Application of Life Cycle Analysis in the Capital Assets IndustryApplication of Life Cycle Analysis in the Capital Assets Industry

Bob PrietoCMAA Webinar

July 17, 2014

Bob PrietoCMAA Webinar

July 17, 2014

Application of Life Cycle Analysis in the Capital Assets IndustryApplication of Life Cycle Analysis in the Capital Assets Industry

About the Book What is Life Cycle Analysis? Relationship to Capital Asset Strategies The Big Ideas The Answer The Life Cycle More Math Useful Tools Application of Life Cycle Analysis in the Capital Assets

Industry

About the BookAbout the Book

Title - Application of Life Cycle Analysis in the Capital Assets Industry

Publisher - Construction Management Association of America (CMAA)

Date - June 2013 ISBN 978-1-938014-06-2

(eBook) ISBN 978-1-938014-07-9

(Print)

Books & ChaptersBooks & Chapters

Topicsin

Strategic Program Management

Bob Prieto

What is Life Cycle AnalysisWhat is Life Cycle Analysis

Life Cycle Analysis is a comprehensive cradle to grave evaluation of capital asset performance (benefits and impacts) that incorporates risk and uncertainty and considers all three of the bottom lines of the Triple Bottom Line.

Life Cycle Analysis Relationship to Capital Asset StrategiesLife Cycle Analysis Relationship to Capital Asset Strategies

Facility or mitigation evaluations as part of permitting activities – allows consideration of uncertainty, risk, scenarios and all three bottom lines

Project selection or prioritization – linked to confidence levels; include uncertainty, risk, scenarios; incorporate resiliency; all three bottom lines allow balanced process

Support project acceleration business cases more robustly

Improve estimate and schedule confidence Inform RFP requirements for PPP and other

performance based contracts as it relates to environmental and social bottom lines

Life Cycle Analysis Relationship to Capital Asset StrategiesLife Cycle Analysis Relationship to Capital Asset Strategies

Enable asset valuation for PPP solicitations and test impact of performance requirements on life cycle value

Facilitate ownership transitions of assets Evaluate full (life cycle) cost of design alternatives and

O&M strategies to enhance Capital Efficiency Strengthen asset management decision making and

processes Support portfolio management decision making Assess impacts of actions and alternatives on resiliency

Potential Owner ChallengesPotential Owner Challenges

Budget processes are not sensitive to life cycle analysis Capital and operating requirements and needs may

enter budget process from disparate groups Costs of indirect support elements viewed as competing

for direct project resources– Support “codes” not recognized as project enablers

Support function leadership may have “mission” backgrounds without a broader “business” context

The Big IdeasThe Big Ideas

Life Cycle Analysis vs.– Life Cycle Costing– Whole Life Costing– Uncertainty

7DSM Optioneering

Life Cycle Analysis (LCA) vs Life Cycle Costing (LCC)Life Cycle Analysis (LCA) vs Life Cycle Costing (LCC)

LCA differs from Life Cycle Costing through its inclusion of:– Revenue and benefits (Capital Efficiency Drivers)– Broad inclusion of indirect asset costs and externalities

• Consistent cost and scope definition is an industry issue in LCC which is not encountered in LCA

– Asset financial structure considerations– Comprehensive inclusion of risks, uncertainties and

multiple possible futures (scenarios)– Holistic consideration of the Triple Bottom Line

• LCA cares about these benefits in ways that do not traditionally reflect themselves in a LCC analysis and thus provides greater focus and impetus to sustainability efforts.

Life Cycle Analysis (LCA) vsWhole Life CostingLife Cycle Analysis (LCA) vsWhole Life Costing

LCA builds on Whole Life Costing expanding consideration to more fully include:– Risk and uncertainty– Financial structure– Environmental and social benefits and impacts on more

than just a financial basis LCA is an essential element of a well founded PPP

program (more on this later) LCA is essential to comprehensively address Capital

Efficiency

A Word on Uncertainty (1/2)A Word on Uncertainty (1/2)

All benefit and impact elements have uncertainty Key is inclusion of uncertainty and understanding

confidence levels– Essential for Capital and Schedule Certainty

In EPC phases uncertainty considered (in part) as comparable to handling of uncertainties and risks utilizing techniques such as Monte Carlo

During operating phase time durations make uncertainties even more significant

Through asset development process we seek to narrow ranges of uncertainties and where possible eliminate them through physical or financial hedges. – None the less, uncertainties remain and must be

incorporated.

