, L.E. (1978) The Economic Analysis of Industrial Projects, Prentice-Hall Inc.
Charnes, J. (2007) Financial modeling with Crystal Ball and Excel, John Wiley & Sons,
New York.
Chow, K. and Denning, K.C. (1994) On variance and lower partial moment betas: the equivalence
of systematic risk measures, Journal of Business Finance and Accounting, Vol. 11,
pp.231241.
Choobineh, F. and Branting, D. (1986) A simple approximation for semivariance, European
Journal of Operational Research, Vol. 27, pp.364370.
Chopra, V.K. and Ziemba, W.T. (1998) The effect of errors in means, variances, and covariances
on optimal portfolio choices, in Ziembia, W.T. and Mulvey, J.M. (Eds): Worldwide Asset and
Liability Modeling, Cambridge University Press, Cambridge, pp.5361.
Corvellec, H. and Macheridis, L. (2010) The moral responsibility of project selectors,
International Journal of Project Management, Vol. 28, pp.212219.
Cozzolino, J.M. (1977) Management of Oil and Gas Exploration Risk, Cozzolino Associates, Inc.,
West Berlin.
DeGarmo, J.R. and Canada, W.C. (1973) Engineering Economy, McMillan Co.
Dey, P.K. (2006) Integrated project evaluation and selection using multiple-attribute decisionmaking technique, International Journal of Production Economics, Vol. 103, No. 1,
pp.90103.

180

F. Belaid

Drew, L.J. (1967) Grid-drilling exploration and its application to the search for petroleum,
Economic Geology, Vol. 62, pp.698710.
Erdogan, M., Mudford, B., Chenoweth, G., Holeywell, R. and Jakubson, J. (2001) Optimization of
decision tree and simulation of portfolios: a comparison, SPE 68575, SPE Hydrocarbon
Economics and Evaluation Symposium, 23 April, Dallas.
Grayson, C.J. (1960) Decisions Under Uncertainty: Drilling Decisions by Oil and Gas Operators,
Harvard Business School, Boston.
Grootveld, H. and Hallerbach, W. (1999) Variance vs downside risk: is there really that much
difference?, European Journal of Operational Research, Vol. 114, pp.304319.
Harbaugh, A.W. and McDonald, H.G. (1984) A Modular Three-Dimensional Finite-Difference
Groundwater Flow Model, United States Geological Survey, Reston, VA.
Harris, D.P. (1984) Mineral Resources Appraisal, Mineral Endowment, Resources and Potential
Supply: Concepts, Methods, and Cases, Oxford Geological Sciences Series, p.445.
Harris, D.P. (1990) Mineral Exploration Decisions: Guide to Economic Analysis and Modeling,
Wiley, New York.
Hertz, D.B. (1968) Investment policies that pay off, Harvard Business Review, Vol. 46, No. 1,
pp.96108.
Hlouskova, J. (2000) The efficient frontier for bounded assets, Mathematical Methods of
Operations Research, Vol. 52, pp.195212.
Homaifar, G. and Graddy, D.B. (1990) Variance and lower partial moment betas as alternative risk
measures in cost of capital estimation: a defense of the CAPM beta, Journal of Business
Finance and Accounting, Vol. 17, pp.677688.
Huang, X. (2008) Portfolio selection with new definition of risk, European Journal of
Operational Research, Vol. 1, No. 1, pp.351357.
Jafarizadeh, B. and Khorshid, R. (2008) A method of project selection based on capital asset
pricing theories in framework of mean-semideviation behavior, International Journal of
Project Management, Vol. 26, pp.612619.
Jonas, D. (2010) Empowering project portfolio managers: how management involvement impacts
project portfolio management performance, International Journal of Project Management,
Vol. 28, pp.818831.
Kaplan, R.S. and Norton, D.P. (2001) The Strategy-Focused Organization: How Balanced
Scorecard Companies Thrive in the New Business Environment, Harvard Business School
Press, Boston.
Karibskii, A.V., Shishorin, Y.R. and Yurchenko, S.S. (2003) Financial and economic analysis and
efficiency evaluation of investment projects and programs, Automation and Remote Control,
Vol. 64, No. 6, pp.886904.
Krumbein, W.C. and Graybil, F.A. (1965) An Introduction to Statistical Models in Geology,
McGraw-Hill, New York.
Laslo, Z. (2010) Project portfolio management: an integrated method for resource planning and
scheduling to minimize planning/scheduling-dependent expenses, International Journal of
Project Management, Vol. 28, pp.609618.
Mantel, S.J., Meredith, J.R., Shafer, S.M. and Sutton, M.M. (2008) Project Management in
Practice, Wiley, Hoboken.
Markowitz, H. (1952a) Portfolio selection, Journal of Finance, Vol. 7, No. 1, pp.7791.
Markowitz, H. (1952b) Portfolio Selection: Efficient Diversification of Investment, John Wiley &
Sons, New York.
Markowitz, H., Todd, P., Xu, G. and Yamane, Y. (1993) Computation of mean-semivariance
efficient sets by the critical line algorithm, Annals of Operations Research, Vol. 45, No. 1,
pp.307317.
Martino, J.P. (1995) Research and Development Project Management, Wiley, New York.

Decision-making process for project portfolio management

181

Merton, R.C. (1973) Theory of rational option pricing, Bell Journal of Economics and
Management Science, Vol. 4, pp.141183.
Modigliani, F. and Merton, M. (1958) The Cost of Capital, Corporation Finance, and the Theory
of Investment, American Economic Review, Vol. 48, No. 3, pp.655669.
Mohanty, R.P. (1992) Project selection by a multiple-criteria decision-making method: an
example from a developing country, International Journal of Project Management, Vol. 10,
No. 1, pp.3138.
Newendorp, P.D. and Schuyler, J.R. (2000) Decision Analysis for Petroleum Exploration, 2nd ed.,
Planning Press, Colorado.
Orman, M. and Duggan, T.E. (1998) Applying modern portfolio theory to upstream investment
decision-making, Paper presented at the 1998 Annual Technical Conference and Exhibition,
2730 September, New Orleans.
Rodriguez, J.M. and Oliveira, K.G. (2005) An application of portfolio optimization with risk
assessment to E&P projects, Proceedings of the 2005 Crystal Ball User Conference, 14 June,
Denver.
Rose, P.R. (1987) Dealing with risk and uncertainty in exploration: how can we improve?,
AAPG Bulletin, Vol. 7, No. 1, pp.116.
Sharpe, W.F. (1964) Capital asset prices a theory of market equilibrium under conditions of
risk, Journal of Finance, Vol. 3, pp.425442.
Turner, J.R. (1992) The Handbook of Project Based Management: Improving Processes for
Achieving Your Strategic Objectives, McGraw-Hill, New York.
Tversky, A. and Kahneman, D. (1991) Loss aversion in riskless choice: a reference dependent
model, Quarterly Journal of Economics, Vol. 106, No. 4, pp.10391061.
Walls, M.R. (2004) Combining decision analysis and portfolio management to improve project
selection in the exploration and production firm, Journal of Petroleum Science and
Engineering, Vol. 44, Nos. 1/2, pp.5565.
Walls, M.R. and Dyer, J.S. (1996) Risk propensity and firm performance: a study of the petroleum
exploration industry, Management Science, Vol. 42, No. 7, pp.10041021.
Wang, J., Xu, Y. and Li, Z. (2009) Research on project selection system of pre-evaluation of
engineering design project bidding, International Journal of Project Management, Vol. 27,
pp.584599.