MONETIZING RISKS A PRIORITIZATION & OPTIMIZATION SOLUTION JASON DE STIGTER, P.E. 13 October 2014

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1 13 October 2014 MONETIZING RISKS A PRIORITIZATION & OPTIMIZATION SOLUTION JASON DE STIGTER, P.E. SENIOR CONSULTANT SOUTHWEST SECTION AWWA ANNUAL CONFERENCE TULSA, OKLAHOMA

2 TOP 5 INDUSTRY ISSUES MIDWEST REGION Aging water and sewer infrastructure Managing operational costs Managing capital costs Ability to fund capital programs Justifying capital improvement programs/rate requirements B&V s Project Prioritization and Optimization Process Addresses these Issues SOURCE: Black & Veatch s 2014 Strategic Directions in the U.S. Water Industry

3 PROJECT PRIORITIZATION AND OPTIMIZATION PROCESS ANSWERS THESE QUESTIONS Are we spending capital where it is most valuable? How much risk are we taking on? Which projects to delay or accelerate? Which, if any, to cut? Utilities Need to Understand and Manage Risk

4 PROCESS DELIVERS THREE CRITICAL PLANNING RESULTS FOR THE BUDGET PROCESS 1. Project Rankings Based on Financial Efficiency NPV benefit and Bang for the Buck metric quantified 2. Project Rankings Based on Planning Criteria Weighted Scoring Approach 3. Optimized Implementation Schedule that Incorporates Budget Constraints Dovetails with Utility Financial Plan for Rate Increases and Financing Needs

5 OVERVIEW OF PROCESS Genetic Algorithm Planning Criteria Capital Costs O&M Impact Revenues Preferred Install & Financial Template NPV Benefit Avoided Case Financial Efficiency Balance Scorecard Project Ranking / Financial Efficiency o Risk Tolerance o Criteria Scoring o Reg. & Env. o Safety 1 1 1

6 THE AM 10-STEP PRACTICE MODEL Identify Projects 1. What is the current state of my assets? 2. What is my required level of service? Develop Asset Registry Assess Condition, Failure Modes Determine Residual Life Determine Life Cycle & Replacement Costs Set Target Levels of Service (LOS) Determine Business Risk ( Criticality ) Prioritize O&M Investment Prioritize Capital Investment Determine Funding Strategy Build AM Plan 3. Which assets are critical to sustained performance? 4. What are my best O&M and CIP investment strategies? 5. What is my best longterm funding strategy?

7 Project Assumption ASSUMPTIONS FORM AND FINANCIAL TEMPLATE = CONSISTENCY, DOCUMENTATION Logo TMUA BUSINESS CASE DEVELOPMENT PROJECT FORM Home Project Number: WPC_NS_0001 User Input Required Project Name: Northside Interceptor Lift Station Screenin Model Project Type: Wastewater Prepared By: B&V/ACR Asset Type: Facility Latest Date Submitted: 17-Jan-13 Please review Ratings Section: Water Pollution Control Original Project Date: 1-Oct-13 Asset Description: Northside Primary Investment Driver: Replacement/Rehabilitation Historical Project No. 179 Input parameters PROJECT DESCRIPTION SECTION Insert Project Description (3-4 sentences) Raw wastewater flows through bar screens before discharging to the wetwell at the Interceptor Lift Station. Trash and rags frequently pass through the screens and clog the lift station pumps. The pumps currently operate on constant speed motors. This project will replace the bar screens with mechanically cleaned fine screens and add variable frequency drives to improve the operating efficiency of the pumps. Cleaning the screens is also a dirty job and TMUA feels like it would be beneficial to eliminate the job for the employees. Description Capital costs Dependent Projects Insert any projects that are dependent on or support this project and associated assumptions. Project Type: Project Number: Target installation Investment Driver Reference Insert Investment Driver justification assumptions (Text must justify the driver). Trash and rags passing through the screens cause clogs in downstream pumps. Impact of deferral: Costly repairs and overflows. Reduce handling of screenings at Northside List any Technical Documents or reports where information came from. Comprehensive Study PLANNING CRITERIA SECTION Insert Regulatory and Environmental Compliance assumptions here (text must justify rating/score). Potential overflows into a golf course. Minor potential for consent order in the long term. O&M pre- and post-construction Probability of failure Reg. and Env. Compliance Reg. and Env. Compliance Definition Scoring Results Regulatory Impact - WPC Environmental Impact Rating: Rating: Rating: Score: Score: Score: Consequence of Failure Revenue generated Primary Output Calculation of financial efficiency Total score based on cost and risk factors Planning Criteria Reg. & Env. Customer Service Safety