A Word on Uncertainty (2/2)A Word on Uncertainty (2/2)

“Optioneering” models uncertainties to compare life cycle options – We may assume that the total for each impact (cost) or

benefit (revenue/income) element is normally distributed and independent.

– We can calculate total uncertainty in the form of a standard deviation such that:• σT = √∑σe

2

where:- σT = total standard deviation- σe = standard deviation for benefit or impact element e (benefit and impact elements should be separately grouped)

- Caution: Coupled Constraints

LCA is Integral to 7DSM Optioneering LCA is Integral to 7DSM Optioneering

7DSM Optioneering expands current “dimensions” used in industry:– Spatial (3D) – uncertainty; assemblies– Time (4D) – cradle to grave– First delivery attributes (5D)

• All benefits and impacts – complete attribute set• Triple bottom line considerations• Expanded risks

– Life cycle attributes (6D)• O&M and End-of-Life benefits and impacts• Triple bottom line considerations• Scenario based

– System performance attributes (7D) – resiliency as an “inherent property”• Linked to externalities inferred by scenarios

7DSM Optioneering Supports Sound Asset Management7DSM Optioneering Supports Sound Asset Management

Sound asset management systems exhibit several characteristics:– Clearly defined and well communicated strategic business

objectives similar to what we see in all well managed programs.

– Executive recognition of the value asset management brings and a commitment to making it successful

– Focus on addressing the strategic level impediments that may exist

– Clarity in identifying and removing the tactical level impediments that such programs face.

– Recognition of what success looks like.

The AnswerThe Answer

LCAPROG, NPV(Confidence) = AllΣ PROJ=1 LCA NPV(Confidence), PROJ (Configx, Globals,Systemicr) – Intra-program transfers

In LCA, this is extended to include all three bottom lines, identifying a Pareto optimal front with the desired confidence level at a program level

…but more on this later….

The Life Cycle – Traditional ViewThe Life Cycle – Traditional View

The Life Cycle – Holistic ViewThe Life Cycle – Holistic View

Triple Bottom Line focus highlights common drivers, systemic risks, wild cards and constraints

Life Cycle StagesLife Cycle Stages

Revenue Indirect asset costs Externalities

Life Cycle Cost– Planning and

permitting– Design– Procurement &

Construction– Operations– Maintenance– End of life

RevenueRevenue

First Revenue Date Plant Availability Factor and Ramp-Up

Period and Rate Asset Life (Duration from First

Revenue during analysis period) Scheduled Shutdowns (Regulatory,

Seasonal, Maintenance) Supply/Demand Balance Normalized

Price(Market Size; Competitor Actions)

Capacity or Throughput Byproduct Value Captured Tax Credits Realized Inflation Adjustments to Normalized

Pricing (Inflation; Currency Exchange Rates) This consideration is key in

determination of Capital Efficiency and in PPP

Indirect Asset CostsIndirect Asset Costs

Land use Tax Regime

– Taxable– Tax Credit– Tax Exempt

Financing structures

Common factors– Financial factors – hyper inflation,

deflation, uninsured portion of disasters (natural, manmade, or Natech)

– Environmental factors – climate change 

– Social factors – change in user behavior, change in surrounding community behavior with respect to the facility

– Correlated risks

Financing Structures impact Capital Efficiency and are driven by PPP “form”

Land UseLand Use

Land use impacts include:– Land use (the plant site)

• Emissions to air• Emissions to water• Emissions to soils.

– Land use change• Mineral and fossil fuel use• Land transformation• Land occupation• Soil erosion, compaction and sealing

– Often ignored in LCA but taking on increasing importance.

ISO 14040 – 14043, largely developed from industrial perspective and do not mention land use as an impact category

Land use considers following factors:– Concurrent availability –site is

available on some basis for use by other facilities. Important when evaluating large program or asset portfolio design. May be either:• Constrained or limited • Unconstrained or unlimited

(except with respect to limiting attributes of the site independent of the facility’s presence at the site)

– Concurrent unavailability – the site is not available for other current use due to the facility’s presence at the site.

