Risk Management in Energy Infrastructure ProjectsApplication to CCS-EOR Projects
Anna AgarwalCenter for Energy and Environmental Policy Research
Massachusetts Institute of TechnologyJuly 30, 2013
Motivation Risks in infrastructure projects are combination of exogenous and endogenous
risks• Exogenous risks: e.g. market risks, geological uncertainty• Endogenous risks: inefficient decision-making by involved entities
Endogenous risks cited as the dominant reason for under-performance in infrastructure projects (Flyvbjerg, Miller and Lessard, Merrow, World Bank Report on Infrastructure)
Challenge in designing contracts to address endogenous risks lies in the multitude of exogenous risks
• Large number of risk factors make to difficult to foresee all future contingencies and specify them in contracts (Williamson, 1971)
Traditionally infrastructure contracts tend to be ‘rule-based’ and not ‘performance-based’, thus contractor has no incentive to reduce risks
Challenge in infrastructure risk management is to change the current contracting approach (Flyvbjerg, 2003)
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ObjectiveDevelop a risk management framework that accounts for
both the exogenous and endogenous risks, and
maximizes the aggregate project value.
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Application: CCS-EOR Prototype Project
Source: Bellona Foundation
500 MW IGCC Coal-fired Plant(with 90% CO2 Capture)
Source: IPCC Report on CCS
CO2
50-mile Pipeline(dedicated)
EOR Oil Field(140 million bbl. oil recovery expected)
Risk Management Framework
Stage 1
Integrated Project Risk Management
- Identify risk factors
- Risk Assessment
a) Characterize the uncertainty
b) Evaluate project risk exposure
- Evaluate efficient risk management
decisions
Stage 2: Address Endogenous Risks
Entity 1 Entity 2 Entity 3…
Evaluate optimal contracts that incentivize the efficient decision-making
Contracts Contracts
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Random Walk Model (Geometric Brownian motion)
Modeling uncertainty in market risk factors
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Shocks to log spot price are normally distributed
• Marginal Benefits of CO2 Capture and Injection
Revenue from oil production
Avoided CO2 emission penalty
• Marginal Costs of CO2 Capture and Injection
Energy penalty of CO2 Capture
O&M Costs of CO2 Injection
Costs involving drilling CO2 injection wells and oil production wells
Contingent Decision-making – Adjust CO2 Capture and Injection Rate
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(depends on oil price)
(depends on electricity price)
(depends on CO2 emission penalty)
Evaluate Optimal CO2 Capture Rate
Optimal capture rate decreases with:Decreasing oil priceDecreasing CO2 priceIncreasing electricity price
14% probability of optimal CO2 capture rate being less than 90%
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Gains from adjusting CO2 capture rate increase withDecreasing oil priceDecreasing CO2 priceIncreasing electricity price
Financial Gains from Contingent Decision-making
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14% probability of positive gains from contingent decision-making
Financial gains can exceed $300 million (16% of project NPV) Expected value of project value gains is
$11 million (0.6% of project NPV)
Financial Gains from Contingent Decision-making
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Criteria for Design of CO2 Delivery Contracts
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2) Incentivize optimal contingent decision-making
1) Minimize the risk of insolvency
Power Plant
Oil Field Pmax
Pmin
Power Plant
Oil Field Pmin
Pmax
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Evaluating Incentives for Contingent DecisionsFixed Price CO2 Contracts ( $ / ton CO2)
82% probability of sub-optimal contingent decision-making
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Evaluating Incentives for Contingent DecisionsIndexed Price CO2 Contracts ( % price of oil / ton CO2)
• Sharing oil price risk reduces likelihood of sub-optimal contingent decision-making to 13%• The scenarios with risk of sub-optimal decisions correspond to low electricity price and high
CO2 emission penalty (poor incentive for power plant to lower CO2 capture rate)• In CCS-EOR projects need to index contract to other risk factors – such as electricity price
and CO2 emission penalty
Conclusions from Market Risk Analysis
• Evaluated optimal contingent decisions, and signified the financial
gains involved.
• Analyzed the implications of contract design and risk-sharing on the
decision-making of the entities.
• Quantitatively illustrated that the final risk exposure of the project
depends on both exogenous risks and endogenous risks.
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