INFRASTRUCTURE RISKS: ENABLING INFORMED DECISIONS Large capital project risk management

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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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CONFIDENTIALITY

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Similarly, management consulting is a competitive business. We view our approaches and insights as proprietary and therefore look to our clients to protect 's interests in our presentations, methodologies and analytical techniques. Under no circumstances should this material be shared with any third party without the written consent of .

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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

Cost overruns

Delays 150 – 200% 40 – 50% 30 – 50% 20 – 30%

100 – 150% 50 – 70% 30 – 60% 15 – 25 %

Planning

• Business-driven project sizing

• Trade-offs invest- ment / operations

• Technology choices

• Equipment

specification gaps

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

Transparency and oversight

• Real-time

progress / issue reporting

• Timely quality assurance

• Delays at

commissioning

• Opportunism or even fraud on-site

Execution

• Deviation management

• Qualified labour force

• Automation and tooling

• Raw materials quality

Nuclear Power Plants

Transport infrastructure

Chemical plants Oil and gas

upstream

Source: Oliver Wyman analysis, delays reflect global industry averages within last decade

Selected typical pain points

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Case study: Typical project delivery issues

Typically large construction projects face a variety of challenges that lead to delays and cost overruns

Risks and challenges Lessons learned

Lack of

risk awareness

• Optimistic planning and expectations, limited reflection of risks in business plan

• Lack of open communication about risks

• Blame games to avoid being risk owner

• Introduction of capital project risk management as a cornerstone to risk culture

• Usage of risk-adjusted KPIs for steering

Limited cost transparency

• Limited consideration of cost escalation over time & across technological alternatives

• Insufficient cost calculation and budgeting

• Limited incentives for cost reduction

• 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

Misaligned

tendering process, commercials and execution

• Lack of long-term partnerships

• Imbalance between price and quality focus

• Prefabrication issues resulting in rework

• Pre-screen and pre-qualify potential suppliers

• Use of framework contracts to build long-term relationships with quality suppliers

• Tighter oversight of prefabrication quality Regulatory impacts

and requirements

• Increasing specifications and functionality to adapt to growing regulations

• Increasing safety regulations

• Regulatory licensing delays

• 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

• Several project views exist (e.g. financial/

technological – design/construction)

• Siloed thinking indirectly promoted

• Integrate project timeline with financial plan for a

unified project plan

• Establish incentives for cooperation and risk mitigation

Lack of standard processes and capturing of experience

• Lack of standardized processes

• Limited consideration of previous project

experience

• Align KPIs across businesses (e.g. number/

turnaround time of documentation changes)

• Formalize best-practice sharing across projects

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Realizing value from risk management

Large Capital Project Risk Management approach support address and mitigation of delays and overruns risk

Increases visibility of key performance drivers

Aligns risk taking with profit and growth targets

Generates higher future returns through disciplined allocation of capital

Stabilizes performance by

protecting against downside scenarios

Promotes risk awareness

within key decision making process

Achieves risk governance and compliance as a by-

product of value creation Reduces risk through more

active and focused risk management

Reduces project

schedule slippage by

mitigating key schedule

risks

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Example of successful results achieved in large project delivery

Oliver Wyman has recently saved >$2bn from Large Capital Projects (1/2)

US$ 2,000 MM

¹

US$ 450 MM US$ 1,500 MM funding

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

1 Opex and Capex benefits

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Example of successful results achieved in large project delivery

Oliver Wyman has recently saved >$2bn from Large Capital Projects (2/2)

US$ 300 MM US$ 250 MM US$ 100 MM

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

• 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

Realized NPV impact

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Large Capital Projects challenges

Each project lifecycle phase has distinct challenges that have a compound effect on project and operational performance

Feasibility

FEED

(Front End Engineering Design)

EPC

(Engineering, Procurement, Construction)

Operations

• Misaligned objectives leaving the project delivery at risk

• Static approval process

• Biased assessments

• Inadequate knowledge of market conditions

• Unsuitable or non- regionally specific analysis

• Compressed

timeframes resulting in incomplete analysis

• 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

• 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

• 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

• Lack of alignment and ownership

• Scope increases

• High levels of contingency

• Incorrect prioritisation of options

• Misallocation of capital

• Over optimistic forecasting

Chal le nges Ris k s • Schedule and cost

overruns

• Scope reduction

• Inefficient use of resources

• Phased go live

• Reduced productivity and ROI

• Significant ‘fix’ costs

• High maintenance

Constrained internal and market capabilities and capacity

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Project delays – project operational later than

planned 2

Cost overruns – CAPEX spend is greater than

expected 1

Profitability shortfall – demand uncertainty due to macro-drivers, competition, productivity development,

cost evolution 3

• Project delays

• Design/technology choices for implementation

• Timing flexibility and schedule re-sequencing

• Integrated project management data (one timeline, cost plan, business case)

