levels of service and their impact on capex phil caffyn, utility consultants ltd please read...

Levels of service and their impact on CapEx

Phil Caffyn,Utility Consultants Ltd

www.utilityconsultants.co.nzwww.capex.cjb.net

Please read disclaimer on second page

www.utilityconsultants.co.nz www.capex.cjb.net

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Disclaimer• This presentation has been prepared primarily

for the Infrastructure CapEx Summit 2008 and is not to be relied upon by event participants or any other person as professional advice.

• This presentation has been compiled by Utility Consultants Ltd at the invitation of Conferenz. Neither Conferenz, its officers or its employees take any responsibility for the factual accuracy of this presentation or for any views, opinions or biases in the content of this presentation.

• Utility Consultants Ltd as the author of this presentation shall not be liable in any way whatsoever for any action or failure to act based on the content of this presentation.


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Presentation topics

• Part 1 – What are LOS.– The asset management model

– Importance of price

– Defining LOS

– Classes of LOS

• Part 2 – Importance of getting LOS right.– Investing in LOS

– Getting the LOS wrong

• Part 3 – Linking LOS to CapEx– LOS variations

– Lifecycle activity variations

– Spend variations


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Part 1 – What are LOS


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The asset management model• The asset management activities within an organisation look a bit like

this…

Customerinterface

Levels OfService

Cash

Operations

Maintenance

CapEx


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The asset management model

• Four components to this model…– Customer interface.

– Transfer of LOS across that interface.

– Transfer of cash across that interface in the opposite

direction.

– Whole range of activities sit against that interface

and stretch back into the organisation.

• In some instances the person receiving the

LOS may be different from the person paying

the cash eg. electricity retailer versus

connected customer, or subsidy for rail.


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Importance of price

• Price is a key component in the LOS mix – any

discussion of LOS without reference to price is

meaningless, because we all want more !!!– Books and DVD’s in the library.

– More swings and slides at the park.

– Trains that run more often.

– Streets that don’t flood after heavy rain.

• Unfortunately the cost structure of an

infrastructure business can make it hard to

nail down any direct and obvious linkage

between LOS and short-term price.


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Importance of price

• And of course, there is the whole matter of

price determining what funds are available for

actually doing the work !!!

• In many infrastructure sectors, price will also

be constrained by “non-market” factors…– Public policy decrees.

– Regulatory determinations.

– Pricing methodologies that are subject to regulatory

approval.

– Priorities of elected members.

– Subsidies from other users or from tax payers.


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Defining LOS

• LOS are what we (or someone else) pay for

every time we use a service, but in this

context, LOS are also the destinations of the

AM journey.

• Without a well-defined destination, it’s hard to

make the journey.

• As Alice in Wonderland concluded “if you

don’t know where you want to go, any road

will take you there”.


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Defining LOS

• So the starting point of robust CapEx, and

indeed the whole AM process, is a set of well-

defined LOS.

• We can broadly define infrastructure LOS in

terms of three characteristics…– Capacity (“how much”)

– Availability (“how often”) – sometimes this can be an

operational decision.

– Quality (“how good”)

• These definitions are a bit arbitrary, and can

be broadly juggled to fit with terms like

reliability and security of supply.


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Defining LOS

• Just a couple of examples to help set the

mode of thinking…

Customer interface

Capacity(how much)

Availability(how often)

Quality(how good)

Airport runway Is it big enough to land all the planes used these days

How often is the runway closed by fog

How bumpy is the surface

Wash bowl in a public toilet

How many bowls are there – do I need to wait

When are the toilets closed to the public

Is it clean

Electricity fuse at my front gate

Is it big enough to supply my max demand

How often does the supply to my fuse go off

Is the voltage stable and free from flicker


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Defining LOS

• My personal view is that LOS are (or need to

be) the next frontier of AM and CapEx.

• Many AMP’s have assumed that LOS are going

to stay the same, so the LOS thing is quite

disconnected from the rest of the AMP.

• However after many years of little or no

upsizing, capacity headroom across many

classes of infrastructure has been eroded to

the point where we need to give serious

thought to capacity as a LOS.


