Quantitative Risk Management Methods, Techniques and Tools. SALAH AL-RAMADHAN Senior Analyst Risk Engineering KPC

Transcription

1 Quantitative Risk Management Methods, Techniques and Tools SALAH AL-RAMADHAN Senior Analyst Risk Engineering KPC

2 Kuwait Petroleum Corporation The national oil company of Kuwait; Operates in Exploration and Production, Refining, Petrochemical and Transportation; KPC Activities concentrated domestically with increasing growth overseas; Upstream Midstream Downstream Overseas expansion mostly through joint ventures and joint operations; KOC KOTC KNPC Production currently in excess of 3 million BPD and 14 million tpa of associated and free gas; KGOC IM KPI Petrochemical business focused on polyolefins, aromatics and glycols; Turnover c. KD 39 billion (2013/14) KUFPEC PIC Assets.c. KD 32 billion (2013/14) Capex in fixed assets c. KD 32 bn next five years: KAFCO Number of employees c

3 KPC ERM Corporate Risk Management Department formed in 2002; essentially an insurance buyer of standard energy policies; Defined an Enterprise Risk Management (ERM) Strategy in 2005 based upon the principles of COSO and the AZ/NZS 4360: 2004 Risk Management Guidelines; Implemented first phase of strategy through 2006 and 2007 with following features:- ERM Policy created; Subsidiaries implemented policy at subordinate level ERM Framework and procedures introduced; Semi qualitative risk matrix and risk register developed; Integrated processes adapted and deployed; Early risk quantification of some key risks; Resource growth and capability building; ERM Information System from Avanon introduced; Insurance programs continue to be adapted; In 2009 our ERM maturity was deemed to be comprehensive. ERM 2030 Strategy developed in 2010 with implementation beginning September 2011, aims at placing KPC ERM at the Strategic Maturity level. Loss Tracking Module (LTM) Avanon OpRisk Suite OpRisk Reporting Module (ORM) Action Tracking Module (ATM) Self Assessmen t Module (SAM) Indicator Rating Module (IRM) Administration Management Module (AMM) Communicate & Consult Establish the Context Identify Risks Analyze Risks Integrate Risks Evaluate Risks Assess Risks Treat Risks Quants. (QTM) Monitor & Review 3

4 ERM Policy KPC ERM Process Framework Establish the Context Establish the external, internal, and risk management context in which the rest of the process will take place. Criteria against which risk will be evaluated should be established and the structure of the analysis defined. Identify Risks Identify what, why, and how things can arise as the basis for further analysis. Analyze Risks Determine the existing controls and analyze risks in terms of consequence and likelihood in the context of those controls. Consequence and likelihood may be combined to produce an estimated level of risk. Integrate Risks Aggregate multiple risk types, reflecting correlations and portfolio effects. Evaluate Risks Compare estimated levels of risk against the pre-established to determine rankings and priorities. Treat Risks Identify risk treatment options, perform a cost-benefit analysis to determine the optimal risk treatment strategy, and develop risk treatment plans. Communicate & Consult Assess Risks Monitor & Review Establish the Context Identify Risks Analyze Risks Integrate Risks Evaluate Risks Treat Risks Monitor and review the risk management process and supporting infrastructure. Communicate & Consult Communicate and consult with internal and external stakeholders as appropriate at each stage of the risk management process and concerning the process as a whole. Monitor & Review

5 KPC ERM Objectives: Three key objectives of KPC s risk Achieve high certainty that the oil sector will meet the expectations of the State Ensure the availability of adequate funding to support oil sector capital expenditure Enable the oil sector to make a more fact-based and quantitative assessment of risk vs. return trade-offs in its activities and projects SOURCE: Team analysis 5

6 Risk Register 6

7 The top ten risks for KPC were identified and mapped to each of the K-Cos Risk modeled and have effect Risk 1 Domestic political influence 2 Regional instability 3 Project execution 4 Hydrocarbon market disruption 5a Crude price volatility 5b Gas price volatility 5c Interest rate volatility 5d Charter rates 6a FX volatility 6b Refining margin volatility 6c Petrochemical price volatility 6d Retail margin volatility 6e Counter-party credit risk 7a HR and HSSE - Manpower 7b HR and HSSE Labor disruptions 8a Operational - Production 8b Operational - Sabotage 9 New technologies 10 Unexpected drop in reserves KCo1 KCo2 KCo3 KCo4 KCo5 KCo6 KCo7 KCo8 KCo risks from risk registers were considered KPC SOURCE: Team Analysis 7

