capital project prioritization process design and economic value methodology stakeholder workshop

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B O N N E V I L L E P O W E R A D M I N I S T R A T I O N Capital Project Prioritization Process design and economic value methodology Stakeholder Workshop BPA Rates Hearing Room September 24, 2012

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Page 1: Capital Project Prioritization Process design and economic value methodology Stakeholder Workshop

B O N N E V I L L E P O W E R A D M I N I S T R A T I O N

Capital Project Prioritization

Process design and economic value methodology

Stakeholder WorkshopBPA Rates Hearing Room

September 24, 2012

Page 2: Capital Project Prioritization Process design and economic value methodology Stakeholder Workshop

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B O N N E V I L L E P O W E R A D M I N I S T R A T I O N

Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Background

BPA and its FCRPS partners face growing investment requirements to replace and modernize aging infrastructure, add transmission capacity to meet loads and integrate generating resources, and meet regional commitments for energy efficiency and fish and wildlife restoration

At the same time, BPA’s access to low cost sources of capital is constrained

BPA lacks an agency-wide method to prioritize diverse investments. A systematic, value-based method for prioritizing capital investments across business units is a leading practice among top performing utilities

During the 2012 Capital Investment Review, BPA proposed to develop an agency method for prioritizing investments• Two workshops were held to discuss alternative approaches and a timeline• Stakeholders then submitted comments and recommendations for BPA’s use in developing its methodology

Since then, BPA has hired a consulting firm and formed a cross-agency team to design and develop an agency-wide prioritization process. This includes three phases:

Phase 1 - Process and methodology design - August/September 2012 Phase 2 - Test/Prove and prepare for implementation - September 2012 - February 2013 Phase 3 - Begin implementation - March 2013

The purpose of today’s workshop: • Provide an overview of BPA’s proposed agency-wide prioritization process and methodology• Obtain feedback on the design before we begin testing and preparing for implementation

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Background (2)

• As designed, the prioritization process can be used to both inform the level and composition of capital budgets and optimize the implementation of budgets as conditions change

• BPA is concerned that reductions in discretionary but high-value investments may lead to a sub-optimized system over time -- with higher risks and lower long-term value for stakeholders

• The analytical results of this process will enable better-informed decisions on the level and composition of the investment program -- but insights from this new process may or may not lead to large changes in the level of capital spending

• BPA will strive to use this new process to balance investment needs, power and transmission rate effects, and access to low-cost capital

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Create an agency-level process that: Furthers the agency’s strategic priorities/objectives

Provides a “level playing field” for projects with different risk/cost/benefit characteristics from various asset categories

Optimizes the agency’s investment portfolio within capital, labor, rate, and other constraints

Ensures decision-making is risk-informed and supported by thorough analysis

Provides transparency both internally and externally

Enables efficient, timely decision making

Enables BPA to track the performance and measure the realized value from investments

The methodology and process will be directed at maximizing the long-term operational and economic value of assets.

BPA’s Capital Allocation Board (CAB) serves as the executive steering team for this project.

(From charter)

Goals

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Prioritized through new prioritization process

“Core” Sustain Investment

Reinvestment in existing assets to maintain system performance and capability

Funded first Funded with remaining capital that the agency

has budgeted

Expansion and “Non-Core” Sustain InvestmentInvestment that “grows” the asset base, i.e., adds capacity or

new capabilities, or that increases operational output or productivity. Also includes sustain investment that is “non-core”

Compliance – 3 years

Investment must occur in next 3-

years in order to comply with

contract, order, or directive

Discretionary -3 years

Investment that may be

valuable, but can be deferred

Policy Commitment – 3 Years

Investment must occur next 3 years to

fulfill commitments made by the

agency

Prioritized through asset strategies, not through new prioritization process

Which investments are covered by the new prioritization process?

We estimate that about 40 percent of the agency’s planned capital program is “core sustain”, 50 percent is expansion, and 10 percent is non-core sustain

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

What is meant by “core” sustain investment?Why are these investments excluded?

