WEFTEC.06 IMPLICATIONS OF ASSET MANAGEMENT ON CAPITAL AND O&M FINANCING

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1 IMPLICATIONS OF ASSET MANAGEMENT ON CAPITAL AND O&M FINANCING Cara Wilson, Priscilla Bloomfield, Steve McDonald *Carollo Engineers, P.C Southwest Macadam Avenue, Suite 300 Portland, OR ABSTRACT Asset management is often used to assess asset repair and replacement (R&R) costs and project timing. However, asset management can also be used to reduce overall asset life cycle costs, from creation through disposal. For example, by purchasing technologically advanced assets today, an agency can greatly reduce operations and maintenance (O&M) costs. Although the capital costs of technologically advanced assets may be higher than standard assets, the longterm savings in O&M costs can outweigh the initial increased capital investment, and, over the lifetime of the asset, reduce life cycle costs. What-if analyses concerning timing of capital projects, O&M efforts, and repair/replacement decisions can be used to determine the optimal scenario for project implementation. Other what-if scenarios can be evaluated, also based on forecasting the optimal asset replacement point, such as determining the time in the asset s life cycle in which O&M investments should be decreased to reduce the overall life cycle costs of the asset. These time influenced O&M strategies, in collusion with the use of energy efficient assets, greatly reduce O&M costs, thereby increasing the agency s future savings. KEYWORDS Life cycle costs, capital improvement projects, O&M savings INTRODUCTION In June 1999, the Government Accounting Standard Board s Statement No. 34 (GASB 34) was implemented which requires the value of capital assets be reported in the annual balance sheets and income statements of government entities. GASB 34 requires the asset values to be reported in one of two ways: 1) by performing a straight-line depreciation of historical acquisition costs or 2) by implementing an asset management program. To comply with these regulations, many government entities have adopted asset management programs which demonstrate that either maintenance spending is adequate to prevent infrastructure deterioration or that infrastructure asset condition is being maintained above minimum acceptable standards. CURRENT AND EVALUATED VALUE 4145

2 One of the first steps in determining the current value of infrastructure assets as part of an asset management program is to evaluate the existing condition of the asset. Another critical step is to determine the current replacement cost of the asset. Used in conjunction with one another, the current asset replacement cost and the existing asset condition can provide a very accurate assessment of the current value of the asset. The advantage in using this methodology, rather than the historical cost valuation, is that costs relating to technological advances and compliance with increased regulatory requirements are included in the current asset value. Additionally, there is a general consensus among industry professionals that using historical costs and straightline depreciation for valuing infrastructure assets is often an inaccurate representation of the actual value of the assets. This consensus has formed due to inaccuracy in 1) bid-tab costs, such as front-loading, which can artificially weight asset costs, and 2) the straight-line depreciation of historical costs, which provides a very conservative approximation of the asset s current value. Current value can be developed using the replacement cost of the asset, which accounts for recent technology improvements, as well as the direct, indirect, and soft costs associated with the project. The current value should be updated over time to account for inflation, and changes in material costs and labor costs. The asset s current condition can be related to the amount, or percentage, of repair that is needed to restore the asset to new condition. These two factors (current condition and current value) can be used to determine the evaluated value of the asset, which provides a more accurate assessment of the overall value of the asset, by incorporating the total costs to replace the asset, modified to account for changes in asset condition over time. An example of calculating evaluated value is presented in Table 1. As shown in the table, although the current value of the asset is increasing due to increasing material costs, inflation, and other factors, the evaluated value of the asset is decreasing based on the deterioration of the asset over time. The evaluated value is therefore a more accurate representation of the real value of the asset. The difference between the current value and the evaluated value of the asset is the expected amount that needs to be reinvested in the asset to bring it back to new condition. This will allow an agency to plan for future fiscal needs in a more effective manner, and can assist in attaining buy-in from City Council, utility customers, and bond rating agencies because the agency has developed and documented a comprehensive evaluation of their future fiscal needs. 4146

