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Operational Risk Management During Uncertainty

Issue 6 and Volume 90.

by Christopher Isakson, DNV KEMA

Regulated electric and gas utilities have seen significant changes as the traditional one-way, franchise monopoly, service model evolves into a more interactive relationship because of smart grids, microgrids, third-party participation in supply markets, regulatory pressures to integrate renewables and demand-side initiatives.

A shift is gaining momentum quickly largely because of state and federal regulatory pressures. Traditional approaches to assessing system and individual asset operating performance and standards, developing rates and regulatory strategies, and responding to federal, state and independent system operator mandates will be increasingly ineffective. Utilities will need new strategies and tools that enable them to:

  • Understand the technologies to be integrated and the requirements of stakeholders that own or operate the technologies;
  • Identify skill sets to meet future customer-driven technology requirements; and
  • Optimize investments in people, processes and assets within a rapidly changing landscape.

Utilities can expect to see more rigorous regulatory prudency reviews, and they will need new planning tools that demonstrate all options have been considered and an optimized capital deployment plan is followed.

Challenges

As a result of the financial crisis, capital expenditures have been constrained at many utilities with only unavoidable expenditures such as refueling reactors at nuclear power plants’ being approved. Power plants—largely coal- and unfinished natural gas-powered—have been mothballed and in some cases cannibalized for parts for existing plants. The result is a backlog of capital projects that compounds the ongoing investment optimization and asset management challenges. In addition, some utilities have not historically viewed capital spending on a fleet basis, which has led to projects that do not deliver the expected rate of return.

Key performance indicators, such as expected forced outage rate (EFOR) for assets, might not be aligned with overall corporate goals and objectives. Business processes typically are silo-based and nonstandard across a generation fleet and transmission and distribution systems, which creates inefficiencies and contributes to higher operations and maintenance costs.

Another contributor to higher costs is the hasty adoption of technology solutions that tend to be point solutions, rather than enterprise business solutions. This can lead to an inability to share data and information with other users, resulting in process inefficiencies and duplication of efforts. Furthermore, corporate long-term asset plans, typically 10-year plans, rarely are integrated with short-term planning for generation assets—one to three-year plans, typically.

“Utility Trends 2012,” an article published in the May/June 2012 issue of Electric Light & Power magazine, quoted Oracle Utilities Senior Vice President and General Manager Rodger Smith on the subject.

“Continuous pressures to reduce costs in capital budgets, maintenance, operations and overhead are forcing utilities to look for better operational analytics and related investment-planning tools to better control costs and optimize limited budgets,” Smith said.

Utility executives are facing competing objectives, higher costs, a massive amount of customer data and rising expectations for service and reliability. Many view operational risk management as the key.

Optimizing Capital Expenditures

Hawaiian Electric Co. Inc. (HECO) was dealing with many of these challenges, as well as assets’ dating from the period of explosive growth in the 1950s that are approaching end-of-life conditions. Recent severe weather had caused serious outages. To support the corporate goal of operational excellence and high customer satisfaction, HECO wanted to ensure its transmission and distribution asset management and proactive replacement program would maximize the value of asset investments.

The Honolulu Star Advertiser quoted HECO President and CEO Dick Rosenblum on the subject.

“Using predictive and preventive diagnostics, asset management (at HECO) is focused on cost-effectively upgrading equipment on our electric system,” Rosenblum said.

HECO enlisted DNV KEMA to assess its asset management practices and equipment data, including current roles, processes, data and information technology systems that support asset management. Using its operational risk model and tools, DNV KEMA provided recommendations for investment prioritization, a streamlined planning and approval process, an asset management model for proactive replacement, and appropriate performance measures for the program.

HECO then had a solid analytical approach for determining capital investment requirements for each asset category. The audit also provided a portfolio analysis of the investment scenarios of each asset strategy to determine optimal investment projects for different levels of funding. The portfolio optimization effort provided HECO with a deeper understanding of the returns and trade-offs associated with investment levels and asset categories (e.g., investing in tree trimming vs. pole replacement). Finally, the project assisted HECO in presenting and defending these investment requirements in rate case filings and proceedings.

Operational Risk Management

Under increasing pressure from regulatory agencies, rating agencies and external stakeholders to improve operational performance, progressive utilities are taking a holistic approach. Operational risk management (ORM) (see Figure 1) addresses operational risk considerations across the enterprise and includes all major business functions (e.g., strategy, capital planning, etc.).

It provides a way to manage the risk of direct and indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. ORM considers the interaction among departments and provides transparency within an organization to identify and manage risks and assure that asset strategy and performance consistently support corporate goals. The result is portfolio optimization, which balances strategic, financial and operational risk at the enterprise level, as well as the business unit level, such as generation. A comprehensive ORM program:

  • Assesses, quantifies and mitigates operational risks;
  • Monitors identified operational risks;
  • Identifies causes of loss events expected and unexpected based on possible probability of occurrence;
  • Analyzes risks for trends, relationships and patterns; and
  • Identifies associated operational risk costs and impact to revenue and return on investment.

ORM examines core utility operations—generation, energy delivery, pipeline operations—as well as core utility management functions, including information technology and telecommunications. It addresses current and future risks and provides strategies to manage tangible operational risks while planning for management of the risks of emerging technologies in a climate of tight working capital, regulatory imperatives and high visibility for any perceived reliability or response shortfalls.

A key aspect of ORM is asset management, the optimal allocation of resources in the pursuit of identified business objectives. These objectives may include meeting threshold criteria related to reliability, performance, costs and prevailing legal mandates. The question is, “Where do I invest the next dollar to achieve the desired objectives, subject to various constraints?”

Asset management is not a new practice; utilities always have managed assets. The change in how utilities manage their assets, however, is part of the shift. Asset management approaches and analytical tools have matured, and decisions can be based on data and facts, not just instincts and intuition. These solutions have come in time to address critical challenges related to increased operating performance pressures and an aging infrastructure and work force.

Need for Operational Risk Management

As energy companies focus increasingly on the risk of utility operations and impact on customers and revenue, they will look for tools to assess complex situations, with many factors outside their control. To increase value, utilities must make risk-adjusted decisions that maximize revenues and reduce costs in an environment of regulatory uncertainty. The problem can be daunting (see Figure 2).

Cost-related factors outnumber the revenue-related options. Moreover, with an increased emphasis on integrating renewable energy into the generation fleet because of renewable portfolio standards, the costs are higher. These increased costs are not allowed to be passed on to customers as part of a regulatory rider, such as the fuel purchase adjustment. Hence, it is imperative to take actions that yield the greatest return and pass regulatory prudency.

Conclusion

Operating in a regulatory environment that pushes utilities to adopt strict maintenance regimens or investments in new assets, generating utilities should avail themselves to the global implementation solutions knowledge base that combines deep analytics, testing and certification expertise with real-world knowledge of risk management, the utility business and equipment and solutions analysis to enable maximum, lasting value.

Executive management must take a holistic view of operations from the control room to the boardroom to better ascertain asset health and management decisions related to investment options and anticipated results. With modern analysis tools, models and global networks, they can know ahead of time why components fail and how to detect and forecast the probability of failure.

Author

Christopher Isakson is a principal with DNV KEMA in Fairfax, Va. He has an MBA from Cornell University and a bachelor’s degree from The George Washington University.

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