INFRASTRUCTURE RISKS: ENABLING INFORMED DECISIONS Large capital project risk management DOHA, November 4 th, 2014 Sandro Melis Partner Oliver Wyman Manufacturing, Transportation and Energy Email: sandro.melis@oliverwyman.com Tel: 00 39 34 8895 2874
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Project challenges and delay drivers Delays and cost-overruns are usually driven by a combination of planning, organizational and execution challenges Planning Business-driven project sizing Trade-offs investment / operations Technology choices Equipment specification gaps Nuclear Power Plants Organisation Contractor selection/ quality Funding gaps/ lack of liquidity Governance structures CFO involvement / lack thereof Communication Information flow within project/ between project and management Bureaucracy Lack of ownership/ blame games Oil and gas upstream Selected typical pain points Transparency and oversight Real-time progress / issue reporting Timely quality assurance Delays at commissioning Opportunism or even fraud on-site Transport infrastructure Execution Deviation management Qualified labour force Automation and tooling Raw materials quality Chemical plants Delays 150 200% 40 50% 30 50% 20 30% Cost overruns 100 150% 50 70% 30 60% 15 25 % Source: Oliver Wyman analysis, delays reflect global industry averages within last decade 3
Case study: Typical project delivery issues Typically large construction projects face a variety of challenges that lead to delays and cost overruns Lack of risk awareness Limited cost transparency Misaligned tendering process, commercials and execution Regulatory impacts and requirements Risks and challenges Optimistic planning and expectations, limited reflection of risks in business plan Lack of open communication about risks Blame games to avoid being risk owner Limited consideration of cost escalation over time & across technological alternatives Insufficient cost calculation and budgeting Limited incentives for cost reduction Lack of long-term partnerships Imbalance between price and quality focus Prefabrication issues resulting in rework Increasing specifications and functionality to adapt to growing regulations Increasing safety regulations Regulatory licensing delays Lessons learned Introduction of capital project risk management as a cornerstone to risk culture Usage of risk-adjusted KPIs for steering Forecast industry prices frequently and align with project costs to ensure long term profitability Define long-term budget to control expenses Define integrated project schedule to minimize delays Pre-screen and pre-qualify potential suppliers Use of framework contracts to build long-term relationships with quality suppliers Tighter oversight of prefabrication quality Align industry requirements forecasting with project planning to ensure alignment with industry structure Establish rigorous safety policies from outset Manage and maintain strong regulatory relations Ineffective organizational interfaces Lack of standard processes and capturing of experience Several project views exist (e.g. financial/ technological design/construction) Siloed thinking indirectly promoted Lack of standardized processes Limited consideration of previous project experience Integrate project timeline with financial plan for a unified project plan Establish incentives for cooperation and risk mitigation Align KPIs across businesses (e.g. number/ turnaround time of documentation changes) Formalize best-practice sharing across projects 4
Realizing value from risk management Large Capital Project Risk Management approach support address and mitigation of delays and overruns risk Reduces risk through more active and focused risk management Increases visibility of key performance drivers Reduces project schedule slippage by mitigating key schedule risks Stabilizes performance by protecting against downside scenarios Aligns risk taking with profit and growth targets Generates higher future returns through disciplined allocation of capital Promotes risk awareness within key decision making process Achieves risk governance and compliance as a byproduct of value creation 5
Example of successful results achieved in large project delivery Oliver Wyman has recently saved >$2bn from Large Capital Projects (1/2) Oil production (projects and fields) Gasification project Power plant design, build and operate Re-evaulated risks and financial projections for five oil fields (following the acquisition of an independent producer) Developed dynamic financial plans and mitigation measures to secure NPV uplift of $2 BN Built capabilities and systems to evaluate risks and inform dynamic financial planning decisions Project cancelled due to excessive risk, sunk cost of $50 MM vs. expected $500 MM loss Developed third-party risk review to support investors due diligence Helped raise over $300 MM equity and $1.2 BN debt from consortium of investors Realized NPV impact US$ 2,000 MM 1 US$ 450 MM US$ 1,500 MM funding 1 Opex and Capex benefits 6
Example of successful results achieved in large project delivery Oliver Wyman has recently saved >$2bn from Large Capital Projects (2/2) Nuclear Power Plant Construction Hydro Dam Upgrade Rail network capacity expansion Developed targeted mitigation activities (Training, contractor/ supplier management, procurement, quality assurance processes, ) Reduced expected delay by 10 months Realized NPV impact Identified key risks and critical path dependencies during construction of a hydro power dam Secured on-time delivery and go-live due to early focus of efforts on the critical construction items and important decisions Created transparency around demand, operational and capital risks which enabled the definition of appropriate mitigation measures Reduced expected delay in ramp up by 24 months Maximized profitability through risk-sharing in tariff design US$ 300 MM US$ 250 MM US$ 100 MM 7