Prioritized through new prioritization process

“Core” Sustain Investment

Reinvestment in existing assets to maintain system performance and capability

Prioritized through asset strategies

Core Sustain defined: investments the primary purpose of which is to replace or refurbish existing assets in order to maintain performance and capabilities

“Core sustain” investment is prioritized through condition-based risk assessments, in which the highest priority is assigned to the most critical equipment and facilities at greatest risk of failure, obsolescence, safety issue, or other risk factor. Included are upgrades necessary to make core sustain investment viable, such as access roads that enable line replacements. Prioritization fo core sustain investment occurs within the asset strategies that are developed by each asset category and approved by the CAB.

“Core” sustain investment will be specified for each asset strategy at the time the CAB approves the strategy.

Sustain investment that is not prioritized and approved through asset strategies will be treated as “discretionary”. Examples include OMET, Synchrophasors, most new IT applications, Keys Decoupling, and new or expanded maintenance headquarters.

-- -- -- -- --

Energy Efficiency capital spending that implements the Council’s current power plan and Fish and Wildlife capital investments that implement the BIOp and current fish accords are generally prioritized by entities outside the FCRPS. For purposes of this process, these investments will be treated as if they were “core sustain” investments, i.e., they will not be subject to the economic analysis and priority ranking process described below for Expansion and “Non-Core” Sustain investment.

The treatment of energy efficiency investment associated with future power plans and fish and wildlife investments associated with new fish accords will be determined later, as part of Phase 2.

Funded first Funded with remaining capital that the agency has

budgeted

Expansion and “Non-Core” Sustain InvestmentInvestment that “grows” the asset base, i.e., adds capacity or

new capabilities, or that increases operational output or productivity. Also includes sustain investment that is “non-core”

Compliance – 3 years

Investment must occur in next 3-

years in order to comply with

contract, order, or directive

Discretionary -3 years

Investment that may be

valuable, but can be deferred

Policy Commitment – 3 Years

Investment must occur next 3 years to

fulfill commitments made by the

agency

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Compliance

Investment must occur during 3-year prioritization window to comply with contracts, orders, directives

Policy Commitment

Investment must occur during 3-year window to fulfill commitments made by the agency

Discretionary

May be preferable that investment occur during the 3-year window, but can be deferred

Driver of investment Projects in this category must be essential to the agency’s ability to comply with a signed contract, regulatory directive, or an executive or judicial branch order or directive. The contract, order or directive must compel BPA to make an investment; failure to make the investment timely would result in a violation. To be eligible, the investment must be authorized and work must begin by no later than the end of the 3-year prioritization window.

Projects in this category are essential to meeting commitments made by the agency. The commitments require that BPA invest in transmission to meet tariff provisions, NOS policy commitments, and load service obligations. Policy Commitment may also include investments in fulfill BiOp and fish accords and fulfill agency commitments to fund conservation to meet Council’s Power Plan. (Treatment of FWL and EE investments will be determined in Phase 2 .) The commitments require that projects be authorized and that investment begins by no later than the end of the 3-year window. A failure to make the investment during the window would result in serious reputational risks and legal risks

Expansion and “non-core” sustain investments that may be highly valuable, but that may be deferred beyond the 3-year prioritization window

Includes economic opportunity investments to reduce operating costs, enhance revenue, improve internal efficiency

Also includes “Compliance” and “Policy Commitment” investments if the investment can be deferred to year 4 or later. (Investments can move from the discretionary category to the categories at left over time)

Discretion on whether and how to invest?

Little or no discretion on whether an investment needs to be made. The purpose and nature of the investment are largely mandated

Little or no discretion on whether an investment needs to be made, although changes in customer needs, market conditions, and other external factors can cause shifts in the composition and timing of the investment. Discretion is normally available on investment alternatives

Discretion on whether to invest and on investment alternatives

Discretion on timing of investment?