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Classes of LOS

• LOS fall into two broad classes…– LOS that benefit those who pay for them (eg.

capacity, availability, quality).

– LOS that benefit others (eg. safety, information

disclosure, absence of interference, amenity value).

• In the AMP’s that I’ve prepared I’ve found it

helpful to consider the LOS in the following

classes…– Customer LOS.

– Regulatory LOS (because most infrastructure is

subject to some form of economic or structural

regulation).

– Community LOS.


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Classes of LOS

• Customer LOS can be further broken into sub-

classes based on what customers say is most

important…– Primary

– Secondary

– Tertiary

• Customer surveys in the electricity lines

industry reveal that customers primary LOS is

keeping the lights on, and getting them back

on if they go off.


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Classes of LOS

• LOS like quick processing of new connection

applications, or providing technical advice are

rated as relatively unimportant when

compared to real-time delivery of LOS across

the customer interface.

• Unfortunately for infrastructure operators, the

most important LOS are those requiring fixed

assets rather than processes.


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Part 2 – Importance ofgetting LOS right


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Investing in LOS

• The CapEx process turns cash into physical

assets which deliver outcomes (the LOS).

• Referring back to the asset management

model, we note that CapEx is very remote

from the customer interface.

• We all appreciate that the moment-by-moment

decisions (operations) made at the customer

interface can significantly impact on LOS.


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Investing in LOS

• We also all appreciate that the CapEx

decisions made in the boardroom and the

backroom will significantly impact on LOS.

• It’s also very clear that the linkages between

CapEx decisions (especially capacity) and

LOS are not simple.

• Hence the CapEx activity has an implicit risk

of mis-matching the capacity and the LOS

(and that’s just when the LOS sits still !!)


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Getting the LOS wrong

• This mis-match of capacity to LOS can occur

in two ways…– Under investment in capacity.

– Over investment in capacity.

• Each of these modes of investment has

significantly different types of risk which (in

my view) are only just beginning to be

understood.

• Under investment usually results in a service

failure in which LOS are not met – the loss of

economic value easily exceeds the cost of

service, and can mean injury or death.


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Getting the LOS wrong

• Over investment usually results in capacity

being built ahead of time (and if demand

growth is low, it may never be used).

• The risks of over investment therefore tend

to be more commercial (and often regulatory)

in contrast to the risks of under investment

which tend to be operational, safety or

reputation.

• My view is that it is better to err on the side

of over investment than under investment as

getting it totally right will prove very hard.


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Part 3 – Linking LOS to CapEx


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Introductory remarks

• Having concluded that the linkage between

CapEx and LOS is complicated, and that

precisely matching CapEx to future LOS is not

easy, this section sets out some thoughts

which will hopefully make it a bit easier.

• A key component of linking LOS to CapEx is

understanding the risks along the way,

because afterall CapEx is a risk-based

discipline.


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LOS variations

• Understanding that the three classes of LOS

(customer, regulatory and community) are

likely to vary over time is very obvious.

• Understanding how those classes of LOS might

vary is a bit more challenging…– How will residential electricity customers demand for

supply quality change as they all buy heat pumps

and plasma TV’s ??

– How will the properties of an airport runway need to

be altered when more airlines start flying A380’s ??

– Will the roads in rural areas withstand increased

numbers of logging trucks as forests are

harvested ??


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Lifecycle activity variations

• Understanding what variations in lifecycle

activities might be required to accommodate

variations in LOS is where it starts to get

tricky.

• Varying operational decisions to meet LOS

variations is pretty straightforward…– Coupling a few extra carriages on to a train or tram

when a big footy game or concert is on.

– Working a fleet of mining trucks two shifts instead of

one to increase production tonnage.

– Winding up a tap changer when the voltage drops.

– Starting a pump when a sump fills up.


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• These are very straightforward decisions that

don’t put the organisation to any capital cost,

and can be easily undone if the decision

proves wrong.

• Most importantly, the linkage between the

LOS variation and the variation to the lifecycle

activity is obvious.

• When variations to LOS require variations to

capacity, availability and quality that are

beyond simple operational activities, things

start to get a bit tricky.


