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STOP PROCRASTINATING!
      NPV IS DEAD: USE RISK AS A KEY
           DECISION PARAMETER.
     By F. Oboni                         & C. Oboni




Riskope International SA © 2009 www.riskope.com       1
This Presentation Uses Two Case Studies
        to Show How Risk Can Be Used as a
      Discriminant in Decision Making for Key
                   Decisions, in:

              -Key Areas of a Corporation,
                -Selecting Alternatives,
                  -Evaluating Projects

      In the second Case Study, a method that
     eliminates the pitfalls of NPV is presented.


Riskope International SA © 2009 www.riskope.com     2
Case Study 1: Introducing In-Pit Crushing
        & Conveying System (IPC&CS) v.s. Shovel
        & Trucking (S&T) in a Large Dump Project.


 The operation was experiencing:
 -critical personnel issues,
 -difficulties with the ageing truck fleet which would
 require a large capital investment for renewal and
 maintenance,
 -the cost of diesel was, in the long run, certain to rise
 again causing concern.

Riskope International SA © 2009 www.riskope.com         3
At pre-feasibility level the aim is to identify situations
that could hinder the performances of the project and
define issues that need to be immediately addressed.




Riskope International SA © 2009 www.riskope.com          4
Risk mitigation geared towards reaching specific
   levels of residual risks vs. mitigative investments.


   RISK                                                      Mitigative
                                  “Acceptable”
                              Mitigative Threshold
                                                             Investment

                                    ALARA
                                    ALARP
                                    BACT


            Costs to
             Attain                              Zero Risk
           Acceptable                                         Acceptable
          Residual Risk                                       Residual
                                                              Risk




Riskope International SA © 2009 www.riskope.com                           5
Comparison between IPC&CS and S&T at the considered coal mine with
 no specific mitigations implemented.

Riskope International SA © 2009 www.riskope.com                   6
Once the appropriate mitigation level for the issues
 described earlier are introduced in the design, the system
 will still be subject to two sets of risks:

 1) Residual risks derived from design mitigated hazards
 (which depend, on the level of mitigation selected by the
 design team)
 2) Risks linked to other issues (which may be independent
 from design mitigation efforts because they find their roots
 in public/workforce perception):

   -Union/personnel unrest
   -Public outcry linked to dust and noise and perceived
   hazards as the new operation is implemented, etc.

Riskope International SA © 2009 www.riskope.com            7
A pre-feasibility qualitative risk analysis should
  reduce the chances of a fatal flaw of the design, by:


  -defining design parameters and
  -bringing changes to the preliminary design geared
  towards increasing the chances of the future
  implementation to work and perform as intended.




Riskope International SA © 2009 www.riskope.com       8
Comparison between IPC&CS and S&T at the considered coal mine with no
 specific mitigations implemented.

Riskope International SA © 2009 www.riskope.com                    9
Riskope International SA © 2009 www.riskope.com   10
If the design mitigation level are not sufficient, then
   the following situations may arise for the IPC&CS:

   -Refusal to accept the changes brought by the
   implementation
   -The system will not reach the promised
   performance level
   -The company will not produce the appropriate
   product
   -Repeated serviceability problems




Riskope International SA © 2009 www.riskope.com         11
All of the last four points could have large to
 catastrophic consequences for the project, and
 probabilities that will depend on the mitigation
 levels defined by the design team.

 If the pre-feasibility level is passed by the IPC&CS,
 the next step will be to:

   -review all of the proposed mitigations,
   -define the residual probabilities of failure and
   -evaluate mitigation alternatives.


Riskope International SA © 2009 www.riskope.com        12
Case Study 2: Long Term Pumping v.s.
         Encapsulation of a Very Large, Leaching,
           Underground Toxic Waste Storage.


This case considers a large underground storage of a
toxic water soluble compound with the potential to leach
into the water table.

In order to prevent the leaching a pumping system has
been installed.


Riskope International SA © 2009 www.riskope.com     13
In the Status Quo, the
 permanent pumping
 system keeps the
 underground water level
 below the lower level of
 the storage.

 However, water percolates from the surface and some
 of the compound is dissolved, leading to the need to
 treat the pumped water.

Riskope International SA © 2009 www.riskope.com         14
Probability   Cost M$
Cause/Hazard for Status Quo alternative


Capital investment will be necessary at start on the 90%         5
treatment plant
Energy cost (diesel for the power plant) has a 30%               to double
yearly chance of

Climate changes has a yearly chance of             15%           to triple




Riskope International SA © 2009 www.riskope.com                       15
The alternative to the
 Status Quo would be a
 Rehabilitation of the site,
 i.e. Encapsulation of the
 underground storage.


