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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Thank you

Anna AgarwalMIT Center for Energy and Environmental Policy Researchannaag@mit.edu