– Loss of optionality – site use, post facility closure, is limited because of the prior presence of the facility

– Permanent unavailability – use of the site, post closure, is not reasonably possible

Financing Structures (1/2)Financing Structures (1/2)

Financing structures considered in a life cycle analysis influenced by many factors including:

– asset characterization– governing financial metrics (ROE, ROI, IRR, ROA)– asset lifetimes before refurbishment or replacement– refinance periods– construction and operations cash flows– residual value of asset

Financing Structures (2/2)Financing Structures (2/2)

ExternalitiesExternalities

Intangibles such as brand value Complexity Assumption migration associated with

longer time frames (dynamic risks) Stakeholder trust Susceptibility to “Black Swan” type

risks “Strategic speed”

– capture greater market share through quick response or first mover advantages

– “Time to market” is especially important in IP driven facility needs where patent expiration effectively defines the most valuable portion of the life-cycle.

Regulatory taxes and subsidies

Potential “Black Swan” factors to be considered in life cycle analysis include:

– Financial factors – hyper inflation, deflation, uninsured portion of disasters (natural, manmade, or Natech)

– Environmental factors – climate change

– Social factors – change in user behavior, change in surrounding community behavior with respect to the facility

– Correlated risks

Dynamic RisksDynamic Risks

Today, we average risk across the entire duration of a project, but in long lived construction programs, sometimes approaching 20 or more years, this may not be appropriate.

Risk parameters with defined means and variances today can change significantly over the life of a program, creating different risk hierarchies and consequentially different risk management strategies and emphasis.

Even more significant as we consider the extended operations and maintenance phase which we must consider in lifecycle analysis

Intra-Organizational – Changed funding availability /cost– Changes to assumptions– Modified review/approval processes– Disruptive economic factors

Inter-Organizational – Emergence of new risk drivers– Increase in constraint coupling– Cumulative impact of changes

Extra-Organizational – Litigation– Change of law/regulation– New labor or material constraints– Political actions– Social actions

Phasing – Unanticipated step changes as

program moves phase to phase

Planning and PermittingPlanning and Permitting

Impact of Permitting on Life Cycle Analysis:– Reduced revenue– Higher risk weighted cost of capital –investors may seek higher returns as they wait

patiently and with a higher degree of uncertainty for the facility to obtain necessary approvals. Similarly debt costs may be higher especially in instances where project funding is utilized.

– Higher permitting costs – Higher environmental mitigation or enhancement costs– Increased project escalation costs

Impact of Permitting on Life Cycle AnalysisImpact of Permitting on Life Cycle Analysis

DesignDesign

Factors Typically Considered in a Capital Asset Life Cycle Analysis– Labor Costs -professional

services– Benefits from

standardization /design reuse– Premium costs incurred

because of schedule– Cost of Time (design

duration/phasing)– Value of Risk (technology or

other first of a kind risks; labor availability risk)

– Design estimate uncertainties (estimating based; management model driven; rework based on late inputs or owner driven changes)

– Consideration given to procurement and supply chain strategies (relates to potential for design rework or impacts on procurement)

– Degree constructability considerations have been incorporated into design activities (influences design and construction management costs with the prospect of reduced construction durations and costs)

– Life cycle and sustainability focus and provision in cost and schedule for more aggressive engagement of O&M managers, staff and key suppliers

Impacts on Design Schedule and CostImpacts on Design Schedule and Cost

Procurement & ConstructionProcurement & Construction

Procurement & Construction – Environmental Bottom LineProcurement & Construction – Environmental Bottom Line

Procurement & Construction – Social Bottom LineProcurement & Construction – Social Bottom Line

OperationsOperations

Operations – Environmental & Social Bottom LinesOperations – Environmental & Social Bottom Lines

Social Metrics

Diversity Existence of equal opportunity policies or

programs Percentage of senior executives who are

women Percentage of staff who are members of

visible minorities Percentage of staff with disabilities Industrial Relations

Percentage of employees represented by independent trade union organizations or other bona fide employee representatives

Percentage of employees covered by collective bargaining agreements

Number of grievances from employees Child Labor Whether contractors are screened (or

percentage screened) for use of child labor Community Earnings donated to the community Use of local contractors and suppliers Involvement in projects with value to the

greater community

MaintenanceMaintenance

Value creation in the maintenance phase begins with a well developed maintenance strategy that incorporates a focus on:

– Dedicated effort of preventative and predictive maintenance

– Reliability centered maintenance– Overall equipment effectiveness

Top performing facilities are characterized by:

– Reliability– Controlled maintenance costs– Sustained profitability

Maintenance practices at such facilities are characterized by:

– Performance based contracting that engages the supply chain financially in success.