The encapsulation would require a large capital investment
(120M$), but afterwards the permanent pumping and
treatment would be reduced considerably.

Riskope International SA © 2009 www.riskope.com        16
Probability   Cost M$
Cause/Hazard for Encapsulation alternative

Capital investment has a chance to double             10%           120
(additional 120M) of
Energy cost (diesel for the power plant) has a        30%           to double
yearly chance of

Climate changes can force to still pump like today?   5%            3.6
unclear? with a chance of




Riskope International SA © 2009 www.riskope.com                           17
Because of uncertainties (construction, long term
climate change, etc.) there is also a chance that after
developing the encapsulation as above, it may be
necessary to maintain pumping as in the Status Quo.

This means that despite investing in the encapsulation
the project still could not work properly, which is an
example of a failed rehabilitation case or a worst case
scenario.



Riskope International SA © 2009 www.riskope.com      18
What makes this case study particularly strong
  •

  against using NPV for alternative selection is that:

  -most of the expense in Rehabilitation is upfront,
  -the yearly expenses (as traditionally done, without
  the risks) are small,
  -the duration is very long; the NPV almost “nullifies”
  any expense coming after approximately 20 years.




Riskope International SA © 2009 www.riskope.com          19
Traditional NPV Analysis

As usual in mining projects let's use for this example a
 Rate of Return of 9% and consider a life duration of
                     forty years.

NB: the NPV are always marked as negative values in
this study to stress the fact that the project generates
             only expenses and no profits.



Riskope International SA © 2009 www.riskope.com      20
Analysis Life Span: 40 years

Rehabilitation: Construction 120M$
0.3M$/yr, NPV: -123.23M$
Status Quo: Construction 0M$
3.6M$/yr, NPV: -42.33M$

 It can be inferred by this simple analysis that the Status
Quo has by far a better NPV value than the
Rehabilitation. We will show later this is a wrong
estimation because of the long life of the project, and
the risks that need to be included into the analysis.


Riskope International SA © 2009 www.riskope.com       21
There are two ways such an analysis could be
  altered to include risks.

  1) Add the yearly risks as an additional cost
  2) Increase the rate of discount to “include
  uncertainties” as we have seen some do.

  Both these attempts would fail to yield pertinent
  results, as we have demonstrated many times
  already in prior examples.



Riskope International SA © 2009 www.riskope.com       22
The NPV replacement method is called
  CDA/ESM™ and is used to compare alternatives in
  financial terms, including:

  a) life’s cycle balance encompassing internal and
  external risks over a selected duration and

  b) project implementation and demobilization costs
  and risks.



Riskope International SA © 2009 www.riskope.com       23
The CDA/ESM™ (Comparative Decision Analysis /
 Economic Safety Margin) eliminates the problems
 linked to the NPV deficiencies


 CDA/ESM™ has been successfully applied to:

 -rope v.s. road transportation,
 -surface v.s. underground solutions,
 -environmental projects,
 -water treatments alternatives,
 -transportation networks and
 -go/no-go decisions.


Riskope International SA © 2009 www.riskope.com    24
CDA/ESM™ is used to compare alternatives in
  financial/risk terms and can yield for each year:

  -the probability of financial failure,
  -the probability of overcoming available financing,
  -the probability of not being able to pay for
  demolition bond etc. and of course a
  -good estimate of the income, even for long term
  projects.



Riskope International SA © 2009 www.riskope.com         25
Example of CDA/ESM application user interface
           (first screen of the input phase)




Riskope International SA © 2009 www.riskope.com   26
CDA/ESM results at the 40 year time horizon for
   the three alternatives: Status Quo, Rehabilitation,
                and Failed Rehabilitation

 Vertical axis:
 Cumulative financial
 results in M$

 (probability of
 fiasco, exceedance
 of specific values
 etc. can be
 evaluated together
 as many other
 critical factors)



Riskope International SA © 2009 www.riskope.com      27
Sensitivity analyses can be performed, for example
 against energy cost increase. The Rehabilitation is way
 more efficient than the Status Quo, once all the
 considered risks are included, over the 40 years of
 expected life span.




Riskope International SA © 2009 www.riskope.com        28
In the Case Study, the Status Quo alternative is less
appealing than Rehabilitation, for any probability of
energy cost increase, because of its risk environment.


More risk scenarios can of course be included in the
analysis.




Riskope International SA © 2009 www.riskope.com    29
CDA / ESM eliminates the pitfalls of NPV, an obsolete
financial concept still used by many.