Little or no discretion on timing of the investment. Often the investment is mandated by date certain. Project must be authorized and work must begin by no later than the end of the 3-year prioritization window in order to comply

Some discretion on timing of the investment. Timeline for completion is driven by agency commitments – must begin during the 3-year window to avoid reputational and legal risks

Examples Signed LGIA agreement, if the agreement requires investment during the 3-year prioritization window

Investment in new security equipment to meet NERC CIP, if investment is required during the 3 years

Investment to meet load service obligations, if necessary during the 3-year window

Network open season-driven investment, if necessary during the 3 years

Large generator interconnection projects, if LGIA is not yet signed, but investment is anticipated to be necessary during the 3 years

Information systems to meet regional dialogue commitments

SLICE application

New or expanded maintenance headquarters or new office building

Keys Decoupling, addition of a hydro generation turbine (e.g., Dworshak 4th unit), and turbine runner replacements for efficiency benefits only

New IT applications driven by business process efficiencies such as TAS, Service Connection

Acceleration of a transmission sustain investment program

Treatment in prioritization process

For these projects, the strategic fit test is deemed to be met. While capital costs are estimated and vetted, the economic value test does not apply. Projects in this category are not priority ranked based on economic value. Like Core Sustain, these projects are funded ahead of Policy Commitment and Discretionary investments

Strategic fit test is deemed to be met. Economic value test applies. These projects are priority ranked along with discretionary investments based on economic value. They are flagged, however, and the CAB will likely fund these projects ahead of discretionary investments

Strategic fit and economic value tests apply. These projects are priority ranked along with Policy Commitment projects based on economic value. They are funded after projects in the Core Sustain, Compliance, and Policy Commitment categories

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How are the categories defined? How will the projects in each category be treated?

Expansion and Remaining Sustain InvestmentInvestment that “grows” the asset base, i.e., adds capacity or new capabilities, or that increases operational output or productivity.

Also includes sustain investment that is “non-core”

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

A 3-year prioritization window

A “prioritization window” is the time horizon for which investments will be pooled and optimized

The window is a rolling window The window right-shifts in 6-month increments as the portfolio is refreshed on a 6-month cycle

A 3-year horizon with fits with the IPR process

N-2 N-1 N N+1 N+2 N+3 N+4 N+5 N+6 N+7 N+8 N+9 N+10 N+11 N+12

Timeline: N=current year

Project D

Project C

Project G

Project A

Project B

Project E

Project I

Project F

Project H

Project J

Project N

Project K

Project L

Planned Projects outsidePrioritization “Window”

CompletedProjectsOutside Prioritization“Window”

Prioritization“Window”

Planned Projects withinPrioritization “Window”

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Prepare portfolio decision

materials for CAB

Peer reviews(Input)

Evaluate new projects

(Probabilistic)

Project results and interdependency

reviews

Re-Balance the portfolioDefine and submit new projects

Peer review categorization new projects

Validate list of new projects

Gather & assess the information for newly

submitted projects

Implement the balancing

decisions

Finalize and review

business cases

Authorize and fund projects

Monitor project performance

Update information of existing projects

Determine financing strategy for portfolio

Evaluate new projects

(Base case)

Overview of the process

Yellow boxes: steps requiring executive action Orange boxes: steps involving peer reviews

Update evaluation of existing projects

A systematic agency-level process will replace decentralized processes Existing process

(simplified)

The new agency-level process is designed to create a level playing field across asset categories, enhance transparency, improve analytical rigor, and build an integrated, holistic

approach to developing and selecting investments

The process will encompass Policy Commitment and Discretionary projects that are newly conceived, projects introduced previously but not yet authorized, and projects

authorized and underway. New projects will be proposed and existing project proposals will be refreshed on a 6-month cycle

Checks and balances have been designed into the process to ensure consistency and safeguard against gaming (e.g., peer reviews)

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Projects will be evaluated using three “tests”

