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

SALAH AL-RAMADHAN

Senior Analyst – Risk

Engineering

KPC

Quantitative Risk Management

Methods, Techniques and Tools

Kuwait Petroleum Corporation

KPC Upstream KOC KGOC KUFPEC Midstream KOTC IM Downstream KNPC KPI PIC KAFCO

The national oil company of Kuwait;

Operates in Exploration and Production,

Refining, Petrochemical and

Transportation;

Activities concentrated domestically with

increasing growth overseas;

Overseas expansion mostly through joint

ventures and joint operations;

Production currently in excess of 3 million

BPD and 14 million tpa of associated and

free gas;

Petrochemical business focused on

poly-olefins, aromatics and glycols;

Turnover – c. KD 39 billion (2013/14)

Assets – .c. KD 32 billion (2013/14)

Capex in fixed assets c. KD 32 bn next

five years:

3

KPC ERM

Treat Risks Assess Risks Com m uni cat e & C ons ult M oni tor & R ev iew

Establish the Context

Identify Risks Analyze Risks Integrate Risks Evaluate Risks Avanon OpRisk Suite

OpRisk Reporting Module (ORM)

Loss Tracking Module (LTM) Self Assessmen t Module (SAM) Indicator Rating Module (IRM) Action Tracking Module (ATM)

Quants. (QTM)

Administration Management Module (AMM)

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.

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

Treat Risks Assess Risks Com m uni ca te & C ons ul t M on ito r & R evi ew

Establish the Context

Identify Risks

Analyze Risks

Integrate Risks

Evaluate Risks

Monitor & Review

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.

KPC ERM Objectives:

SOURCE: Team analysis

Three key objectives of KPC’s risk

Achieve high certainty that the oil sector will meet

the expectations of the State

Enable the oil sector to make a more fact-based and

quantitative assessment of risk vs. return trade-offs

in its activities and projects

Ensure the availability of adequate funding to

support oil sector capital expenditure

Risk modeled and have effect

KCo1 KCo2 KCo3 KCo4 KCo5 KCo6 KCo7 KCo8 KCo9

7b HR and HSSE – Labor disruptions

6d Retail margin volatility

5d Charter rates

9 New technologies

7a HR and HSSE - Manpower

8b Operational - Sabotage

10 Unexpected drop in reserves

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

6a FX volatility

6b Refining margin volatility

6c Petrochemical price volatility

6e Counter-party credit risk

8a Operational - Production

Risk

SOURCE: Team Analysis

The top ten risks for KPC were identified and

mapped to each of the K-Cos

KPC

1400 risks from risk registers were considered

Top 10 risks for KPC

Top risks

Strategic project risk

▪

Large project execution risks

3

Portfolio/business risk

▪

Disruptions in hydrocarbon market due to demand shifts in import countries

4

Financial risk (Counterparty, Liquidity, Market)

▪

Global crude/gas price volatility and related country/credit risk

▪

Refining/petrochemical margins and related FX risks

5 6

Political/

regulatory risk

▪

External influence on key decisions

▪

War or political instability in the region

1 2

Operational/ technical risk

▪

HSSE and HR risks

▪

Operational risks leading to unplanned shutdowns or other supply chain disruptions

▪

New technologies risks Company reserves

7 8 9 10 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

Risk Modeling

Three quantitative tools were developed to answers the key

questions for decision makers

Five Year

Planning

(CFaR)

Capital

Investment

and Appraisal

(RAROC)

•

What is the probability of the project to

break-even?

•

What are the top-risks for the project?

Strategic

Direction

and Planning

Process

•

What is the best strategic option based on

risk return profile?

•

Will the company be able to repay its debt

commitments?

•

What is the chance of meeting Five Year Plan

the baseline cash flow?

•

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?

Software -Palisade @Risk add in to XL

@Risk features currently used :-

RiskCorrmat

RiskTarget

RiskCorrel

RiskMax

Data Source

RiskMean

RiskPercentile

RiskOutput

RiskDiscrete

RiskResultsGraph

RiskNormal

RiskPert

RiskTriang

RiskUniform

Central or network servers

• Functionality – around correlation and matrices;

• Ease of access and familiarity – with the XL style user interface;

• Excel skills – easily extended into @Risk application and environment;

• Economics and efficiency – cost and speed to get up and running acceptable;

@Risk 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;

Choice based on:-

Architecture: 4 modules centralized at KPC and 7

modules maintained at K-Company level

KPC level K-Com-pany level 5 11 … KPI CFAR PIC CFAR KOC CFAR K-companies have option

to change shared

assumptions for running their own scenarios

Shared K-company run data

3

KNPC CFAR KGOC CFAR

Shared engine

Assumptions master 2 4 KPC CFAR model

Each K Company has it’s own risk model; output measures

risks modelled both in deterministic and stochastic cases

SOURCE: Team analysis; expert interviews; k-company working teams

War/political scenario Project delays

Oil price

Relevant risk factors

▪ 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

Financial models

▪ 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

… KPI KNPC KOC Model output Financial Non-financial ▪ 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