8 Top 10 risks for KPC Top risks Political/ regulatory risk 1 External influence on key decisions 2 War or political instability in the region 3 step approach to arrive at list of top 10 risks for KPC Evaluate high and very high risks from bottom up KPC risk registry Compare with risks most important to Oil and Gas industry in top-down review Map risks against KPC strategic directives Strategic project risk Portfolio/business risk Financial risk (Counterparty, Liquidity, Market) Operational/ technical risk Large project execution risks 3 4 Disruptions in hydrocarbon market due to demand shifts in import countries 5 Global crude/gas price volatility and related country/credit risk 6 Refining/petrochemical margins and related FX risks 7 HSSE and HR risks 8 Operational risks leading to unplanned shutdowns or other supply chain disruptions 9 New technologies risks 10 Company reserves 8

9 Risk Modeling 9

10 Three quantitative tools were developed to answers the key questions for decision makers What is the chance of meeting Five Year Plan the baseline cash flow? Five Year Planning (CFaR) What are the top risks on the company s portfolio? How much funding will the company require to service all its obligations with a high degree of confidence? Will the company be able to repay its debt commitments? Capital Investment and Appraisal (RAROC) Strategic Direction and Planning Process What is the probability of the project to break-even? What are the top-risks for the project? What is the best strategic option based on risk return profile? 10

11 Software add in to XL Choice based on:- Functionality around correlation and matrices; Ease of access and familiarity with the XL style user interface; Excel skills easily extended application and environment; Economics and efficiency cost and speed to get up and running features currently used :- RiskCorrmat RiskTarget RiskCorrel RiskMax Data Source RiskMean RiskPercentile RiskOutput RiskDiscrete RiskResultsGraph RiskNormal RiskPert RiskTriang RiskUniform Central or network Features not currently used but which we have an interest in: Time series modeling VBA, macros and automation; Risk Library RiskSimTable Sensitivity analysis, scenrios and optimization; Other decision tools applications;

12 Architecture: 4 modules centralized at KPC and 7 modules maintained at K-Company level 1 Assumptions master 2 4 Shared engine KPC CFAR model KPC level K-companies have option to change shared assumptions for running their own scenarios 3 Shared K-company run data 5 11 K-Company level KGOC CFAR KNPC CFAR KPI CFAR PIC CFAR KOC CFAR SOURCE: Team analysis 12

13 Each K Company has it s own risk model; output measures risks modelled both in deterministic and stochastic cases Relevant risk factors Financial models Model output War/political scenario Project delays Oil price KPI KNPC KOC Financial Non-financial All relevant risks modelled for all K Companies Focused risks modelled in detail for K Companies Deviation from base case due to each of these risks modelled separately All 9 K companies deterministic financial cash flows is modelled For each of these deterministic, the impact of all relevant risks modelled separately for output Cash flow distribution (by each risk type for each K Company) 1 Varies by K company For KGOC and KOC Oil capacity Gas production For KNPC Refining capacity 1 While we calculate cumulative cash flows, we will use discount rate as follows 0% for next 5 years, 10% for remaining 15 years/there after SOURCE: Team analysis; expert interviews; k-company working teams 13

14 Model provides cash flow from operation over time and as a cumulative distribution Mn KD Cumulative operating five year cash flow (20XX-20YY) Yearly cash flow from operations (20XX-20YY) Illustrative 5th Mean Baseline 95th 95th 5th Baseline Mean Probability Cash flow x y z Cash flow Model can also calculate deviation from baseline for production volumes 20XX YY SOURCE: K-Company CFAR model illustrative example. Team analysis 14

15 Rank risks based on contribution to total cash flow at risk, and quantifies diversification effect 5 year cash flows (20XX-YY) Illustrative Risks Global crude/gas price volatility External influence on key decisions Large project execution risks New technologies risks Refining/petrochemical prices Operational risks Cash Risk = Baseline 5 th Percentile Remarks Baseline refers to currently projected cash flows from the 5 Year plan Diversification results from low or negative correlation of various individual risks leading to total risk lower than sum of individual risks HSSE and HR risks Diversification Total SOURCE: K-Company CFAR model illustrative example. Team analysisa 15