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• Consider the previous example of working a

fleet of mining trucks two shifts instead of

one to increase production tonnage.

• That option will probably work fine for a short

period – sure there will be maintenance and

personnel issues to be addressed.

• If, however, the increased production is likely

to be a long-term thing, there will be other

options such as buying a fleet of bigger

trucks, or replacing trucks with conveyors.


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• Each of those options (two shifting, bigger

trucks, conveyors) stretches back into the

asset management model away from the

customer interface, into that area that is less

obviously connected to the LOS.

• The choices involve long-term capital

decisions that the organisation will be stuck

with for a long time.

• The right choice will depend on the

organisations policies, strategies and

markets (and in many cases the regulatory

regime).


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Spend variations

• Once we think we know the variations to

lifecycle activities that are required to meet

varying LOS, the final step is to identify the

spend variations.

• This used to be as simple as estimating

present day costs and multiplying by an

agreed inflation index.

• Alas – no more !!!

• Costs of key inputs – steel, cement, copper,

glass, diesel and labor - all seem to be

rushing ahead of the official inflation rate.


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Getting the linkages right• Conclude this section with a brief model...

LOSvariations

Lifecycle activity

variations

Spend variations

Key risks- Failure to understand how LOS are created by

the organisations’ activities and processes.- Failure to accurately model likely future

demands for capacity, availability and quality.

Key risks- Failure to understand how LOS variations will

require variations to existing lifecycle activities.- Failure to understand the options available for

meeting required future LOS (simple linear scaling may not be the best option).

- Failure to understand the organisations criteria for assessing options.

- Failure to use the correct decision tools for assessing the options.

- Failure to understand how a regulatory regime may treat costs and discriminate between options (especially between OpEx and CapEx).

Key risks- Failure to correctly estimate future costs.- Failure to inform internal stakeholders of cost

increases.

Very straightforward – no excuse for getting this wrong

Can be hard, but some well thought out scenarios should provide accurate

estimates

Getting people on side can be hard, but still no excuse for getting this wrong

Can be hard, but again some well thought out scenarios should provide

some reasonable forecasts

None of these are dead easy, but neither are they very hard. Some clear thought around each of these issues will minimise the risks of each step,

which in turns minimises the cumulative risk


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Practical things to take away


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• Understand what LOS your organisation

provides, and how they might fit within a

generic framework of capacity, availability

and quality.

• Understand exactly what the customer

interface is, both physically and

commercially.

• Understand that some LOS do not directly

benefit your paying customers .


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• Understand the role of price, how it funds the

business model, and what factors might

constrain prices or distort price signals.

• Understand the nature and risks of over- and

under-investing in capacity.

• Clearly understand the risks involved in

linking CapEx to LOS, and how clear thinking

and appropriate use of analytical tools can

minimise those risks.


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Contact me for more info.


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• Phone (07) 854-6541

• Mobile (021) 606-670

• Email [email protected]

• Skype philcaffyn

• Web www.utilityconsultants.co.nz

• Web www.capex.cjb.net

• Subscribe to “Pipes & Wires” (email

me).

Contact me for more info.

mailto:[email protected]


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Contact me for more info.• Request the following slide shows on similar topics…

• Implementing the UK asset management specification PAS 55-1:2004 in the infrastructure sector. Request

• Setting service levels for utility networks. Request

• Tariff control of pipes & wires utilities – where is it heading. Request

• Renewals – (half) the hidden side of CapEx. Request

• Upsizing –the other half of the hidden side of CapEx. Request

• Getting the CapEx right in the infrastructure sectors. Request

mailto:[email protected]?subject=Request%20PAS%2055%20slide%20show

mailto:[email protected]?subject=Request%20%22Setting%20service%20levels%20for%20utility%20networks%22%20slide%20show


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Contact me for more info.• Visit Utility Consultants library to request other slide

shows, monographs and research reports.

• Visit Utility Consultants specialist CapEx website for specific insights.

levels of service and their impact on capex phil caffyn, utility consultants ltd please read...

Documents

transfer of los

los wrongpart

los right

discussion of los

utility consultants

modelcustomer interface

transfer of cash

infrastructure business