Model provides cash flow from operation over time

and as a cumulative distribution

20YY

+3

+2

+1

20XX

Mean Baseline 95th 5th

Mn KD

Yearly cash flow from operations

(20XX-20YY)

5th

Mean

95th

Cumulative operating five year cash

flow (20XX-20YY)

Model can also calculate

deviation from baseline for

P

ro

b

ab

ilit

y

Cash flow

Cash

f

lo

w

x

y

z

Illustrative

Baseline

Rank risks based on contribution to total cash flow at

risk, and quantifies diversification effect

Cash Flow @ Risk =

Baseline – 5

th

Percentile

Risks

Total

Diversification

HSSE and HR risks

Operational risks

Refining/petrochemical prices

New technologies risks

Large project execution risks

External influence on

key decisions

Global crude/gas price volatility

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

SOURCE: K-Company CFAR model – illustrative example. Team analysisa

5 year cash flows (20XX-YY)

Illustrative

Old project appraisal approach with a probabilistic

risk view

From deterministic …

… to probabilistic

3

2

1

Future value

Frequency of occurrence in simulation

3

2

1

High

case

Base

Case

Low

case

▪

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

The risk-return quantification methodology adds probabilistic

metrics on top of the current appraisal and strategic metrics

▪

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

Return metrics Time metrics Sensitivity/ Scenarios Value metrics

Additional risk-adjusted metrics

introduced by the methodology

Metrics was used for

program appraisal

1

▪

Expected IRR

▪

RAROC (Risk adjusted return on

capital)

▪

IRR

▪

Profitability index

▪

Expected payback period

▪

Payback period

▪

NPV at risk (NPVaR)

▪

Probabilities

–

To breakeven

–

To meet baseline

▪

Sensitivity of NPV to

–

CAPEX overrun

–

Oil price

–

Project delay

▪

Scenarios

▪

Expected NPV

▪

NPV

Overview of risk-based economics for project

Key metrics

▪

IRR, % 13 10%

▪

Payback period, year 10 tbd

▪

NPVaR, KD B1-P5

▪

Prob. to breakeven, % 70% tbd

▪

NPV/I, % >0

24%

▪

Prob. to meet baseline, % tbd

▪

Profitability index 1.88 >1 E1

▪

NPV, KD Min Required Expected metrics NPV distribution, KD Key risks Key risks NPVaR, KD Contribution, Percent 0 NPVaR = B1-P5 Expected NPV Baseline Observations

▪

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 E1 B1 (P5) 24% 5th percentile 10 9 1.8 B1 Baseline metrics

▪

RAROC, % 10% >0 80% Return on capital BIGGER

▪

Capex , KD BIG 85% Breakeven point

SOURCE: Economic model, team analysis

70%

NPV, KD

20BB

▪

Commissioning date 20AA

.CCCX

▪

Peak production, tpa CCC2

69 4 20 R4 Execution delay Feedstock availability Crude price Refining margins Capex overrun R1 R2 R3 -R5 59 Probability to meet baseline Probability to breakeven -1 Illustrative Numbers 19

NPVaR breakdown

Key risks Assumptions

R1

R2

All All Rs together

Diversification Totall Sum of Rs Execution delay (-R5) Feedstock availability R4 Crude price R3 Refining margins Capex Overrun

▪

Modeled as delay on similar projects

▪

~29% volatility based on historical oil prices for last 20 years

▪

~20% volatility based on historical oil and products prices for last 20 years

NPVaR, KD

▪

Average delay of 11 months with a standard deviation of 6 months based on a benchmark

▪

-5% to 40% overrun in capital expenditure based on external benchmarks

Risk Modeling Strategic Options

Consider several strategic options, while remaining within the boundaries

of internal constraints

PRELIMINARY Option 1 Option 2 Option 4

Strategic initiatives

Potential strategic options

Total capex for strategic programs

108 Total investment

Option 5

92

▪

Develop upstream unconventional 12 0 14

▪

Develop non-associated gas 10 16

▪

Grow conventional internationally 22 22 22

▪

Grow refining capacity _{18 14 18}

▪

Grow refining capacity internationally 21 21 21

▪

Enhance Gas Processing / Import Capacity 5 5 5

▪

Develop upstream conventional 15

▪

Develop pet-chems <1 <1

116

▪

Grow unconventional internationally 4 4

Option 3 114 12 25 18 24 5 <1 4 14 16 22 14 21 5 7 123 9 <1 4 Option 6 0 25 18 24 5 10 <1 95 2 15 15 15 15 10 10 10 Illustrative Numbers

Value creation of strategic options on portfolio

SOURCE: Strategic Planning model, team analysis

10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 Value (NPV), KD Risk (NPVaR), KDmm Option 6 Option 5 Option 4 Option 3 Option 2 Option 1a Option 1 (Current plan) Alternative option preferable Preferred option depends on risk appetite

Preferred option depends on risk appetite

Current FYP preferable

RAROC Less risky strategy

More risky strategy KPC view

Illustrative

ERM in KPC will be much more effective organisation

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