• 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

• Profitability shortfall

• Resilience in operating model/operational excellence/

pricing and contract design choices

• Strong accountability for project management for financials

• Organisational improvements and BU incentives

2 3

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

Enhanced value capture

FCF over time (In US$ MM)

Mitigation activities

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

1

Operating phase Planning and construction phase

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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

Key activities Objective Project phases

• Determine key risks and analyse risk drivers

• Calculate impact of key project risks

• Develop a risk model for future usage throughout the lifecycle

• Identify and evaluate key risk mitigation options

• Develop a set of mitigation measures for future

implementation

• Develop project mitigation monitoring tool

• Operationalize mitigation actions Dynamic

Forecasting Risk assessment

and quantification

1 2 Execution and

mitigation tracking

3

• 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

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High concentration of risk around top 3 drivers

Poor contractor

selection

Weak equipm't

supply chain

Project design

Construct.

equipm't &

materials issues

Issues w/

working docs

Slow/

costly tendering

process

Cost/

delays in decision- making

Complex cost planning

Post- poned delays

Cost/

delays - breach of

contract

Post- decision equipm't specs change

Funding/

liquidity

Other ext. Risks

Notes: Represents individual risk contribution excluding inter-risk diversification. NPV contribution as deviation from plan in the 1:10 pessimistic case

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

•Delay of cooling pumps

•Delay of steam generator

• Coordination of construction works

• Poor quality of works

• Shortage of labour

• Delay of reactor vessel supply

• Works / activity sequencing

13.57047 NPV risk contribution Total risk to NPV Difference between the sum of

individual contributions and total risk

Example Nuclear Power Plant project – NPV risk contributions by factor (BN USD)

Sanitized client example

Transparency on key drivers of NPV dilution provides the basis for the development of effective mitigation strategies

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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

0 100 200 300 400

Supply of pressure compensator vessel

Supply of the main circulating pump Supply of feed water line from turbine driven feed water pump to high-…

SD. Installation of turbine condersators (without water box) Supply of high pressure preheater

(HPP)-7

SA. Assembly of turbogenerator Supply of high pressure preheater

(HPP)-6

Supply of suction pipe of turbine driven feed water pump and…

Construction of containment at level till +55,6 (2nd tier of containment) Supply of steamgenerators, including

pillars

Supply of turbine condensator Supply of pipelines of emergency

core cooling system Supply of pipelines of main

circulation line Supply of polar crane Supply of reactor vessel

Optimistic case delay (days) Mean delay Pessimistic case delay (days)

Supply of high pressure preheater #6

Supply of high pressure preheater #7 capacitor

Construction 43%

Equipment 39%

Other 18%

Breakdown of costs Key drivers of project delay

FCF impact of cost vs. delays (2016)

Delays Cost

Typical drivers

• Miscalculation of cost during planning

• Price changes in steel, copper, and other commodities

• Default of contractors

• Insufficient delivery quality

Average forgone revenue of a 1 day delay = $1 MM

Impact of cost overruns Impact of project delays

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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

Decrease in risk contribution

due to realization of the mitigation measures

NPV risk contribution (USD MM)

Time contribution (days)

Without mitigation measures With mitigation measures

0 50 100 150 200 250

Poor contractor selection Weak equipm't supply chain Project design Construct. equipm't & materials issues Issues w/ working docs 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

0 100 200 300

Sanitized client example

The analytical approach to project risk identification, quantification,

management and mitigation helped to reduced expected delays by more than

10 months

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Note: Possible deviation of the realistic values from the calculated ones can occur even if all mitigation measures are fully realized

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 (Rostov-3)

Current measures

New measures implemented

by general contractor

New measures implemented by all parties involved

Residual risk (Rostov-3) C

B A

Project specific measures

Project risk appetite

Achieving a significant effect with mitigation measures in this group is possible with an aggressive pace of

implementation

D

Unmitigated NPV impact

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 re- planning 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 KPIs

Non-project specific

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Risk parameterization

Risk quantification

Key risks

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

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

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

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Benefits from this approach

Large project risk management can improve IRR (by 1 to 1.5%) and reduce risk cost by 15-20%

• 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 Increased expected

IRR, with reduced variability

• 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 Greater capital

efficiency, with overall downside protection

• 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 Improved investor

confidence in project economics

Source: Oliver Wyman client project results with clients on Large Project Risk Management

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