8 PROJECT BUSINESS CASE IS EVALUATED USING FINANCIAL TEMPLATE TO CALCULATE RISK WEIGHTED NPV Capital Cost of Project O&M Costs of Project Failure Probability of Failure Consequence of Failure Revenue Impact of Project Business Case Development Process Incorporates NPV and includes Risk Analysis Probability Distribution Inputs Discounted Cash Financial Template Flow Model Probability Distribution Output (Incorporates Risk/Uncertainty) % % % % Probability 60% 50% 40% % % % % $500 $550 $600 $650 $700 $750 $800 $850 $900 $ All of the above costs and revenues drive Project NPV.

9 40-yr NPV Probability Distribution Example Business Case Development NPV of Cost Water NPV Distribution of Cost --Water Sheridan Tank No. 2 Rehab/Repaint Tank Repaint/Rehab. Probability Planned Install Distribution Y-axis shows relative probability ,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 X-axis shows range of NPV results NPV of Cost (Thousands $) Failure Consequence

10 EXAMPLE PROJECT FINANCIAL ANALYSIS Business Case Development Project Value based on the Avoided Case Process Quantifies the Cost/Risk of Project Delay Probability 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Planned Install Project Scheduling Impact 2 Year Delay Cost of Delay Avoided Case 0% $200 $300 $400 $500 $600 $700 $800 NPV of Cost [$000] Value of Project Risk analysis is incorporated in NPV results through Monte Carlo Simulation

11 FINANCIAL ANALYSIS CONSISTENTLY EVALUATES PROJECTS BASED ON PROJECT NPV Business Case Development Consistent project proforma used for economic and risk analysis Both avoided costs and cash savings /revenue incorporated Financial Efficiency or Bang for the Buck = Expected Outcome / Capital Cost Count Project ID Expected Outcome NPV Capital Cost Nominal$ $000 $000 Install Year 1 Project G -36,710 1, Project Q -19,686 2, Project X -10,912 6, Project H -5,636 26, Project B -4,041 5, Project W -3, Project E -3,731 8, Project K -3,359 2, Project T -2,392 1, Project D -1,201 2, Project I , Project M ,

12 PLANNING CRITERIA ARE USED WITH THE FINANCIAL RESULTS TO ARRIVE AT A BALANCED SCORE FOR EACH PROJECT Business Case Development These Planning Criteria Results are used to validate and fine tune the CIP schedule decisions. Customer Service Safety Reg. & Env. Financial Efficiency Project A Project B Project C Project D Project E Project F Project G Project H Project I Project J Project K Project L Project M Project N Project O Project P Project Q Project R Project S Project T Project U Project V Project W Project X Project Y Score Project ID

13 Example 1: Water Tank Recoating & Repainting Business Case Development Options: Pay Now OR Pay MORE Later with shortterm cost savings. Preferred Option depends on how much MORE and when. Case Study in leveraging staff experience. POF = Years before next maintenance cycle and experience with changing historical maintenance cycle COF = Additional Capital Cost for full replacement of the water tank.

14 Example 2: Water Distribution Pipe Replacement Program Business Case Development Historical Planned vs. Unplanned for water distribution pipeline costs. Age Histograms to project future unplanned costs assuming run to failure approach and various funding levels Calculate NPV of Cost for each funding level (planned + unplanned costs)

15 Example 3: Collection System & Consent Order Risk Business Case Development Modeling Approach: Consent order applied to each basin area. POF = likelihood of repeating SSO in an basin area causing Basin Consent Order. COF = Regulator requires ultimate solution requiring additional capital projects with potential for the completion of other projects. COF also incorporates value of CIP schedule flexibility.

