MINI CASE $5\mathrm{.}1$ WILDCAT DYNAMICS

Wildcat Dynamics is an oil exploration company, founded in $1980.$ The company has been successful in bringing in Wildcat wells in various parts of the United States and Canada. By $1999$ the company has reasonable financial reserves of its own, but also occasionally entered into partnership with a group of investors in Calgary. Hence, the firm usually does not have great difficulty in raising funds for a reasonably good wildcat prospect.

It has been Wildcat Dynamic's policy to sell off the rights to produce the oil once a well was brought in$.$ Activities were confined to locating possible sites, arranging for appropriate leases, and contracting for drilling operations. In June of $1999$ the company is trying to decide whether to drill on a parcel of land taken in Alberta. The lease had been taken out in $1997$ but the company had been busy elsewhere until now. The lease would expire soon and the company had to decide whether or not to drill.

The cost of drilling at the site would be $$700,000.$ This would be all lost if the well were dry. If the well were successful, the value would depend upon the extent of the reserves uncovered. For simplicity, management generally considered only two alternatives, described humorously as either a $"$ or a "soaking" well. The revenue associated with selling the rights to a wet well were in excess of the drilling cost. For a soaking well, revenues were expected to be $ above the drilling cost.

William Cooper, the company geologist, was consulted about the chances of actually finding oil. He said that the chances depended upon whether or not a particular structure lay underneath the proposed drilling site. If the underlying lime$-$shale formation rose into a where Wildcat proposed to drill, then there were substantially better chances of finding oil than if existed. Mr$.$ Cooper said that he estimated$$that there were roughly

upon experiences of other drillers in the area and his own accumulated knowledge of geology. Cooper also gave the following estimates of finding oil, given the existence of dome:

wet" well

$$2\mathrm{.}2$M$,$ i$.$e$.$ $$1\mathrm{.}5$M

$6\mathrm{.}7$M$,$ or $$6$M

flat dome shape

no such dome structure

$6$ chances in $10$ of such a dome structure

underneath the Wildcat site. He based this estimate$$Drilling Result

Dry Well Wet Well Soaking Well

Dome Structure

$\mathrm{.}60\mathrm{.}25\mathrm{.}15$

No Dome Structure

$\mathrm{.}85\mathrm{.}125\mathrm{.}025$

Probabilities of Oil

Mr$.$ Cooper noted that these estimates represented his best judgement about the results of drilling. He indicated that another expert might come up with a different set of estimates and that in fact, there were no such things as "right" probability estimates in this business.

Seismic Test Possibility

Cooper also suggested that Wildcat might consider the possibility of taking a seismic test on the site before

drilling. $.$ The seismic test would give an indication of the existence or non$-$existence $.$ Cooper emphasized that the seismic test was not foolproof. Sometimes intermediate layers of rock reflected the seismic soundings sufficiently to give the impression of a dome when none is there, and sometimes the soundings are misinterpreted to say that no dome exists when in fact it does. Cooper said that in his best opinion, the chance that the test would indicate the presence of a dome or not was $50/50.$ In response to

These cases are intended to serve as a basis for class discussion, rather than to illustrate either effective or ineffective handling of an administrative situation.

$$This test would cost $$100,000$

of the dome structure

questions about the test reliability, he indicated that:

$$The probability that a dome is present given a positive test $=0\mathrm{.}9$; and therefore

the probability that a dome is NOT present given a positive test $=0\mathrm{.}1.$

$$The probability that a dome is NOT present given a negative test $=0\mathrm{.}7$; and therefore

the probability that a dome is present given a negative test $=0\mathrm{.}3.$

$($The seismic test is clearly better at detecting the presence of a dome than it is in determining when there isn$$t a dome.$)$

Questions:

$1.$ Portray this decision problem in a decision tree.

$2.$ Based upon expected Value, what should Wildcat do$?$