The evaluation of a project with CDA/ESM includes:

-the annual risks potentially afflicting the project,
-construction risks,
-risks of malfunctioning, and possibly also the
-demolition/reclamation costs.




Riskope International SA © 2009 www.riskope.com         30

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Cda Esm Comparative Decision Analysis Economic Safety Margin

  • 1. STOP PROCRASTINATING! NPV IS DEAD: USE RISK AS A KEY DECISION PARAMETER. By F. Oboni & C. Oboni Riskope International SA © 2009 www.riskope.com 1
  • 2. This Presentation Uses Two Case Studies to Show How Risk Can Be Used as a Discriminant in Decision Making for Key Decisions, in: -Key Areas of a Corporation, -Selecting Alternatives, -Evaluating Projects In the second Case Study, a method that eliminates the pitfalls of NPV is presented. Riskope International SA © 2009 www.riskope.com 2
  • 3. Case Study 1: Introducing In-Pit Crushing & Conveying System (IPC&CS) v.s. Shovel & Trucking (S&T) in a Large Dump Project. The operation was experiencing: -critical personnel issues, -difficulties with the ageing truck fleet which would require a large capital investment for renewal and maintenance, -the cost of diesel was, in the long run, certain to rise again causing concern. Riskope International SA © 2009 www.riskope.com 3
  • 4. At pre-feasibility level the aim is to identify situations that could hinder the performances of the project and define issues that need to be immediately addressed. Riskope International SA © 2009 www.riskope.com 4
  • 5. Risk mitigation geared towards reaching specific levels of residual risks vs. mitigative investments. RISK Mitigative “Acceptable” Mitigative Threshold Investment ALARA ALARP BACT Costs to Attain Zero Risk Acceptable Acceptable Residual Risk Residual Risk Riskope International SA © 2009 www.riskope.com 5
  • 6. Comparison between IPC&CS and S&T at the considered coal mine with no specific mitigations implemented. Riskope International SA © 2009 www.riskope.com 6
  • 7. Once the appropriate mitigation level for the issues described earlier are introduced in the design, the system will still be subject to two sets of risks: 1) Residual risks derived from design mitigated hazards (which depend, on the level of mitigation selected by the design team) 2) Risks linked to other issues (which may be independent from design mitigation efforts because they find their roots in public/workforce perception): -Union/personnel unrest -Public outcry linked to dust and noise and perceived hazards as the new operation is implemented, etc. Riskope International SA © 2009 www.riskope.com 7
  • 8. A pre-feasibility qualitative risk analysis should reduce the chances of a fatal flaw of the design, by: -defining design parameters and -bringing changes to the preliminary design geared towards increasing the chances of the future implementation to work and perform as intended. Riskope International SA © 2009 www.riskope.com 8
  • 9. Comparison between IPC&CS and S&T at the considered coal mine with no specific mitigations implemented. Riskope International SA © 2009 www.riskope.com 9
  • 10. Riskope International SA © 2009 www.riskope.com 10
  • 11. If the design mitigation level are not sufficient, then the following situations may arise for the IPC&CS: -Refusal to accept the changes brought by the implementation -The system will not reach the promised performance level -The company will not produce the appropriate product -Repeated serviceability problems Riskope International SA © 2009 www.riskope.com 11
  • 12. All of the last four points could have large to catastrophic consequences for the project, and probabilities that will depend on the mitigation levels defined by the design team. If the pre-feasibility level is passed by the IPC&CS, the next step will be to: -review all of the proposed mitigations, -define the residual probabilities of failure and -evaluate mitigation alternatives. Riskope International SA © 2009 www.riskope.com 12
  • 13. Case Study 2: Long Term Pumping v.s. Encapsulation of a Very Large, Leaching, Underground Toxic Waste Storage. This case considers a large underground storage of a toxic water soluble compound with the potential to leach into the water table. In order to prevent the leaching a pumping system has been installed. Riskope International SA © 2009 www.riskope.com 13
  • 14. In the Status Quo, the permanent pumping system keeps the underground water level below the lower level of the storage. However, water percolates from the surface and some of the compound is dissolved, leading to the need to treat the pumped water. Riskope International SA © 2009 www.riskope.com 14
  • 15. Probability Cost M$ Cause/Hazard for Status Quo alternative Capital investment will be necessary at start on the 90% 5 treatment plant Energy cost (diesel for the power plant) has a 30% to double yearly chance of Climate changes has a yearly chance of 15% to triple Riskope International SA © 2009 www.riskope.com 15
