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Optimal Mitigation Strategy for Electricity Wildfire Risk

A key challenge for asset management organisations is identifying and quantifying risks associated with specific asset classes and developing optimal strategies to mitigate these risks. Developing these strategies can be complex for asset management businesses managing a large number of assets which have variable failure rates over many years.

Parsons Brinckerhoff has a long and established history advising clients in asset management across a range of infrastructure sectors. Recently, Parsons Brinckerhoff was engaged to assist an electricity network business in Australia in responding to an asset management issue which posed a significant risk to the business.

The electricity network business was located in a high bushfire risk area of Australia which had recently experienced the worst bushfires in Australia’s history, with over a billion dollars ($AUD) of property damage and significant loss of life. The Royal Commission established to investigate the bushfires found that the fires were caused by a combination of extreme weather conditions, arson, and power line failures. The associated exposure of electricity network businesses to considerable financial and legal risk from power line failures meant that a business-as-usual approach to the management of these assets was no longer appropriate

 

Optimal Asset Management Strategy

The utility provider engaged Parsons Brinckerhoff to develop an asset management strategy which mitigated the bushfire risk. This asset investment strategy was required to be prudent and efficient in accordance with the key principles of the Regulatory Investment Test, a test applied to major expenditure programs proposed by regulated energy businesses in Australia.

Quantifying the Risk

Parsons Brinckerhoff developed an optimal asset investment strategy using risk-based cost benefit analysis. This involved the use of a probabilistic risk metric to predict the asset failure rate and cost-benefit analysis of asset replacement investment options to determine the preferred strategy for managing future replacements of overhead conductor assets.

To quantify the long-term risk to the business from failing overhead conductor assets, Parsons Brinckerhoff developed a model which predicted the annual number of conductor failures over the next 20 years. The model used historical failure data and a cumulative normal distribution function to determine the probability of asset failure as it ages. A symmetrical cumulative normal distribution reasonably modelled the failure behaviour of aging conductor assets. It predicts a consistently low random chance of failure through the early stages of asset life and models the rapidly increasing probability of failure once the wear-out zone is reached.

Parsons Brinckerhoff’s risk model found that a large proportion of the business’ conductor asset inventory was nearing the end of its service life and was predicted to start failing at an increasing rate, as shown in Box 1.The risk model was calibrated with key variables which influence asset condition and hence the probability of asset failure. These variables were informed by the business’ conductor fault investigations, which indicated that the main factors influencing asset failure in the area were the type of conductor material (e.g. steel, aluminium, or copper) and proximity to the coast where assets are subject to salty deposits and
corrode at a faster rate. 

The emerging risk profile equated to a ten-fold increase in the forecast number of failures over the next 20 years, as shown in Box 2 (on the following page). As any one of these failures could result in a catastrophic
bushfire event, this emerging risk posed a significant liability to the
business and community in which it distributed power.

Naturally, the business could reduce this risk by investing in the replacement of conductor assets that are aging and likely to start failing. The question was thus: what is the optimum level of investment to mitigate this risk? 

Valuing Investment Costs and Benefits

To determine this optimal level, long-term investment costs and benefits associated with different investment scenario options were valued in monetary terms to enable a comparison of investment options from a present value perspective. This cost-benefit analysis essentially addressed the trade-off between investment outlays (costs) and the reduction in risk (benefits) for each level of investment.

Investment Costs

Five asset investment scenario options were developed in conjunction with the electricity network business. These annual investment options were as follows: 

  • Investment option 1: No replacement

  • Investment option 2: Business-as-usual asset replacements each year

  • Investment option 3: Increasing asset replacement investment to $20 million

  • Investment option 4: Increasing asset replacement investment to $40 million

  • Investment option 5: Investment to maintain constant risk over 20 years

The investment amount in each option provides a volume of conductor to be replaced each year. For instance, the $20 million and $40 million investment options correspond to the replacement of approximately 485km and 970km of conductor per year. 

Investment Benefits

Investment benefits relate to the reduction in risk from each asset investment option. These “benefits” are based on the avoided costs of conductor failure. As is often the case in the assessment of long-term asset management investment strategies, these benefits are not in the form of real incomes, but rather avoided costs due to reduced expected future liabilities.

The avoided costs were quantified in terms of the avoided economic consequences of bushfires, accounting for values such as avoided property damage, avoided power outages, avoided environmental destruction, and avoided loss of life. The economic values associated with these benefits can be significant, and in the case of catastrophic bushfire events can avoid business liabilities in the order of billions of dollars. These benefits are, of course, weighted against the relative likelihood that an asset failure would result in a minor, major, or in rare cases, a catastrophic bushfire event.                                                                         

Investment Scenario Modelling

 

With the emerging risk quantified and the investment costs and benefits valued in dollar terms, investment scenarios could be modelled for each of the five investment options over the next 20 years. These investment scenarios quantified the effect of the five conductor replacement investment options on the forecast number of failures over this period, as shown in Box 3.

Comparing the forecast failures between the “do nothing” option and the options to invest various amounts in asset replacement, enables calculation of the avoided number of failures for each investment option relative to the option where no investment is made to replace at-risk assets.

Preferred Investment Option

To determine the preferred investment option, net present values (NPVs) are generated for each investment option, as shown in Box 4. The NPVs are based on the expected discounted costs and benefits that the business will face each year under each option, enabling comparisons of the financial performance of the five investment options.  

The NPV results indicate that the strategy to invest $20 million per year has the highest NPV over 20 years and is thus the preferred investment strategy to manage the emerging quantified risk associated with aging conductor assets. This result was confirmed through a number of sensitivity tests which varied key model inputs and found that the $20 million annual investment remained the preferred investment strategy. 

Applying this preferred investment strategy over 20 years is forecast to produce an outcome for the business which is $50 million ($AUD 2009/10) better than the next preferred investment option and $274 million ($AUD 2009/10) better than the “do nothing” option in which no investment is made to replace aging conductor, but significant liabilities are forecast to result from the failure of these assets. It is important to note that the preferred strategy is not only the most economically efficient option for the business but also for the community. The community ultimately bears the costs of electricity system asset replacements, and gains the benefit of fewer asset failures that could potentially trigger bushfires causing catastrophic damage to people, infrastructure, and the environment. 

Quantified Support for Complex Asset

Parsons Brinckerhoff’s recommended investment option, to invest $20 million a year in asset replacement, was used to support the commencement of a $400 million conductor replacement program to manage the risk of conductor failure over a 20-year period. This level of investment was built into the client’s business plans and included in the expenditure forecast submitted to the Australia Energy Regulator (AER).  

Investment Decisions

The adoption of a quantified approach to selecting an optimal asset management strategy enables infrastructure businesses to obtain maximum value from their assets. The use of this optimised investment approach enables businesses to resolve uncertainties associated with emerging asset risks, identify asset characteristics with greatest influence on the asset failure rate, and determine the optimal timing and replacement volumes for critical assets, over short and long planning periods.  

It is especially applicable for infrastructure organizations that manage a large number of assets and where asset failures can have high consequential costs for the business, community, or the environment.

 

Image Header Source: Dave Young (Creative Commons)