1. Strategic fit• An advisory assessment of each project’s usefulness in delivering on the agency’s strategic priorities• This test applied to Discretionary projects only; the test is assumed to be met for Compliance and Policy Commitment

projects

2. Value contribution• Project benefits and costs are evaluated using two principal metrics:

1. “Net Economic Benefits Ratio” (applies to Policy commitment and to Discretionary projects, but not Compliance projects)

2. “NPV BPA Cash Flows” (applies to all three types of projects)• Policy Commitment and Discretionary projects will be ranked initially on the basis of the first metric, Net Economic

Benefits Ratio

3. Feasibility • Evaluates the affordability, revenue requirement impact, and execution risks of project portfolios

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What are the ingredients of the Net Economic Benefits Ratio?

“PV Project Investment” includes the present value of: Upfront project costs (project planning, environmental review (NEPA), land/land rights acquisition, procurement,

construction/installation)

“PV Economic Benefits” includes the present value of (examples): Avoided congestion costs (avoided fuel and other production costs that are enabled by adding capacity on constrained

transmission paths) Avoided power purchase costs or increased power sales Labor cost savings through process efficiencies Avoided customer value losses from outages Avoided CO2 or other environmental costs (monetized) Post project maintenance and operations costs (maintenance, repairs, monitoring, licensing (IT), support)

“Ban

g fo

r the

buc

k” ra

tio

SMEs/project submitters will be asked to submit a quantitative range for each key cost and benefit input (e.g., p10, p50, p90)

Net EconomicBenefit Ratio

=PV Project Investment

PV Economic Benefits – PV Project Investment

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The test for economic value Each project will be evaluated through standardized lenses

PV of project net benefit and key risk factors(Illustrative)

0%20%40%60%80%

100%

Sensitivity analyses will identify key value/risk

drivers

Uncertainties in project value

will be captured probabilistically

Economic benefit of the project ($)

Cum

ulati

ve p

roba

bilit

y

Base case

Market priceLoad growthWind gen. scenarioSteel price Land acquisition cost

……

Design cost

Value/net benefit will be quantified from two perspectives:

• Value to BPA and its stakeholders

• Value to Region

Time series of cost, benefit and resource requirement (Illustrative)

years

$ co

st, B

enefi

t, FT

Es

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Stakeholder Workshop on Capital Project Prioritization, Sep 24 2012

Once projects have been evaluated, the results will be compiled and examined from a portfolio perspective

Portfolio starting point: projects are ranked purely on the basis of their net economic benefit ratios

The CAB may then make changes to the portfolio -- defer, accelerate, remove or add projects – by taking into account such factors as:

• The portfolio’s effectiveness in delivering the agency’s strategic priorities

• Project interdependencies (e.g., overlaps and gaps, sequencing)

• Cost and benefit uncertainties/risks

• The availability of labor resources and planned outage time needed to execute the portfolio as proposed

• The availability of capital for projects covered by the portfolio

• The beneficiaries of projects and whether costs are allocated roughly commensurate with benefits received

• The portfolio’s impact on power and transmission revenue requirements and rates

• Expectations for portfolio performance

• The net impact of any changes on economic value

The CAB will be provided with a variety of decision support materials, such as shown on the following slides

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Economic Value Test (Net Economic Benefits Ratio)

Status: “A-I” – Authorized and Initiated, “A-NI” – Authorized, but Not Initiated, “N” – Newly added, Blank – Previously added, not authorizedCategory: “D” – Discretionary Project, “PC” – Policy Commitment Project