Risks Challenges Large Capital Projects challenges Each project lifecycle phase has distinct challenges that have a compound effect on project and operational performance Feasibility Misaligned objectives leaving the project delivery at risk Static approval process Biased assessments Inadequate knowledge of market conditions Unsuitable or nonregionally specific analysis Compressed timeframes resulting in incomplete analysis FEED (Front End Engineering Design) Stakeholder complexity - political, regulatory, shareholders, operations Ineffective organizational interfaces Limited consideration of long term factors Front End Loading (FEL) activity does not actively mitigate delivery risk Unrealistic planning expectations resulting in false delivery schedules EPC (Engineering, Procurement, Construction) New tech and remote areas Organization and contracts not designed around risk Avoidance of accountability with no open communication about risk & performance Siloed program architecture and decision making Insufficient cost challenge decisions and minimal regard for operational outcomes Limited preemptive mitigation Operations Constrained internal and market capabilities and capacity Technical complexity physical location, technological advances, scale of projects High competition for limited local and global resources Building operational teams Effective commissioning and start up Retrospective fixes to meet operational needs Mitigation measures not in place Incorrect prioritisation of options Lack of alignment and ownership Schedule and cost overruns Reduced productivity and ROI Misallocation of capital Scope increases Scope reduction Significant fix costs Over optimistic forecasting High levels of contingency Inefficient use of resources High maintenance Phased go live 8
Dynamic forecasting: Use risks to make informed decisions Transparency on the risks to project value informs how to optimise performance throughout the project life cycle FCF over time (In US$ MM) Planning and construction phase Operating phase 2 Project delays project operational later than planned 3 Profitability shortfall demand uncertainty due to macro-drivers, competition, productivity development, cost evolution 1 Cost overruns CAPEX spend is greater than expected Mitigation activities 1 Cost overruns Raw material/fx hedging Increase efficiency productivity through training initiatives Minimise rework cost through forward looking quality assurance Alignment of KPIs to project performance to manage costs Original Plan often based on optimistic assumptions in regard to project execution and market success Risked forecast dynamically updated based on current status and forward-looking risk assessment Post mitigation forecast considering impact of net positive investments into mitigation activities Enhanced value capture 2 Project delays 3 Profitability shortfall Design/technology choices for implementation Timing flexibility and schedule re-sequencing Integrated project management data (one timeline, cost plan, business case) Resilience in operating model/operational excellence/ pricing and contract design choices Strong accountability for project management for financials Organisational improvements and BU incentives 9
Large Project Risk Management approach Three key stages define the approach to capital project risk management, and can be applied to a variety of projects at any point in their lifecycle Project phases Risk assessment 1 and quantification 2 Dynamic Forecasting 3 Execution and mitigation tracking Objective Determine key risks and analyse risk drivers Identify and evaluate key risk mitigation options Develop project mitigation monitoring tool Calculate impact of key project risks Develop a risk model for future usage throughout the lifecycle Develop a set of mitigation measures for future implementation Operationalize mitigation actions Key activities Develop perspective of engineers/ management Agree risk prioritization Determine data and quantification requirements Develop risk quantification model Calibrate results and prioritise risks for mitigation Develop risk mitigation activities Assessment of cost-benefit of mitigation options Expected NPV versus option cost Compare to project hurdle rate and risk appetite Develop governance framework and guidebook of mitigation activities Develop mitigation implementation action plan Assign risk mitigation owners Determine operationalization of mitigation activities timeline Provide effectiveness tracking platform for mitigation measures Integrate mitigation tracking into project operations Organizational capability growth 10
Risk assessment and quantification Often large capital projects suffer from a high concentration of risks, implying that a few risks represent more than the majority of the overall volatility Example Nuclear Power Plant project NPV risk contributions by factor (BN USD) Sanitized client example High concentration of risk around top 3 drivers NPV risk contribution Total risk to NPV Difference between the sum of individual contributions and total risk Delay of reactor vessel supply Works / activity sequencing Delay of cooling pumps Delay of steam generator Coordination of construction works Poor quality of works Shortage of labour Poor contractor selection Weak equipm't supply chain Project design Construct. equipm't & materials issues Issues w/ working docs Slow/ costly tendering process Complex cost planning Cost/ delays in decisionmaking Postponed delays Cost/ delays - breach of contract Postdecision equipm't specs change Funding/ liquidity Other ext. Risks Transparency on key drivers of NPV dilution provides the basis for the development of effective mitigation strategies Notes: Represents individual risk contribution excluding inter-risk diversification. NPV contribution as deviation from plan in the 1:10 pessimistic case 11
