The innovative use of risk appetite and tolerance to inform project decisions IRMSA Conference November 2012 Presented by: Oliver Laloux and Reshma Ramkumar www.mondialcons.com Specialist Risk and Business Consultants
Risk, opportunity & risk management Risk Risk is exposure to the consequences of uncertainty In context of STRATEGY and OBJECTIVES, or what success may look like at different levels It has several aspects: Causes Controls Consequences Likelihood Treatment Opportunity/Reward
Risk management adds value All businesses and projects involve technical & commercial risks Risk taking is often necessary to achieve business targets...... but risk-taking must be managed carefully
Level of Granularity Decision Making takes place in three broad spheres Projects for growth can range in impact and positioning from the operational to the strategic Strategy Strategy defines long term corporate goals - e.g. Become market leader by increasing market share by 20%in 5yrs Provide shareholders with a 15% ROI Tactical & Capital Allocation Operations Budgeting Capital Allocation Plans translate strategic goals into more tangible medium term objectives- e.g. - Open 3 new mines in the next two years Increase margins by 15% Budgets are short term control mechanisms that set performance parameters - e.g. cost / ton revenue / employee Time Horizon
Definitions Risk appetite How much risk does the business feel comfortable with in any given area? ie Business as Usual risk levels Risk tolerance How much risk might we practically accept, in excess of our risk appetite, in pursuit of greater reward ie what is our absolute limit within any given area? Both of these must take Reward into account risk tolerance should be viewed as the outer limit, beyond which no further increase in reward will justify further increase in risk.
At any one time the project pipeline is relatively full At many companies a disproportional amount of time and effort is spent here i.e. on project execution
Decisions? At any point in time decisions have to be made on either what project? or what option? Traditional valuation models (NPV, IRR, RIO, etc..) do not always provide the full story So we use risk management and specifically our RA tools in combination with risk appetite and tolerance as a tool to help decisions
Background Risk management methodologies and tool sets premised on ISO 31000. With specific policies, procedures and supporting guidelines Requires risk to be identified and managed at all stages of the funnel With specific project/ investment set, aligned and integrated to the group risk management way Risk prioritisation scheme that looks like:
Description Revenue variance annual or Impact on the 5 year ounce profile Stakeholder Relations/reputation Environment (Incl. noncompliance with permits or licenses Industrial Relations Rating value Risk impacts on objectives- severity scales Financial Projects Legal Market cap/npv Profit variance annual Safety & Health Capex Variance Time impact Operations Risk impact categories relate to strategic objectives and operational/ business plan/project objectives Projects Capex Variance Scope variance or Impact on the 5 year ounce profile Time impact
Minor Major Catastrophi c factor Risk is considered in terms of A variance from what success looks like Positive or negative Revenue variance annual /Loss of Investment (USD) Health and Safety Time impact Reputation/stakeholder relations Environmental Legal/Licence to operate OPEX fluctuations (impact on cost curve position) 1 Large variance from where the company wants to be- dangerous territory only to be tolerated if reward is equally large and risk can be treated Little Variance from defined success factors Large variance from defined success factors Small to negligible variance from stated success factors, generally within the appetite of the company given that there is a reward associated with taking the risk
Definitions Risk appetite How much risk does the business feel comfortable with in any given area? ie Business as Usual risk levels Risk tolerance How much risk might we practically accept, in excess of our risk appetite, in pursuit of greater reward ie what is our absolute limit within any given area? Both of these must take Reward into account risk tolerance should be viewed as the outer limit, beyond which no further increase in reward will justify further increase in risk.