3 Table 1 - Condition, Current Value, and Evaluated Value Year 0 Year 10 Year 20 Condition Current Value $10 $11 $12.10 Evaluated Value $10 $9.50 $6.05 Notes: 1. Condition 1 = best, 5 = worst 2. Current value assumed to escalate by 1% per year. LIFE CYCLE COSTS Asset management can be used to reduce overall asset life cycle costs, from creation through disposal. For example, by purchasing technologically advanced assets today, an agency can greatly reduce operations and maintenance (O&M) costs. Although the capital costs of technologically advanced assets may be higher than standard assets, the long-term savings in O&M costs can outweigh the initial increased capital investment, and, over the lifetime of the asset, reduce life cycle costs. Because O&M costs are comprised of three main elements (labor, power, and chemicals/supplies), overall O&M costs are decreased by reducing the cost associated with these three elements. Labor costs typically cannot be significantly reduced through capital improvements, and therefore this element does not have a substantial impact on reducing overall O&M costs. However, improved technology can increase ease of asset operation, thereby increasing the efficiency of O&M personnel. Therefore, labor costs can be indirectly reduced through capital investments in more technologically advanced assets. Power and chemical/supply costs provide the greatest potential for increased savings in O&M activities. The use of energy efficient assets, such as chemical metering pumps, can greatly reduce O&M costs by minimizing power usage and improving the accuracy of chemical dosing. Although energy efficient assets generally have a higher capital cost due to improved technology, the savings incurred by these assets over a lifetime of use outweigh the initial increased capital costs. For example, an evaluation of the total life cycle costs of generating Class A biosolids using screw presses with steam and lime addition vs. centrifuges combined with digestion upgrade to three-phase anaerobic digestion was made (Kabouris et al., 2005). This evaluation considered 4147

4 capital costs, annual operating costs (such as power, chemicals, hauling, disposal, etc.), and annual maintenance costs (including ease of accessibility, ease of maintenance, and maintenance frequency), among other criteria. Although the centrifuges-based option for generating Class A biosolids had a higher initial capital cost compared to the screw presses option, the long-term operations and maintenance costs of the centrifuges-based option were significantly lower, resulting in a lower overall life cycle cost for the centrifuges-based option. The net present worth total life cycle cost estimates for the screw presses and the centrifugesbased options is presented in Table 2. Table 2 - Life Cycle Costs Data for Screw Press and Centrifuge Cost Estimates (in Millions of Dollars) Cost Components Screw Presses Centrifuges Capital $3.34 $4.99 Power $0.04 $0.28 Steam $1.28 N/A Lime $2.96 N/A Operations $0.06 $0.24 Maintenance $0.08 $0.26 Polymer $2.30 $1.40 Gas Credit N/A ($0.54) Disposal $2.70 $2.32 TOTAL $12.76 $8.95 Schedule Schedule and timing of project implementation also has a significant effect on O&M savings. Management decisions such as whether to decrease LOS goals to reduce maintenance costs, or to run the asset to failure, play an important role in decreasing O&M costs. What-if analyses concerning timing of capital projects, O&M efforts, and repair/replacement decisions can be used to determine the optimal scenario for project implementation. An example of how these what-if analyses can be used to reduce O&M costs is determining the optimal replacement point in the asset s life cycle. The optimal replacement point is defined as the best time in the asset life cycle to replace the asset, so that large amounts of the O&M budget are not used to repair technologically outdated assets. Of course, the optimal replacement point varies for different types of assets and different utilities. Therefore, an analysis of the variables impacting the replacement timing, such as the agency s level of service goals, reserve funding, and the expected construction time to implement the project, is conducted. 4148

5 A simplified example of when to replace an asset is presented in Figure 1. One method for determining the timing of asset replacement is by identifying at what point in the assets life the maintenance costs will begin increasing due to the deterioration of the assets condition. As seen in the figure, this point is the time at which the tangent to the condition curve is equal to the slope of a standard straight-line analysis as predicted based on the expected useful life of the asset. By proceeding along the condition curve without replacing the asset at this time, more investment is needed in the regular maintenance of the asset than would be expected based on the straight-line depreciation, which is inherently a very conservative prediction of maintenance requirements and asset condition. Therefore, it is reasonable to schedule the rehabilitation or replacement of the asset at the point in which the slope of the tangent to the curve is equal to the slope of the straight-line depreciation. Figure 1 - Asset Rehabilitation or Replacement Timing An additional what-if analysis, also based on forecasting the optimal asset replacement point, is determining the time in the asset s life cycle in which O&M investments should be decreased. For example, if the optimal asset replacement point is determined to be one year from today, O&M costs could be decreased considerably, and focused primarily on patch-work repairs, because it is known that the asset will be replaced shortly with an asset of improved technology. These time influenced O&M strategies, in collusion with the use of energy efficient assets, greatly reduce O&M costs, thereby increasing the agency s future savings. 4149

6 CONCLUSIONS In summary, several management techniques exist which can be utilized to increase the effectiveness of a utility s performance in addition to decreasing both short-term and long-term costs. These techniques include developing an accurate assessment of an asset s current value, evaluation of total life cycle costs (including power, labor and chemical costs), and scheduling of project rehabilitation or replacement and the associated impacts on existing operations and maintenance costs. REFERENCES Kabouris, J. C.; Gillette, R.A.; Jones, T.T.; Bates, B.R. (2005). Evaluation of Belt Filter Presses, Centrifuges, and Screw Presses for Dewatering Digested Waste Activated Sludge at St. Petersburg s Water Reclamation Facilities. WEFTEC