Key drivers of deteriorating project performance Case example: Despite significant potential cost overruns, we found delays to commissioning posed the greatest threat to the erosion of project NPV Impact of cost overruns Breakdown of costs Impact of project delays Key drivers of project delay Other 18% Construction 43% Supply of reactor vessel Supply of polar crane Supply of pipelines of main circulation line Supply of pipelines of emergency core cooling system Equipment 39% FCF impact of cost vs. delays (2016) Typical drivers Miscalculation of cost during planning Price changes in steel, copper, and other commodities Default of contractors Insufficient delivery quality Supply of turbine condensator Supply of steamgenerators, including pillars Construction of containment at level till +55,6 (2nd tier of containment) Supply of suction pipe of turbine driven feed water pump and Supply of high pressure preheater Supply of high (HPP)-6 pressure preheater #6 SA. Assembly of turbogenerator Supply of high pressure preheater Supply of high (HPP)-7 pressure preheater #7 SD. Installation of turbine capacitor condersators (without water box) Supply of feed water line from turbine driven feed water pump to high- Supply of the main circulating pump Supply of pressure compensator vessel 0 100 200 300 400 Optimistic case delay (days) Mean delay Pessimistic case delay (days) Delays Cost Average forgone revenue of a 1 day delay = $1 MM 12
Identification of risk mitigation measures A detailed analysis of NPV sensitivities allows to evaluate mitigation strategies in line with their impact on the overall project value NPV risk contribution (USD MM) Time contribution (days) Sanitized client example Poor contractor selection Weak equipm't supply chain Project design Construct. equipm't & materials issues Issues w/ working docs Decrease in risk contribution due to realization of the mitigation measures Slow/costly tendering process Cost/delays in decision-making Complex cost planning Post-poned delays Cost/delays - breach of contract Post-decision equipment specschange Funding/liquidity Other external risks 0 50 100 150 200 250 0 100 200 300 Without mitigation measures With mitigation measures The analytical approach to project risk identification, quantification, management and mitigation helped to reduced expected delays by more than 10 months 13
Project risk appetite Risk mitigation impacts Risk mitigation measures can be developed to bring net risk exposure levels within an acceptable tolerance range NPV effect of mitigation measures (Deviation from plan in pessimistic case, US$MM) Unmitigated NPV (Rostov-3) impact A Current measures B Achieving a significant effect with mitigation measures in this group is possible with an aggressive pace of implementation New measures implemented by general contractor C New measures implemented by all parties involved D Residual risk (Rostov-3) Project specific measures Non-project specific KPIs Note: Possible deviation of the realistic values from the calculated ones can occur even if all mitigation measures are fully realized A Contractor under-delivery: proactively allocate less attractive tasks and improve on-site task management Unavailability of material: LEAN program roll-out and integration with project management systems Design errors: technological sequence re-ordering Supply chain: pressure on suppliers for on-time delivery B Contractor under-delivery: Use of single consolidated timeline Design errors: develop new KPIs and incentives to improve replanning process Supply chain: provide first drafts of the documents for equipment at the early staged of the delivery C Contractor under-delivery: use hi-tech equipment, increase financial responsibility and incentives for required quality level, as well as provide additional education to engineers Supply chain: increase inventory warehouse space, start mounting already available equipment and improve approval process for recovered equipment Complexity in cost planning: create additional items in the master data catalogue for equipment items ensure full adequate capture D Contractor under-delivery: refine compensation structure and production and technical education Supply chain: improve overall QA and approval process Unavailability of materials: Develop crane facilities Tendering process: improve tendering process by increasing the specificity of tenders, restrict the number of suppliers for delivery, and change the weighting between cost and other factors (e.g. reliability) Number of risks: centralize management of equipment inventory and establish clear divisions of responsibilities and 14
Project management tool In order to enable full implementation of mitigation measures we use a specialized mitigation tracking tool linked to the risk model Link between project management tool and risk model Risk model Risk parameterization Project management tool Purpose Allows regular reporting on risks and associated mitigation measures Saves information regarding mitigation measures and actions for their realization (mitigation guidebook) Provides regular and standardized reporting platform Key risks Risk quantification Use and process Risk model provides key risks via the dedicated export sheet Mitigation measures are being developed and assessed Mitigation measure activity plan entered into the tool and tracked regularly Standard reporting available to management Propose to include in standard reporting 15
Benefits from this approach Large project risk management can improve IRR (by 1 to 1.5%) and reduce risk cost by 15-20% Increased expected IRR, with reduced variability Centralizes financial and technical operating information to provide visibility into project s economic drivers and sensitivities Identifies material economic drivers and risk neutral ways to increase return using physical and financial contracts (suppliers, EPC contractors) IRR uplift of >150 bps from baseline estimate Greater capital efficiency, with overall downside protection Provides a framework for analyzing and interpreting the risk-return trade-offs and the cost-benefit of alternative risk mitigation strategies Leads to most efficient allocation of risk management resources that keep the project within investors acceptable risk taking levels Total cost of risk reduction of 15-20% from status quo mitigation plan Improved investor confidence in project economics Clear and compelling story for investors that rigorous planning and risk analysis has been completed for the project Reassures potential investors that the economic business case is supported under a wide range of market scenarios Full capital raised with 20% reduction in debt financing costs Source: Oliver Wyman client project results with clients on Large Project Risk Management 16
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