# W5_AlShehhi_Calculating MARR Using Analytical Hierarchy Methodology

1. Problem Definition.

MARR calculated in W4 blog without considering Risk Scoring. For any upstream or downstream investment in oil and gas, there are associated risks with any investment and that varies from one location to another. These risks include, but not limited to, type of reservoir, onshore/offshore activity, remoteness, complexity of asset, etc. It is important that these risks to be quantified in terms of percentage so that will be plugged into the MARR equation.

MARR = WACC + Risk Scoring + Country Risk[1]

2. Identify the Feasible Alternative.

The Analytical Hierarchy AHP is a process for making a decision in an organized way to generate priorities. To make a comparison, a scale of number, that indicates how many times more important or

dominant one element is over another element which respect to the criterion with respect to which they are compared is, required.

Table 1: The fundamental scale of absolute numbers [2]

Figure1: Range of Project Risks and its Criterion [3]

A pair wise comparison matrix for each criterion is the next result to be calculated until priorities obtained for the sub criterion.

In order to determine range of project risk and its criterion, see Figure1. After that, those criterions are summarized to determine the relative ranking for each sub-criterion.

3. Development of the Outcome for Alternative

To calculate for each of the criterion of the above section, Matrix algebra is used and results are summarized in below table and graph below.

Table 6: Matrix Results and Matrix Rank for each Criterion

Figure 2: Hierarchical Tree with Matrix Rank Result

Looking at Table7, and since no reservoir in Oman that can be described as an offshore and unconventional at the same time, 37.91% is considered as an outlier and 4.21% can be considered as highest most reasonable percentage. Lowest risk is 0.02%

Table 7: Risk Scoring based on Risk Matrix Rank

Calculating for MARR by including both maximum and minimum risk scoring, it was found that

–          For the most risky project

MARR= 8.6% + 4.21% = 12.81%

–          For the least risky project

MARR = 8.6% + 0.02% = 8.62%

4. Selection a Criterion

MARR that is more conservative will be selected.

5. Analysis and Comparison of the Alternative.

It was found that previously calculated MARR (8.6%) is lower than after including risk ranking, 12.81%. This would lead to the conclusion that risk ranking need to be considered when calculating MARR in order to obtain more vigilant figure.

6. Selection of the Preferred Alternative.

Range of 12.81 to 8.62% to considered as MARR.

7. Performance Monitoring and the Post Evaluation of Result.

The above calculated range is based on 100% equity funding, which is low risk and not necessarily actual. Ten-year treasury bill to be considered, current calculation is based on three-month treasurybill. MARR to be recalculated considering both equity and debt funding.

8. References:

1. Liana, Lita, (February, 2014), Using Analytical Hierarchy Process to Determine Appropriate Minimum Attractive Rate of Return for Oil and Gas Projects in Indonesia, Vol III, Issue II, Retrieved on July 6, 2014, from http://pmworldjournal.net/wp-content/uploads/2014/01/pmwj19-feb2014-liana-analytical-hierarchy-for-roi-oilandgas-projects-indonesia-FeaturedPaper.pdf
2. Satty, T.L. (2008) Decision making with the analytical hierarchy process. Int. J. Services Sciences, Vol.1, No.1, Retrived on July 6, 2014, from http://www.researchgate.net/publication/228628807_Decision_making_with_the_analytic_hierarchy_process
3. By Author
4. Lita, (2013, February 19). W6.0_LL_WACC&MARR_Gol vs Contractors, Mercure AACE 2013, Retrieved on July 8, 2014, from http://kristalaace2014.wordpress.com/2014/03/29/w5_gw_drilling-a-well-hurdle-rate/comment-page-1/