16 Example 4: Collection System Growth Project Business Case Development Revenue forecast is uncertain. Expected Volumes? Timing of Volumes? Used Existing Rates with a discount for other downstream costs associated with new flows to calculate an incremental rate Volumes forecast based on pipeline capacity and growth areas likelihood of success for development Projected Flows Likelihood of Success Incremental Rate Flow Timing

17 PROJECTS SCHEDULED TO INCLUDE BUDGET CONSTRAINTS Annual Capital Costs NO BUDGET constraint Installation years determined through Prioritization Process Annual Capital Costs WITH BUDGET constraint Lower ranking projects moved back in schedule to meet budget constraints Transmission Asset 1 Substation Asset Transmission Asset 1 Substation Asset Powerhouses Asset 3 Dams Asset & 4 Convyance 70.0 Powerhouses Asset 3 Dams Asset & 4 Convyance Nominal $Millions Optimization Model Nominal $Millions Annual Budget

18 OPTIMIZATION MODEL Develops Portfolio Project Schedule based on a given budget constraint Portfolio Scheduling is Optimized through Genetic Algorithm. Optimization Value = Minimize portfolio risk weighted NPV of Cost Key Questions that are Answered Cost Risk Focus: Are we spending capital where it is most valuable? Project Scheduling Risk Cost Focus: How much Risk are we taking on by delaying projects?

19 PORTFOLIO OPTIMIZATION RESULTS: RISK FOCUS Business Case Development Project Scheduling Current CIP Budget Level = Optimized CIP Budget Level Optimization decreases overall Portfolio NPV of Cost while Maintaining Budget Levels Average NPV of Cost ($Millions) $300 $250 $200 $150 $100 $50 $0 $247 $23 $43 $157 $171 $20 $23 $109 Asset Class A Asset Class B Asset Class C Asset Class D $158 $20 $22 $99 $23 $18 $17 Run to Failure Current CIP Optimized CIP

20 OPTIMIZATION RESULTS: COST FOCUS Business Case Development Project Scheduling Optimization identified $11 Million in capital project cost for delay outside of 5 Year CIP period with minimal increase in risk Additional Delays within 5 Year CIP Period

21 OPTIMIZATION RESULTS: RISK IMPACT Business Case Development Project Scheduling Value in delaying $11 million in capital projects outweighs future cost risk from system and asset failure

22 OPTIMIZATION RESULTS: BALANCED SCORECARD RISK REDUCTION Business Case Development Project Scheduling Investment Drives Risk Reduction

23 RECAP: PROCESS DELIVERS THREE CRITICAL PLANNING RESULTS FOR THE BUDGET PROCESS 1. Project Rankings Based on Financial Efficiency NPV benefit and Bang for the Buck metric quantified 2. Project Rankings Based on Planning Criteria Weighted Scoring Approach 3. Optimized Implementation Schedule that Incorporates Budget Constraints Dovetails with Utility Financial Plan for Rate Increases and Financing Needs

24 VALUE OF PRIORITIZATION AND OPTIMIZATION PROCESS Strategic Value Objectively Incorporates Risk Tolerance and Budget Constraints Defendable Approach Visual and quantified risk of project delays Condition of Asset incorporate Understanding and quantification of risk Functional Value Documentation of all project assumptions Quick sensitivity analysis Consistency Strategic and Functional Value Align to Defend Your Capital Program New budget constraints Easy integration of new projects added to CIP Quick re-prioritization when assumptions change Communication Between Business Units and Functions

25 SUMMARY - BALANCING TRADEOFFS In summary, this prioritization process and model assists utilities with managing the important balance of the following management and budget tradeoffs: Performance, Cost, and Risk Budget constraints Capex vs. Opex tradeoffs Risk: Reliability and Outages, Safety, Financial Identifies greatest Value Creation projects in portfolio Process helps management balance tradeoffs between budget constraints and risk.

26 ANNUAL CONFERENCE TULSA, OKLAHOMA OCTOBER 13-14, 2014 Jason De Stigter Senior Consultant (913) Mat Powis Senior Consultant (913)