– Profit centered maintenance in which maintenance and reliability is viewed as integral to financial success.

– Systematic failure elimination– Mindset, process, and culture are

the most critical elements in systematically eliminating failures.

Maintenance – Environmental & Social Bottom LinesMaintenance – Environmental & Social Bottom Lines

How do various emissions or discharges to the environment change based on different maintenance regimes (with different cost and performance profiles)?

– Does more frequent changing of filters reduce dust and particulate emissions? 

– What are the right performance levels (effectiveness) for secondary water treatment systems before chemical recharge of cleaning or replacement of filter media?

How often should “white roofs”, solar panels and windows be washed to improve their energy performance characteristics? Alternately, would application of a photocatalytic extend the time between cleanings?

How can periodic maintenance “campaigns” be leveraged to create broader community benefits?

– Can hazardous material collection efforts on-site include receiving such materials from the community (used motor oils, chemicals, batteries, and electronics)?

Can maintenance training programs or facilities be “opened” up to train a broader cadre locally, enabling local community skills and employability, while creating a broader future labor pool for the lifecycle of the modeled capital asset?

End of LifeEnd of Life

More MathMore Math

…but it’s the ideas that are important….

LCA NPV(Confidence)=

PΣ t=1 [(All Σ n=1 C(n(σ, PDF), t, q, ScenarioN, Configx, D#(t, ScenarioN), Limit#(t, D,

ScenarioN)) *q ) - (All Σ n=1 R(n(σ, PDF), t, q, ScenarioN, Configx, D#(t, ScenarioN), Limit#(t, D, ScenarioN)) *q )]

Complexity of CostComplexity of Cost

C = Cost or benefit associated with:– A given cost factor, n, that is a function of σ and PDF, where:

• σ describes the uncertainty (standard deviation or minimum and maximum) of Cn , and a

• Probability distribution function, PDF, related to σ and described by a distribution type (normal, triangular, lognormal, etc.)

– in the time period, t– with associated discount factor, q– where CConfidence is indicative of the associated confidence level (CConfidence50,

CConfidence80, CConfidence90). C(t) = CBase Period Value * Cumulative EF(t)

– Cumulative EF(t) = 1*(1+EF(1))*(1+EF(2))*(1+EF(3))………*(1+EF(t)), where:• EF(t) is the escalation associated with the cost factor in time period, t

LCA NPV(Confidence)= PΣ t=1 (All Σ n=1 C(n(σ, PDF), t, q) *q )– Where q is the discount factor

• Different cost factors may be associated with different discount rates when multiple funding sources are used

– full lifecycle to end of life (t = P)

Segregate Revenues and BenefitsSegregate Revenues and Benefits

This summation is undertaken for all revenue (R) and cost (C) elements, where: Revenue (R) and Cost (C) are segregated to ensure each is comprehensively

covered. Revenue or more generally, benefits, may be treated as negative costs in the general form for determining LCA.

Each Revenue (R) and Cost (C) element is individually characterized such that: – Rn, where the various revenue elements may be written as R1, R2, R3 …,the

characterization of each revenue element may differ– Cn, where the various cost elements may be written as C1, C2, C3 …,the

characterization of each cost element may differ

Drivers and Scenarios MatterDrivers and Scenarios Matter

Revenue (R) and Cost (C) properties include σ, PDF, q, EF and also:– Linkage to common drivers, D, of the general form D# such as D1,D2, D3

• May influence behavior of multiple Revenue (R) and Cost (C) elements in a correlated way

• Drivers may be a function of time and will vary by Scenario, which is described later in this section. Drivers could then be written as D#(t, ScenarioN)

– Linkage to defined constraints (Limit) that may vary over time and be influenced by the value of one or more common Drivers, D, as well as the Scenario being considered. Limits would take the general form of Limit#(t, D, ScenarioN)

– Scenario, where sets of Drivers and Constraints maybe associated with a given capital asset narrative associated with the Base Case for determination of the asset’s LCA.

Stress Test for ResilienceStress Test for Resilience

LCA optimization across all three bottom lines can then be stress tested against alternative scenarios, outside the range of Drivers, Constraints and Uncertainties otherwise considered.

– Stress testing will help determine the resilience of the capital asset program’s performance.

