Combine the physical and financial aspects of an asset!

As consultants in the field of ISO-standards related to physical assets (primarily infrastructure) we most often don´t see very excited reactions among the clients. Recently we have however it has happened a few times with very diverse clients and I´ll share the instances with you here. (The relevant info is public)

At other cases we produce valuation statements, rather large financial models in Excel, reviews and second opinions on physical assets (primarily power assets in our case). Those assignments also require attention to detail and plentiful of reading combined with clear analysis and stamina. If stirring excitement with the client, it is then limited to a very small piece of the work or report, namely the few lines covering the financial value. Not the more technical parameters producing the input.

Recently we ran those in combination and received very interested and committed response. I will try to make a popular and brief description to the field and the performed simulations. There should indeed be a public interest in this field (management of utilities) and in our view a broader professional commitment to asset management.

What is Asset Management?

When googling Asset Management, the primary hits are within financial advisory. When adding ISO 55000 you receive hits covering management of primarily large physical complexes such as power plants, railroads, roads, water treatment plants, airports, harbors, oil refineries, gas pipelines etc. The images show hard hats worn on plants rather than bankers on Wall street. These worlds often seem apart. Say the words maintenance plan to someone in finance and you often get a blank face. Say balance sheet to an engineer and you often get the similar blank face.

Where do we find asset management?

ISO 55000 is the international standard for Asset Management. The standard defines asset management as “coordinated activities to realize value from assets”. Further it describes an asset as something which has or can have value, it may hence be built, planned or under construction. It may also not necessarily be physical; however this discipline focuses on tangible assets.

A systematic optimization approach

Under Asset Management following the principles of ISO 55000 an integrated approach is taken to leading and managing the organization owning and operating an asset in a way which serves and optimizes the organizational objectives. Hence, the very common pitfalls of maximizing or minimizing individual parameters and disciplines can be avoided. The allure of minimizing annual O&M-cost, maximizing production, implementing the most ambitious risk management, squeezing life length etc. is here given a framework of being matched against each other and optimized to serve the overall goals of the organization, without neglecting any parameter or leaving it to chance. The parameters and their weight need to be adapted to the individual asset, organization and time. Example of parameters can be seen in the below illustration.

The Hexagon of Asset Management Optimization (example parameters):

The performed simulations

We have run a few simulations of impact on asset value based on possible asset management strategies of two different types of physical assets, using a set of inputs being typical respectively public. The purpose has been to enable clients to not only grasp consequences but also to compare and prioritize different measures. Ultimately to enhance likelihood of taking decisions leading to successful asset management.

The simulations are, in our view, not very common. Of course, maintenance engineers are interested in expressing the economic effects of their work, which most often takes the form of how much money can be saved annually on O&M. And thereby missing the big potentials, which we will come to. People involved in financial valuations often sees that different sets of e.g. maintenance cost or production assumptions have impact on cash flow and thereby the valuation but typically lack the possibility to check plausibility of these and evaluating the cross-effects and therefore moving back to alternatives accepted in policies of the bank, insurer or similar or in some entrepreneurial cases move into dangerous risk willingness. Consequences of things going wrong in e.g. power plants or railroads can, in the true essence of the word, be fatal.

The tested wind power case

We have adjusted real cases of a very typical Swedish wind farm, into something we can call the median Swedish wind farm. This technology and market are evolving exponentially, over time annual energy production roughly doubles every three years, right now from roughly 20 TWh to 40 TWh around 2021, investments for the period sums up to around 70 bln SEK.

More analysis and statistics on the Swedish wind power market can be found in this presentation.

Hence, the “typical” or median farm is a moving target. To reflect common wind projects built over time and looking on farm roughly being half way through its original intended life length; we came to the following case:

“The example median Swedish wind farm”:

· 4 turbines of each 2 MW, equaling totally: 8 MW

· Annual Energy Production (AEP): 24 GWh

· Operating Expenditure (OpEx): 0,1 SEK/kWh

· Remaining life length: 11 years

· Average future revenue using traded forward contracts: 0,43 öre/kWh

· Discounting rate (Weighted Average Cost of Capital): 6%

-->By using above inputs to calculating and discounting cash flows to net present value (NPV), we arrive at a valuation of 61,1 MSEK.

So what happens when altering a few of the inputs?

