INCORPORATING RISK IN CAPITAL PRIORITIZATION

Water and wastewater utilities across the nation are faced with increasingly complex capital improvement decisions. While existing equipment ages and needs to be replaced or upgraded, population growth demands that utilities invest in new infrastructure. The myriad of stakeholders involved adds more complexity to the decision-making process. Developing strategies and making decisions in an environment where many of the parameters are uncertain is a challenge that requires experience and judgment. There are several approaches to addressing this uncertainty ranging from “six people in a room” to extremely complex statistical modeling. Often times, the correct solution lies somewhere in the middle, where institutional and expert knowledge is combined with probabilistic techniques. This approach allows for structured decision-making that incorporates risk elements while maintaining transparency for all stakeholders.

Several water and wastewater utilities across the United States are in the process of conducting comprehensive and systematic evaluations of their systems in order to develop a framework for prioritizing necessary capital improvements. Prioritizing these capital expenditures requires a dynamic and flexible process that can evaluate a wide variety of projects on a consistent basis. The prioritization process must be designed to develop action programs that reduce downside exposures and improve expected outcomes. In short, the process must be:

Transparent; easy to understand

Documentable

Defendable to the public, regulators, and oversight agencies

Black & Veatch has developed a decision-making process that consistently and transparently evaluates a wide variety of projects and issues that confront utilities. The analysis uses a probabilistic approach utilizing Monte Carlo simulations and is quantified through Net Present Value tornado diagrams and probability distributions. The evaluations are accomplished by assessing the condition and failure probability of components; identifying and evaluating rehabilitation, repair, and replacement needs; developing cost estimates of necessary improvements; and producing a capital improvement program that is prioritized using a defendable and statistically-based process.

This paper examines the detailed cost, probability, and timing estimates within a customized financial evaluation model in order to analyze the value and risk mitigation effectiveness of proposed capital projects. In particular, this paper discusses:

In-depth definition of issues, possible outcomes, and probabilities

Fully quantified value-at-risk specification of the inter-relationships among projects and issues

Identification of innovative capital action programs with improved expected outcomes and reduced exposures

Effective program execution resulting from improved implementation plans and performance management

This capital prioritization process provides water and wastewater utilities with the ability to obtain a strategic direction in very uncertain environments and to develop proactive capital plans and investments that are evaluated on a consistent basis. In addition, this process provides an easy-to-understand framework that facilitates “buy-in” and support across all organizational units.