The Implementation of RAROC

In his Team Briefing #8 for Year 2016-17, Jamal Jafaar, stated that: “From a planning perspective, in order to ensure that our strategic programs are globally competitive and are able to withstand various risks and uncertainties and still be economically attractive, some elements of risks are being introduced to our economic evaluation process through the adoption of the “Risk Adjusted Return on Capital” (RAROC) financial indicator… adopting RAROC will not only boost the benefits we gain from our capital investments, but will also assist us in making better operational and financial decisions by honing our risk management capabilities. This will form the basis in the future for all Strategic Program Economic evaluation with quantifiable economic profitability indicators as an outcome”.

 

In light of this statement, Operational Planning Team has been working diligently for the past few months to design and implement the RAROC methodology. The development program which will span six months is targeted to finish in January 2017, in order to be ready to fully implement RAROC starting Fiscal Year 2017/18.

 

RAROC will build on existing activities that are undertaken by the asset teams, developing a new risk based approach to assess capital investments at a program level when funding is requested, incorporating a methodology to quantify risk in economics calculations

The current delivery structure within KOC and the relationship between project funding requirements at Project Gate System (PGS) Stage Gate (SG) 3.1 and the RAROC analysis is depicted in the figure 1:

 

 

Program economic evaluation is required during the Front End Loading (FEL) stages in the PGS. The current program economic evaluation takes into account all relevant costs, revenue and timing. Economic indicators such as NPV, IRR, etc. are applied using cost of capital to compute the time value of cash flows. Petroleum Economic Evaluation Program (PEEP) is the uniform system used across KOC as the main program economic evaluation tool.

 

RAROC will leverage the existing approach to program economics and introduce additional steps to provide a range of new risk based economic indicators. It will drive new methods of economic evaluation to enable more fact-based and quantitative assessments of risk across Capital Programs. RAROC is a method that has been mandated by KPC and will need to be implemented for all Strategic and Retrofitting Programs by Budget Cycle 17/18. The process also brings other benefits to KOC, especially around the approach to identifying and managing risks across all projects and programs. The strategic process map for RAROC is set out in Figure 2, highlighting the critical inputs for calculating the expected program RAROC and other related metrics:

1. Risk register: which identifies, quantifies and responds to all key risks associated with the selected program; and

2. PEEP data: which includes key economic inputs, including expected CAPEX and OPEX costs, production, revenue as well as economic indicators such as NPV and IRR.

 

 

 Expected NPV: The most likely NPV of the project based on the Monte Carlo simulation results automatically calculated in the RAROC model. This is also known as the P50 value as it is the value the NPV is equally likely to be above or below;

 Planned Investment: The total planned CAPEX and OPEX over the lifetime of the project, discounted for time; and

 NPVaR (Net Present Value at Risk): NPVaR is the amount of NPV that stands to be lost as a result of such risks occurring within a program or project. It is calculated as (Baseline NPV minus P5 NPV. For this calculation, P5 is used instead of P1 or P0 to ignore tail values which have less than 5% probability of happening. KOC will use Palisade @Risk software to undertake Monte Carlo analysis that sets out what the P5 value is for the programs.

The RAROC metric for each project / program will enable the development of an effective evaluation framework that is able to easily rank programs and projects, considering appropriate weighting to risk and return - a key KOC and KPC objective.

 

RAROC principles ensures a consistent approach for program economic evaluations by:

 Undertaking structured risk management and governance processes that support RAROC application;

 Performing consistent reporting and producing dashboards that can be provided to stakeholders, such as KPC;

 Developing a consistent approach to define and quantify risks, their impacts and how they contribute towards the key RAROC metrics;

 Providing the capability to model risks across specific projects or the overall program; and

 Creating the right culture for risk management and economic evaluation.

Implementing the right risk governance structure will ensure that there is a clear ownership of the RAROC process and the supporting risk and economic requirements. This enables KOC to establish a standard approach for how RAROC is developed, analysed, evaluated, communicated and monitored. The governance structure should ensure that:

 Clear ownerships are established, including the creation of defined roles and necessary training on the detailed RAROC requirements;

 There are consistent, governance processes for identifying, analysing, evaluating, communicating and monitoring risk throughout KOC projects;

 Where possible, KOC delivery and risk management resources should adopt common technical terms to facilitate consistent risk analysis and achieve clear and consistent communication of risks; and

 Risks are effectively and proactively managed throughout.

Consistent reporting will give stakeholders an understanding of the expected return on investment for capital programs - recognising the impact of risk - which will help achieve KOC’s strategic and project delivery objectives and identify which actions should be undertaken to maximise the RAROC. These actions will often be related to improved risk management and optimised delivery of the capital investment (i.e. efficient efforts to reduce the initial investment, maximising operational excellence to reduce cost / increase productivity, etc.).

RAROC reporting will include consistent dashboards and reports set out in the MS Excel model, to ensure RAROC outputs for all programs are presented in the same manner.

Creating the right culture around economics, risk management and RAROC plays an important part in framing the quality and integrity of the RAROC process, and will enable a proactive stance to risk management and investment appraisal. Culture principles will:

• Ensure that risk management is included in the generic competency framework for all asset teams who understand the programs they contribute to and their risks;

• Embed the RAROC process and the sharing of lessons learned widely across KOC teams, showing the importance and benefits of risk management, RAROC and its application to their business activities; and

• Encourage a positive team spirit and a collaborative culture between stakeholders who are required to undertake a RAROC model.

 

The key benefits of implementing RAROC for KOC include:

1. Presenting program investment with economic evaluations that weigh profitability against risk to differentiate between programs;

2. Promoting a culture of risk-based evaluation and provide a standardized way to measure risk to support the Project Review Committee and other stakeholders in the decision making process;

3. Driving enhanced, consistent risk management across all capital programs; and

4. Providing a new quantitative method of risk management that allows the user to transparently identify key risks and develop response actions to manage them.

Implementation

RAROC is required to be applied to all Strategic and Retrofitting programs starting Fiscal Year 2017/18. It is a mandatory requirement as part of closing Stage Gate 3.1 and to raise the budget proposal. The process design and development is underway and will be concluded by January 2017. Champions from all concerned Directorates have been nominated, and are actively engaged in the design of the process, as well as the training.

An extensive training program is conducted for all stakeholders. It consists of three sessions and workshops primarily covering risk assessment, PEEP data review, and RAROC model. The objectives of the training programs are:

 To test the RAROC framework on live programs, gaining feedback on the model and processes

 To test the framework on different types of programs across different asset teams to confirm the applicability

 T engage with asset teams prior to full implementation, working with them to carry out the process for the first time

 T increase risk management awareness and upskill program teams through risk identification workshops to improve RAROC inputs