The altered parameters and impact on value:

1. Increasing life length 1 year -->NPV +3,6 MSEK

2. Increasing life length 2 years --> NPV +7 MSEK

3. Decreasing life length 1 year -->NPV -3,8 MSEK

4. Decreasing OpEx 0,01 SEK/kWh -->NPV +1,9 MSEK

5. Increasing OpEx 0,01 SEK/kWh -->NPV -2,1 MSEK

6. Increasing availability and thereby increasing Annual Energy Production 1 GWh --> NPV +3 MSEK

7. Decreasing availability and thereby decreasing Annual Energy Production 1 GWh --> NPV -3 MSEK

8. Combined effects thanks to poor asset management; life length down 1 year, OpEx up 0,01 SEK/kWh, availability and AEP down 1 GWh (those things often go together as a consequence of ill-run machines) (These changes in input are not stark) --> NPV -10,2 MSEK

9. Combined effects thanks to thought-through asset management; life length up 1 years, OpEx down 0,01 SEK/kWh, availability and AEP up 1 GWh --> NPV +9,1 MSEK

The impacts of poor, neutral or strong asset management regimes on individual parameters may not seem so big, be it +-1 year life length, OpEx +- 0,01 SEK/kWh or +-4% production. We have seen much bigger deviations, especially downwards, largely due to lack of asset management strategies that at least briefly tries to cover the major parameters and try to optimize the common goal of NPV. Combined the negative input of these rather modest deviations downward sums up to -10,2 MSEK. This can typically be equal to half the equity and hence loosing 50% of share value.

Going the other way by employing a well-adapted asset management strategy, moving individual parameters into slight improvements, which on an annual basis may not seem big, results in increased asset valuation of +9,1 MSEK. Then, as a consequence of stronger, more stable performance and basis for more prudent reporting may also well lead to a lower risk premium from financiers and hence lower financing cost. When adding the parameter of discounting rate going down 1%, another 3,9 MSEK is gained on asset value, coming to 74,1 MSEK.

The delta between poor and strong asset management is 23,1 MSEK. For an asset originally valued 61,1 MSEK.

Having given many PowerPoint-presentation and sending over many reports, it is striking how this part stroke light in the eyes of the client.

The tested railroad case

In this case we use information from one of the many investment cases which the Swedish Transport Administration (Trafikverket) makes public here.

Investment calculations for public owners work partly similar and partly different to private. Important economic similarity between most infrastructure assets lies in the CapEx, OpEx, revenue and financing structures. Namely, a very large capital expenditure (CapEx, Investment) will be followed by a long number of years of producing basic human utility, often with foreseeable revenues and costs. A result is calculations stretching over far longer time periods than for businesses involved in manufacturing, trade etc.

The main difference lies in production not being sold under market pricing and hence not receiving a revenue which reflects the economic benefit experienced by it´s users. Therefore, the Cost Revenue Analysis used under market pricing is replaced with Cost Benefit Analysis, where economical values are given to the relevant costs and benefits associated with the asset. In the case of Trafikverket, the parameters consist of effects given an economical value to calculate cost and benefit both to individuals, companies, the government budget and societal and environmental effects. Among these effects are travel time, deaths and severally wounded, climate, human health etc. These are weighed against costs related to investment and operation & maintenance. As in the case of the private power asset, Trafikverket calculates present values for each of the analyzed effects and when summing up, a net present value can be calculated also here. The method used by Trafikverket is called ASEK 6.1 and is explained in a public report over 408 pages here. The report covers a large number of parameters with scientific approach but it comments that there is a lack of knowledge on the economics of Operation and Maintenance and that this field would benefit from further research.

It should be added that in the total investment appraisal (Samlad effektbedömning, SEB) of Trafikverket, also non-quantitative aspects are taken into consideration.

The analyzed case, Tomteboda-Kallhäll, increased capacity, part 2, BVST014:

· Suggested scope: two additional railroad tracks, tunnel under Sundbyberg, straightened curves etc

· Life length: 60 years

· Discounting rate: 3,5%

· Travel time effects, Present Value (PV): 10 226 MSEK

· Ticket revenues, PV: 1 219 MSEK

· Traffic operation costs, PV: -489 MSEK

· Operation and maintenance, PV: -58 MSEK

· Refurbishing reinvestments, PV: -70 MSEK

· Construction cost (CapEx), PV: -10 426 MSEK

· +20 other parameters

· --> SUM, Net Present Value = 821 MSEK

Hence, the suggested investment has a positive net effect on overall economics of society and should be undertaken. (A positive investment decision has also been taken, however after some alteration to the project)

After internal discussions we simulated a few scenarios reflecting different styles and outcomes of asset management, similar to the above wind power case.

The altered parameters and their impact on value:

1. 5% improved availability and travel time effects NPV +~1 300 MSEK

2. 8% improved availability and travel time effects àNPV +~1 600 MSEK

3. 8% drop in availability and travel time effects àNPV 0 (Not profitable!) 4. Increased life length to 66 years Travel time PV +1 023 MSEK -->O&M PV -6 MSEK -->NPV ~1 800 MSEK 5. Decrease in life length to 54 years àTravel time PV -1 003 MSEK -->O&M PV -6 MSEK -->NPV -~200 MSEK

Net present value is more than doubled by a 10% increase in life length. For a case of public rail road.

The relative changes are stark, especially from changes in life length.

Also here, where the client does not hold shares in the operation, this particular part stroke light.

We hope this has shed light on matters relevant to you. If you have further interest in the topic and want to come in contact with us, don´t hesitate to use e.g.: