'Understanding risk is its own reward in offshore wind'
Good risk management can help ensure that engineers and investors alike are comfortable with a project's profile, says Michael Hotze
Balancing an engineer’s enthusiasm to detail risk versus an investor’s need for a simple and reliable project assessment is one of the main challenges facing offshore wind projects.
Good risk management identifies risk areas within the project, assesses likely project contingency fund requirements and provides senior management with a tool for monitoring and mitigating risks.
However, a classic trap is to end up with 500+ risks in the risk register, each with their own pre- and post-mitigation probabilities, min, mid and max cost and time impacts, and no reliable means of handling or making good sense of this data.
The project sponsors then revert to a classic rule of thumb: “Contingency should be X% of capex”, where X seems to be dependent on the time of day, the mood in the project and which similar project last hit the headlines.
Little wonder that many projects either significantly over or under shoot their initial contingency estimate.
This is a consequence of the main mistake that we see in offshore wind projects time and time again; the difficulty of using the risk register and the programme to incorporate the cost of delay into the contingency assessment. In most projects the risk register has become too large to manipulate and it is not used to calculate the cost of delay even though it contains all the delay risks!
Basically, there are three approaches used to quantify capex contingency including the cost of delay:
- Assessing the cost of the risks without looking at knock-on delay effects. There is a chance that you may end up fooling yourself if you only use this method.
- Assessing the cost of risks including one iteration of knock-on delay effects. One iteration means that you only look at the next package after the one that is delayed. With smaller risk registers, with for example ten risks, this can easily be built into the register. With larger risk registers, even one iteration becomes tricky to manage.
- Assessing the cost of risks including all iterations of knock-on effects. Identifying all iterations of knock-on effects means that you look at the effect of the delay on all subsequent packages. One risk can often cause a ripple effect into many other risks.
Each approach significantly changes the risk values presented in the risk register. Additionally, the bigger the risk register, the harder it becomes to include even one iteration of delay because so many risks can be linked.
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For example, running a very simplified risk register with 50 identified risks can, say, result in a risk value of €10m if you do not look at knock-on effects. If you include one iteration of knock-on delays, this figure typically increases to €17.5m and subsequently to €20m if you include all iterations of knock-on delays. If you use a bigger risk register with 500 entries the step change is almost impossible to predict.
Coming back to the world of enthusiastic engineers and high-level management, the only realistic way to balance the conflicting requirements is to:
- Develop strict rules around what does and does not go into the risk register – keep it to the essential risks only.
- Make sure the project team identifies, quantifies and owns the risks – it is their project to run.
- Bundle similar risks together. Do not lose the detail, just create a headline risk and then hang multiple detailed risks beneath it. Only use the probabilities and impacts assigned to the headline risk in the analysis, and track the detailed risks during the project execution using them to inform and adjust the headline risk. This will significantly reduce the analysis burden.
- A Monte Carlo based risk analysis tool — which uses computer algorithms based on repeated random sampling — can be useful for automating the assessment of knock-on risks. Write your own Monte Carlo analysis engine, or hire someone who has done it already, so you can link the risks and understand how the risk profile is calculated. You can then build the project 10,000 times triggering risks and their linked knock-on risks based on the probability assigned to the initial risk.
- Carry out scenario analysis, peer review or pre-mortem exercises at key stages in the project’s execution to make sure you have found all the big risks.
When you’ve succeeded in doing all this, the engineer’s concerns will be conveyed in a way that investors understand. You may be surprised by the results, but it takes you one step closer towards a successful wind farm development, based on a realistic risk profile that is owned at all levels of the project.
Michael Hotze is a Director of Offshore Wind Consultants Ltd and is involved in many offshore wind projects from the initial feasibility stages through procurement, design, certification, construction and into operation.