Appetite and Tolerance
Appetite and Tolerance Risk Appetite / Tolerance - Growco top risks - May 2011 Growco Risk appetite Risk Tolerance Time > 24 month delay 6-12 month delay 6 month delay 3 month delay 2 month delay Scope variance/ profile variance > 40 % >30 % > 20 % >5% Capital variance >25 % of > 20 % of >15 % of > 5 % of impact on profile within 5 year budget period > 400 000 > 300 000 > 200 000 How > much 10 % or >10% of how little of something > 100 000 >50 000 7 6 5 4 3 potential for security incidents Early structural failure of current facility Labour department interventions HSE event in old facility These look different depending on sunken capital consequences/im pact types 1 month delay in project - None < 5 % of > 20 000 2 None < 2 % of < 10 000 1 1 2 3 4 5 6 The next 20-30 years 1 event every 50 years 0-15% 20-30% Within a 5 to 10 year time frame 30-50% The 5 year Strategic Planning period 50-65% Over time 1 to 2 year budget period 65-80% Every 6 months 80-100%
Practical application in projects We had one project with four options Essentially aimed at more or less the same outputs but key differences in infrastructure, context and technical details Capex range R 500 m - R 1,4 billion Financially, the cheapest option was obviously the preferred option Detailed risk assessments (upside and downside), of the project and to the project completed as part of the considerations
Project A: Option 1 Risk Appetite / Tolerance - Growco top risks - May 2011 Growco Risk appetite Risk Tolerance Time > 24 month delay 6-12 month delay 6 month delay Scope variance/ profile variance > 40 % >30 % > 20 % Capital variance >25 % of > 20 % of >15 % of impact on profile within 5 year budget period > 400 000 > 300 000 > 200 000 7 6 5 potential for security incidents Early structural failure of current facility Labour department interventions HSE event in old facility sunken capital 3 month delay >10% > 10 % of > 100 000 4 2 month delay >5% > 5 % of >50 000 3 1 month delay in project - None < 5 % of > 20 000 2 None < 2 % of < 10 000 1 1 2 3 4 5 6 The next 20-30 years 1 event every 50 years 0-15% 20-30% Within a 5 to 10 year time frame 30-50% The 5 year Strategic Planning period 50-65% 1 to 2 year budget period 65-80% Every 6 months 80-100%
Option 1 Growco Risk appetite Risk Tolerance Time Scope variance/ profile variance Capital variance impact on profile within 5 year budget period > 24 month delay in the delivery of the project (stage or execution) > 40 % >25 % of > 400 000 7 Decision to stop project once started (old area closed off)* 6-12 month delay in the delivery of the project (stage or execution) >30 % > 20 % of > 300 000 6 Extended EPCM and Costs Product contamination (from extended scope) Condition/Sustainabilit y of current plant External o cha 6 month delay in the delivery of the project (stage or execution) 3 month delay in the delivery of the project (stage or execution) > 20 % >10% >15 % of > 10 % of > 200 000 > 100 000 5 4 She/Security incident Financial fluctuations (forex, input costs) Cost explosion on old facility Structural steel (availability, price) 2 month delay in the delivery of the project (stage or execution) >5% > 5 % of >50 000 3 Turnover of staff - loss of skills 1 month delay in project - None < 5 % of > 20 000 2 None < 2 % of < 10 000 1 1 2 3 4 5 6 In extreme circumstances only, 1 event every 50 years 0-15% Could be incurred in the next 20-30 years 20-30% Could be incurred within a 5 to 10 year time frame 30-50% Could be incurred within the 5 year Strategic Planning period 50-65% Could be incurred once over the next 1 to 2 year budget period 65-80% Could be incurred twice or more during the next financial year (every 6 months) 80-100%
Option 4 Risk Appetite / Tolerance - Growco top risks - May 2011 Growco Risk appetite Risk Tolerance Time > 24 month delay in the delivery of the project (stage or execution) 6-12 month delay in the delivery of the project (stage or execution) 6 month delay in the delivery of the project (stage or execution) 3 month delay in the delivery of the project (stage or execution) 2 month delay in the delivery of the project (stage or execution) Scope variance/ profile variance > 40 % >30 % > 20 % >10% >5% Capital variance >25 % of > 20 % of >15 % of > 10 % of > 5 % of impact on profile within 5 year budget period > 400 000 > 300 000 > 200 000 > 100 000 >50 000 7 6 5 4 3 Structural steel (availability, price) She/Security incident Financial fluctuations (forex, input costs) Condition/ Sustainability of current plant Product contamination (from extended scope) Cost explosion on old facility Decision to stop project once started (old area closed off)* Turnover of staff - loss of skills External or internal change 1 month delay in project - None < 5 % of > 20 000 2 Extended EPCM and Costs None < 2 % of < 10 000 1 1 2 3 4 5 6 In extreme circumstances only, 1 event every 50 years 0-15% Could be incurred in the next 20-30 years 20-30% Could be incurred within a 5 to 10 year time frame 30-50% Could be incurred within the 5 year Strategic Planning period 50-65% Could be incurred once over the next 1 to 2 year budget period 65-80% Could be incurred twice or more during the next financial year (every 6 months) 80-100%
Decisions Option 4, although more expensive did not necessarily carry less risks However, the type and range of risks were greater in terms of option 1 (range in 2,3) A number of them were above the Board s stated tolerance position And we could not treat them to a lower position
Lesson learned Requires some education of decision makers Very useful as a decision tool together with traditional elements (NPV, etc..) Helps and informs decisions where an easy solution is not readily obvious DEFENSIBLE Must consider risks to the project and of the project Is done in connection with QRA, Sensitivity analysis etc.. Takes a bit more time, but avoids delays going back and forth between options.
Thank You Reproduction and distribution of this document without the express permission of the authors is strictly prohibited. Although some of the materials in this presentation are in the public domain, some of the methodologies and models presented herein are proprietary materials of the author(s) and or the company for whom the presenters work..