Catastrophic failures: Identifying risk exposure and setting investment priorities

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Editor's note: In the commentary below, Roy Ellis, Executive Director of Ernst & Young LLP Power & Utilities practice, highlights some key points from his new paper, Managing the risk of catastrophic failure: Developing a risk-informed development strategy for critical assets. While the paper uses pipeline failure as an example, we thought electric utilities with aging infrastructure might find his perspective of interest.

 

 

By Roy Ellis

 

The nation’s aging critical power and utility assets present a growing risk. A failure of these assets in densely populated areas exposes the operator to greater consequences, as evidenced by a fatal explosion in the San Francisco area that could ultimately cost pipeline owners $2 billion to cover restitution and rebuilding.

 

The full financial impact of the next catastrophe-in-waiting cannot be ignored.

 

For power and utility companies, this necessitates a change of approach in how they maintain critical infrastructure. Instead of being guided by regulatory compliance, utilities should adopt a risk-based evaluative method – similar to that used by the airline industry – that considers the likelihood and consequence of a catastrophic failure.

 

This involves a three-step, jurisdictionally focused process to identify risk exposure and set investment priorities accordingly.

 

Step one: assess jurisdictional risk exposure

This involves dividing assets into three asset investment categories and conducting an assessment of these assets to confirm compliance, risk exposure and jurisdictional mitigation priorities.

 

Step two: prioritize and optimize the investment plan

Once all jurisdictions or business units have completed an individual assessment, this information is combined with all other risk components to create a structure against which a utility can consider investments and compare the risk impact of alternative mitigations.

 

The utility will then use these scenarios to develop internal, cross-jurisdictional consensus that incorporates the local reality of what can be achieved with the mitigation alternatives. From this information, the utility will create a final risk-ranking list that harmonizes all jurisdictional requests for investment funding with a clear view of the risk mitigation resulting from those investments.

Step three: create risk and regulatory alignment

In this step, a utility will share information developed from the first two steps with all external stakeholders to inform and gain support for the required investment plan. The objective is to clearly articulate the corporate risk tolerance and current risk profile and explain how each risk mitigation investment changes the profile – and at what cost – in order to build consensus with the regulators for the needed investments.

 

The key output of this process is exposing the regulators to the relative likelihood and consequence of failure by demonstrating a compelling case for investment built on a sophisticated and professional analysis.

 

It’s time for utilities to make the shift from compliance to a more proactive risk management approach. Used correctly, a risk-based approach can help utilities effectively manage the risk of critical asset failure. It can also produce a compelling regulatory case that can accelerate the replacement of high-risk assets as well as make a constructive case for a more equitable approach to risk and consequence-sharing between shareholders and ratepayers.

 

The full paper can be downloaded here >>

 

Roy Ellis is an executive director with Ernst & Young’s Advisory Services practice. He has a strong utility background with experience developing and delivering system and process improvements for Tier One utilities.

 

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