Illustrative

Name Status CategoryAsset

Category

Economic Benefits –

Project Investment

Project Investment (excl. Sunk

Cost)Net Economic Benefits Ratio 2013 2014 2015 2016 2017 2018 Total

2013-2015 Budget

1 Project C A-I D 3 2,346.00 68.61 33.85 30.0 30.0 12.0 6.0 0.0 0.0 78.0 72.02 Project E A-I D 4 318.60 12.78 26.79 2.0 2.0 4.0 4.0 4.0 0.0 16.0 8.03 Project A N PC 6 3,495.00 145.23 21.83 0.0 70.0 40.0 40.0 20.0 10.0 180.0 110.04 Project B A-I D 5 549.00 30.93 16.16 10.0 10.0 12.0 4.0 0.0 0.0 36.0 32.05 Project D A-NI D 3 954.00 72.33 12.78 30.0 36.0 12.0 4.0 0.0 0.0 82.0 78.06 Project I D 7 474.00 41.09 11.69 2.0 8.0 20.0 10.0 6.0 6.0 52.0 30.07 Project G N PC 4 849.60 79.72 10.01 0.0 20.0 36.0 30.0 14.0 0.0 100.0 56.08 Project AG N D 7 74.88 9.41 8.13 0.0 4.0 2.0 2.0 2.0 2.0 12.0 6.09 Project F N D 5 216.72 29.87 6.48 0.0 16.0 12.0 8.0 0.0 0.0 36.0 28.0

10 Project N A-I PC 7 66.96 10.22 6.62 10.0 1.0 0.0 0.0 0.0 0.0 11.0 11.011 Project AU N D 1 128.16 24.67 4.96 10.0 4.0 4.0 4.0 4.0 4.0 30.0 18.012 Project Q A-NI D 7 370.80 85.43 4.48 20.0 40.0 24.0 16.0 0.0 0.0 100.0 84.013 Project H N PC 3 662.40 151.58 4.12 0.0 24.0 76.0 50.0 24.0 20.0 194.0 100.014 Project J A-I PC 4 215.28 59.08 3.44 20.0 20.0 10.0 10.0 10.0 0.0 70.0 50.015 Project K A-NI D 6 93.60 35.02 2.75 4.0 12.0 18.0 8.0 0.0 0.0 42.0 34.016 Project AN D 3 122.40 43.88 2.75 20.0 16.0 10.0 4.0 0.0 0.0 50.0 46.017 Project AF D 4 288.00 118.90 2.49 48.0 48.0 30.0 10.0 0.0 0.0 136.0 126.018 Project O N PC 7 326.04 159.35 1.95 0.0 50.0 60.0 60.0 20.0 10.0 200.0 110.019 Project P D 6 17.16 8.98 1.86 4.0 6.0 0.0 0.0 0.0 0.0 10.0 10.020 Project R D 3 80.52 43.67 1.82 0.0 50.0 0.0 0.0 0.0 0.0 50.0 50.0

Project Project Investment Detail (Nominal Dollar, p50 Case)Economic Test

(Expected Present Value)

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Funding Curve (Overall)

Core Sustain Projects

Compliance Projects

3-year capital spending forecast (illustrative)

Illustrative

Balancing/re-balancing the portfolio

Proj

ects

to th

e le

ft o

f thi

s lin

e ha

ve a

3:1

net

eco

nom

ic b

enefi

ts ra

tio

Discretionary & Policy Commitment Projects

Projects to the right of this line have less than a 1:1 ratio

Cumulative FY 2013-2015 Capital Expenditures (Nominal $, M)

A funding curve can be used to both

to establish a capital budget and

optimize a budget’s implementation

as conditions change

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Priority ranking is compared to available capital budgetIllustration

This is the first portfolio alternative that the CAB would review – the one constructed based purely on economic value

Alternative 1 “Maximize Economic Value within budget constraint” • Projects selected: C, E, A, B, D, I, G, AG, F, N, AU, Q, H, J, K, AN, AF (16 Projects)• Total Economic Value (Expected Value, PV): $ 11.2B• Total Investment (PV): $1,02B• Overall economic value ratio: 11.0 , Marginal ratio : 2.49 (Project AF)• 2013-2015 Budget Needs: $889M

1. Different colors represent projects in different asset categories

2. Different shapes represent project status• Square = “In flight” projects• Diamond = Projects previously nominated --

updated• Triangle = newly nominated projects

3. Red Label = Policy Commitment projects

Previous 3-year capital spending forecast

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Project value and project cost uncertainties will be considered (Illustration: Portfolio Alternative 1)

Net Economic Benefits (PV, $ million)-$1000 $0 $1000 $2000 $3000

Project C

Project D

Project G

Project B

Project H

Project I

Project E

Project Q

Project O

Project AF

Project F

Project J

Project Z

Project AN

Project Investment (PV, $ million)$0 $200 $400

Project C

Project D

Project G

Project B

Project H

Project I

Project E

Project Q

Project O

Project AF

Project F

Project J

Project Z

Project AN

Legend

10% 90%50%

Expected Value

Economic benefit uncertainties Investment cost uncertainties

Typically, project benefit

uncertainties are greater

than project cost

uncertainties

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Comparing Portfolio AlternativesIllustration

Portfolio alternatives may be designed to reduce risk/uncertainty, smooth out costs and benefits over time, redistribute costs and benefits across asset categories, or meet other objectives

Each alternative will be evaluated for economic, access to capital, revenue requirement/rate, and other implications

Alternative1: Maximize economic valueAlternative 2: All Policy Commitment projects funded ahead of discretionary projectsAlternative 3: Reduce uncertainty.

Alternative 1

Alternative 3

Alternative 2

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Feasibility test

Portfolio alternatives will be reviewed for their feasibility before a selection is made

• Is the portfolio of investments affordable (Is the needed capital available? Will O&M funding be available to sustain the asset after it is placed in service?)

• Are the implications for BPA cash flows acceptable (net present value of cash flows)?

• Are the implications for BPA revenue requirements acceptable (present value of revenue requirements)?

• Who are the beneficiaries of economic value? Can the project costs be allocated/shared equitably?

• Are resource and outage requirements manageable?

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Key changes to proposed methodology In response to stakeholder comments received during the Capital Investment Review

Key Stakeholder Concerns (CIR)BPA’s Proposed Approach

BPA response

BPA should not limit its prioritization efforts to discretionary investments alone

All capital investments will be prioritized. “Core” sustain investments (i.e., replacements, refurbishments, and certain modernizations )will be prioritized via asset management strategies. This prioritization is based on risk assessments that take into account the importance of assets and their likelihood of failure, obsolescence, or other risk factor. All other investments, including all expansion investments and “non-core” sustain investments, will be prioritized through the new methodology and process.

BPA needs to narrow and more tightly define the criteria it will use to declare a project “mandatory”. BPA needs to take a hard look at which projects are truly “mandatory”

The criteria have been refined and will continue to be refined during Phase 2. “Mandatory” investments are now divided into “compliance” and “policy commitment” categories that are carefully defined. A system of checks and balances has been designed to ensure that the criteria are applied consistently across the agency’s diverse investments. Policy commitment investments will be subject to the same economic analysis as discretionary investments

BPA should consider the timing of projects in the prioritization process. The impact of deferring projects should be taken into account

Project evaluations are being designed to capture the economic and other impacts of deferring projects for one or more years. The results will be considered when determining the prioritized mix and timing of projects

BPA’s proposed approach does not consider the inevitable over-runs and under-runs when constructing capital projects

Project cost and project benefit uncertainties will be captured in the economic analyses. Project cost and benefit updates will be considered when the portfolio is balanced each 6-month cycle

Projects should be executed in rank order up to the limit of capital available

Projects will initially be ranked on the basis of their net economic benefit ratios. Final decisions on the the portfolio will take into account the economics and strategic fit of projects, cost and benefit risks, availability of capital, revenue requirement and rate impacts, and other factors. Once approved, the portfolio’s implementation will be monitored and adjusted to ensure capital expenditures are within acceptable levels

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Next steps

BPA will proceed with Phase 2 of its agency-wide prioritization process – Test/Prove and Prepare for Implementation

We will provide stakeholders with an update on our progress at the February, 2013 QBR