Achieve Asset Performance Certainty
November 1, 2011 by David Bowcott
Every asset developed has a plan. What is the cost to design and develop the asset? When will the asset be completed? What will the maintenance costs of the asset be once up and running? Are the assumptions of operational costs accurate? Will the prices for items produced by the asset go up, down or remain the same?
These and other questions should be answered in the asset’s plan. In order to gain buy-in from all key stakeholders (such as company management, company board of directors, lenders, designers, contractors and subcontractors) your plan has to be sound. The more certainty created through effective communication of the asset’s plan, the greater chance that all stakeholders will put forward their best efforts when participating in the development process. All developers of assets want to convey Asset Performance Certainty (APC), and it is through detailed up front planning and analysis that this will be achieved.
The cornerstone of any asset plan is the Financial Model (or the Cash Flow Forecast). What are the cash outlays and cash inflows prior to construction, during construction, and well into operations? This model becomes your primary tool for convincing key stakeholders that this asset should be developed and they should contribute their best terms. If any stakeholder perceives the Financial Model is missing something, thereby creating potential for a deviation from plan, then that stakeholder will load their terms up with contingency and thus not put forward their best terms. Your company’s directors and officers may have a much higher equity hurdle rate given the perceived risk, your debt partners may juice the interest rates offered for the loan, and your contractors may provide pricing that is higher than it should be for the construction of the asset. Something is needed to convince these stakeholders that APC will be achieved and their concerns are unfounded therefore their terms should be improved.
Here are some tools that are complimentary to your Financial Model, and will help you in achieving project success:
Project Enterprise Risk Assessment (PERA): A project due diligence report that is made up of three sections: a) The Risk Matrix, b) The Risk Management Program, and c) The Risk Script. The Risk Matrix is an inventory of all construction and operational risks facing your specific asset’s development. Within this matrix the risks are prioritized (through probability and severity ratings), allocated (who holds the risk based on contract terms), and finally mapped to solutions (both risk transfer solution and risk control solutions). The Risk Management Program is designed directly from The Risk Matrix. With an eye to the priority risks, the Insurance Program, the Performance Security Program and the Risk Control Program are tailored to the project acting as a recipe for your broker and contractor to bring to reality. Finally, a detailed script of the priority risks is created through The Risk Script. A detailed review of priority risks, and their associated risk solutions, is required to ensure comfort can be created with key stakeholders in the event they raise these specific risks in negations.
Contractor Enterprise Risk Assessment (CERA): Whether you are hiring design firms, construction contractors, construction subcontractors, or operational contractors, you want to know those key contractors can deliver on their contracts. The fact that they can provide you with a large corporate guarantee and large letters of credit is nice, but if they can’t carry out the work given to them, what’s the point in hiring them to only wait for the moment you will use their performance security to simply replace them. A good CERA document will provide a thorough review of all of the contractor’s practices ensuring the contractor is best in class. Categories reviewed should include areas such as subcontractor prequalification practices, quality assurance/quality control, payment processes, financial/legal review and safety. Counterparty risk management isn’t only looking at the financial strength of the counter-party, it is also vital to look at the operational strength as well.
Risk Transfer Solutions: Ensuring the Insurance and Performance Security program for your asset’s development is made up of the best technology the financial markets have to offer is vital to your projects’ success. Are the solutions integrated? Do they provide mitigation/rectification/loss advance solutions? Are they the broadest cover available in the marketplace? And is the pricing the best available? There are several new solutions when it comes to construction and operations risk transfer solutions’ and being aware of them ensures success.
The above methodologies and tools will be vital to achieving APC, and more so, will be vital to achieving best terms from all key stakeholders as you use these solutions to create better perceptions of risk.
David Bowcott is senior vice-president, national director of large/strategic accounts, AON Reed Stenhouse Inc. Send comments to email@example.com.
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