16 Risk Modeling Strategic Projects 16

17 Old project appraisal approach with a probabilistic risk view From deterministic to probabilistic Frequency of occurrence in simulation 1 High case 2 Base Case 3 Low case Future value Discrete scenarios with no associated understanding of probability of occurrence Scenarios based on intuitive assessment bias likely in selection Fat tail risks often ignored Fact based assessment of full range of outcomes with associated probabilities Removes bias towards most likely scenario Quantify potential downsides and upsides at appropriate probability 17

18 The risk-return quantification methodology adds probabilistic metrics on top of the current appraisal and strategic metrics Value metrics NPV Metrics was used for program appraisal 1 Additional risk-adjusted metrics introduced by the methodology Expected NPV Return metrics Time metrics IRR Profitability index Payback period Expected IRR RAROC (Risk adjusted return on capital) Expected payback period Sensitivity/ Scenarios Sensitivity of NPV to CAPEX overrun Oil price Project delay Scenarios NPV at risk (NPVaR) Probabilities To breakeven To meet baseline Stress-test expected economic performance of the project Prioritize and assess magnitude of key risks to focus mitigation actions Estimate likelihood of project success and the underlying value to the organization 1 Using base case assumptions SOURCE: Team analysis

19 Overview of risk-based economics for project NPV distribution, KD 5 th percentile (P5) Breakeven point Probability to breakeven 70% 0 Expected NPV E1 NPVaR = B1-P5 Baseline Probability to meet baseline 24% B1 NPV, KD Key metrics Commissioning date Peak production, tpa Capex, KD Illustrative Numbers Baseline metrics 20AA CCC2 BIG Expected metrics 20BB.CCCX BIGGER Min Required NPV, KD B1 E1 IRR, % % Payback period, year 9 10 tbd Profitability index >1 Return on NPV/I, % 80% 85% >0 capital RAROC, % 10% >0 NPVaR, KD B1-P5 Prob. to breakeven, % 70% tbd Prob. to meet baseline, % 24% tbd Key risks Observations Key risks Crude price Capex overrun Refining margins Feedstock availability Execution delay -R5 NPVaR, KD R3 R4 R1 R2 Contribution, Percent Difference between baseline NPV and expected NPV, mainly driven by crude price, results in a lower probability to meet the baseline Probability to breakeven implying that the project is likely to be profitable Large NPVaR brings down expected return on capital after risk adjustment SOURCE: Economic model, team analysis 19

20 NPVaR breakdown Key risks Crude price NPVaR, KD R1 Assumptions ~29% volatility based on historical oil prices for last 20 years Capex Overrun R2-5% to 40% overrun in capital expenditure based on external benchmarks Refining margins Feedstock availability Execution delay R3 R4 (-R5) ~20% volatility based on historical oil and products prices for last 20 years Modeled as delay on similar projects Average delay of 11 months with a standard deviation of 6 months based on a benchmark Totall Sum of Rs Diversification Delta All All Rs together SOURCE: Economic model, team analysis 20

21 Risk Modeling Strategic Options 21

22 Consider several strategic options, while remaining within the boundaries of internal constraints Illustrative Numbers Potential strategic options Total capex for strategic programs PRELIMINARY Option 1 Option 2 Option 3 Option 4 Option 5 Option 6 Strategic initiatives Develop upstream conventional Develop upstream unconventional Develop non-associated gas Grow conventional internationally Grow refining capacity Grow refining capacity internationally Enhance Gas Processing / Import Capacity Develop pet-chems <1 <1 <1 <1 7 <1 Grow unconventional internationally Total investment SOURCE: Illustrative Approach; team analysis 22

23 Value creation of strategic options on portfolio Illustrative KPC view Value (NPV), KD Less risky strategy More risky strategy RAROC Alternative option preferable Preferred option depends on risk appetite Option 4 Option 6 Option 5 Option 2 Option 3 Option 1a Option 1 (Current plan) Preferred option depends on risk appetite Current FYP preferable Risk (NPVaR), KDmm SOURCE: Strategic Planning model, team analysis 23

24 ERM in KPC will be much more effective organisation An effective management tool to support better decision making A much deeper understanding of major risks and how they affect the businesses and Oil sector's ability to implement the 2030 strategy Concrete materials with quantification of the risks improving ability to engage the stakeholders in an informed manner Attention drawn towards the extreme tail risks facing the oil sector Suitable leading risk indicators and a good understanding how to quantify and assess the impact of range of mitigation options Ability to evaluate the investment portfolio from a risk adjusted point of view to create increased organizational value both at a KPC level and individual K-co level 24

25 Thank You