– Scenarios may be enumerated in the general form:• ScenarioN, where N is the scenario enumeration number. Variations around a given

scenario for the purposes of stress (S) testing would be of the form ScenarioN

S1, ScenarioNS2, ScenarioN

S3…

Program Configurations MatterProgram Configurations Matter

In a multi-project program, various configurations may be tested.– Configurations may be enumerated in the general form:

• ConfigX, where x is the configuration enumeration number• Variations around a given configuration would be of the form Configx

1, Configx

2, Configx3

LCA NPV(Confidence)=

PΣ t=1 [(All Σ n=1 C(n(σ, PDF), t, q, ScenarioN, Configx, D#(t, ScenarioN), Limit#(t, D,

ScenarioN)) *q ) - (All Σ n=1 R(n(σ, PDF), t, q, ScenarioN, Configx, D#(t, ScenarioN), Limit#(t, D, ScenarioN)) *q )]

Program Level LCAProgram Level LCA

LCA NPV(Confidence)= – PΣ t=1 [(All Σ n=1 C(n(σ, PDF), t, q, ScenarioN, Configx, D#(t, ScenarioN), Limit#(t, D, ScenarioN)) *q ) - (All Σ

n=1 R(n(σ, PDF), t, q, ScenarioN, Configx, D#(t, ScenarioN), Limit#(t, D, ScenarioN)) *q )]

We may write this as:– LCA NPV(Confidence), PROJ (Configx, Globals,Systemicr)

Where:– Configx defines a project, PROJ, as being included in a specific program or portfolio configuration, x,

together with a set of associated characteristics that may act upon project specific values, uncertainties, Scenarios, drivers and Constraints)

– Globals defines a Global Scenario set, s, consisting of global drivers and constraints that in turn may act upon, or limit, project specific values, uncertainties, Scenarios, drivers and Constraints across all projects comprising the portfolio or program

– Systemicr defines a program wide Systemic Risk set, r, including both internal and external risks, considered in determining the LCA value for a specific project in the portfolio

Then on a programmatic basis (along one of the three bottom lines and at a given confidence level), the program LCA or LCAPROG may be seen as the sum across all projects within the program less intra-program transfers to avoid double counting of benefits or impacts.

LCAPROG, NPV(Confidence) = – AllΣ PROJ=1 LCA NPV(Confidence), PROJ (Configx, Globals,Systemicr) – Intra-program transfers

In a triple bottom line approach to LCA, this approach is extended to include all three bottom lines, identifying a Pareto optimal front with the desired confidence level at a program level.

Useful ToolsUseful Tools

Appendix 1 - Candidate Strategies for Risk Reduction to Consider in Conjunction with LCA Option Selection

Appendix 2 - Candidate Areas for Social Bottom Line Metrics

Appendix 4 - Opportunity Checklist Appendix 5 - Impediments for Implementing a Sound

Asset Management System

Application of Life Cycle Analysis in the Capital Assets IndustryApplication of Life Cycle Analysis in the Capital Assets Industry

Life Cycle Analysis brings a broadened perspective to traditional life cycle costing methodologies: – Revenue and its timing are incorporated– Risk and uncertainty are specifically addressed in modeling

and subsequent optimization– Benefits, unertainties and impacts are considered not only

from an economic bottom line perspective but similarly from an environmental and social bottom line perspective

The developed analysis framework provides a basis for periodic reconfirmation of adopted strategies or reconfiguration guidance if changed future states so díctate

It is intended not just as an up-front option assessment or validation tool but a dynamic life cycle based management tool essential in managing today’s capital asset portfolios.

Life Cycle Analysis Enables Capital Asset StrategiesLife Cycle Analysis Enables Capital Asset Strategies

Facility or mitigation evaluations as part of permitting activities – allows consideration of uncertainty, risk, scenarios and all three bottom lines

Project selection or prioritization – linked to confidence levels; include uncertainty, risk, scenarios; incorporate resiliency; all three bottom lines allow balanced process

Support project acceleration business cases more robustly

Improve estimate and schedule confidence Inform RFP requirements for PPP and other

performance based contracts as it relates to environmental and social bottom lines

Life Cycle Analysis Enables Capital Asset StrategiesLife Cycle Analysis Enables Capital Asset Strategies

Enable asset valuation for PPP solicitations and test impact of performance requirements on life cycle value

Facilitate ownership transitions of assets Evaluate full (life cycle) cost of design alternatives and

O&M strategies to enhance Capital Efficiency Strengthen asset management decision making and

processes Support portfolio management decision making Assess impacts of actions and alternatives on resiliency

?