  • 16. The alternative to the Status Quo would be a Rehabilitation of the site, i.e. Encapsulation of the underground storage. The encapsulation would require a large capital investment (120M$), but afterwards the permanent pumping and treatment would be reduced considerably. Riskope International SA © 2009 www.riskope.com 16
  • 17. Probability Cost M$ Cause/Hazard for Encapsulation alternative Capital investment has a chance to double 10% 120 (additional 120M) of Energy cost (diesel for the power plant) has a 30% to double yearly chance of Climate changes can force to still pump like today? 5% 3.6 unclear? with a chance of Riskope International SA © 2009 www.riskope.com 17
  • 18. Because of uncertainties (construction, long term climate change, etc.) there is also a chance that after developing the encapsulation as above, it may be necessary to maintain pumping as in the Status Quo. This means that despite investing in the encapsulation the project still could not work properly, which is an example of a failed rehabilitation case or a worst case scenario. Riskope International SA © 2009 www.riskope.com 18
  • 19. What makes this case study particularly strong • against using NPV for alternative selection is that: -most of the expense in Rehabilitation is upfront, -the yearly expenses (as traditionally done, without the risks) are small, -the duration is very long; the NPV almost “nullifies” any expense coming after approximately 20 years. Riskope International SA © 2009 www.riskope.com 19
  • 20. Traditional NPV Analysis As usual in mining projects let's use for this example a Rate of Return of 9% and consider a life duration of forty years. NB: the NPV are always marked as negative values in this study to stress the fact that the project generates only expenses and no profits. Riskope International SA © 2009 www.riskope.com 20
  • 21. Analysis Life Span: 40 years Rehabilitation: Construction 120M$ 0.3M$/yr, NPV: -123.23M$ Status Quo: Construction 0M$ 3.6M$/yr, NPV: -42.33M$ It can be inferred by this simple analysis that the Status Quo has by far a better NPV value than the Rehabilitation. We will show later this is a wrong estimation because of the long life of the project, and the risks that need to be included into the analysis. Riskope International SA © 2009 www.riskope.com 21
  • 22. There are two ways such an analysis could be altered to include risks. 1) Add the yearly risks as an additional cost 2) Increase the rate of discount to “include uncertainties” as we have seen some do. Both these attempts would fail to yield pertinent results, as we have demonstrated many times already in prior examples. Riskope International SA © 2009 www.riskope.com 22
  • 23. The NPV replacement method is called CDA/ESM™ and is used to compare alternatives in financial terms, including: a) life’s cycle balance encompassing internal and external risks over a selected duration and b) project implementation and demobilization costs and risks. Riskope International SA © 2009 www.riskope.com 23
  • 24. The CDA/ESM™ (Comparative Decision Analysis / Economic Safety Margin) eliminates the problems linked to the NPV deficiencies CDA/ESM™ has been successfully applied to: -rope v.s. road transportation, -surface v.s. underground solutions, -environmental projects, -water treatments alternatives, -transportation networks and -go/no-go decisions. Riskope International SA © 2009 www.riskope.com 24
  • 25. CDA/ESM™ is used to compare alternatives in financial/risk terms and can yield for each year: -the probability of financial failure, -the probability of overcoming available financing, -the probability of not being able to pay for demolition bond etc. and of course a -good estimate of the income, even for long term projects. Riskope International SA © 2009 www.riskope.com 25
  • 26. Example of CDA/ESM application user interface (first screen of the input phase) Riskope International SA © 2009 www.riskope.com 26
  • 27. CDA/ESM results at the 40 year time horizon for the three alternatives: Status Quo, Rehabilitation, and Failed Rehabilitation Vertical axis: Cumulative financial results in M$ (probability of fiasco, exceedance of specific values etc. can be evaluated together as many other critical factors) Riskope International SA © 2009 www.riskope.com 27
  • 28. Sensitivity analyses can be performed, for example against energy cost increase. The Rehabilitation is way more efficient than the Status Quo, once all the considered risks are included, over the 40 years of expected life span. Riskope International SA © 2009 www.riskope.com 28
  • 29. In the Case Study, the Status Quo alternative is less appealing than Rehabilitation, for any probability of energy cost increase, because of its risk environment. More risk scenarios can of course be included in the analysis. Riskope International SA © 2009 www.riskope.com 29
  • 30. CDA / ESM eliminates the pitfalls of NPV, an obsolete financial concept still used by many. The evaluation of a project with CDA/ESM includes: -the annual risks potentially afflicting the project, -construction risks, -risks of malfunctioning, and possibly also the -demolition/reclamation costs. Riskope International SA © 2009 www.riskope.com 30