Valuation of risks and opportunities

How to Use

This framework requires more analysis than standard costing procedures. Quantifying uncertainties and risks is far from trivial, but their absolute quantification is not always necessary. Relative risk assessments may be enough to choose between alternatives, and identifying the most important risks may suffice for further project optimisation. As valuing uncertainties and specific qualities is a complex task, this conceptual framework indicates how to handle and value BwN qualities and related uncertainties. It involves the following steps:

  1. Risks and qualities
  2. Prices and performance
  3. Valuation and costing
  4. Design and communication

Often costing and budgeting is done by experts that have little or no expertise in the technical and practical aspects of a project. Stimulating them to interact, yields better assessments, as the process becomes more iterative and interactive and it also safeguards consistency.There are therefore various levels of using the framework. Most important is an overview of relevant cost key figures for the main design components. For many BwN projects, movement of sand or clay and working with sand and clay are major cost components. Therefore, one needs to have an overview of the possible costs involved, and of the variables that determine these costs, such as transport distances for earth-moving.

1. Risks and qualities

This step comprises analysing and identifying uncertainties, risks and qualities. Uncertainties and risks are related to e.g. market price variations and trends, modelling, design, implementation, (uncertain) performance and environmental design conditions and their time-evolution. Qualities are mainly related to ecosystem services and related functions. This step consists of 2 parts:

  1. Analysing types of risks and qualities: some are related to market situation and prices, some are relevant to the functional performance of a project. Relevant categories for e.g. coastal management projects refer to climate change, morphological models, grain size of available sand.
  2. Analysing consequences of relevant future scenarios: those uncertainties that are relevant to the functional performance of a project on the long term under different circumstances (e.g. climate change) should be clustered into a limited number of relevant scenarios for further analysis.

2. Prices and performance

Market – related:

  1. Market analysis and consultation focuses on the way in which the market situation and also contract conditions may influence the price of the contract. Most of these aspects are part of normal costing procedures, except for the way in which contract conditions may influence market prices. Contract conditions, notably the combination of building and subsequent Operation and Maintenance, can have a large impact on market prices.
  2. Price development analysis takes into account the influence of e.g. fuel prices, which constitute an important part of the costs for nourishment, and technological developments on the long-term development of prices. This is not a standard procedure but will be relevant in case of long-term assessment and life-cycle costing.

Performance – related:

  1. Functional risk analysis considers the performance and functioning of a project under one scenario, with emphasis on internal factors that may affect performance, such as modeling uncertainties and implementation uncertainties. Often this analysis is included in order to establish a bandwidth for operation and maintenance costs and to identify the need for contingencies or the perspective for adaptive management.
  2. Performance analysis considers the performance and functioning under a set of different scenarios, with emphasis on external factors that drive performance, such as climate change and long-term sand availability.
  3. Other performance benefits are the domain of ecosystem services that are not directly related to the primary functionality/purpose of the project. They may consist of benefits to safety, recreation, real estate, water supply and other functions.

The assessment should focus on the most relevant risks and qualities only, i.e.:

  • Those that have substantial budget implications and are therefore important to financing.
  • Those that create marked differences between project alternatives and are therefore important to decision-making.
  • Those that depend on project design and should be considered in the design process.

For scenario analysis also the number of relevant scenario parameters should be limited. This can be done by clustering relevant scenario variables that generate similar kinds of uncertainties and have similar effects on long-term performance.

3. Valuation and costing

The next step is to integrate the results of these assessments in the costing sheets. Often this can be done within the standard costing sheets. Long-term performance can be expressed in terms of a “performance premium” in order to enable comparison of different alternatives. Uncertainties can be addressed as:

  1. Different discount rates enable incorporating risks and uncertainties. Higher discount rates can be applied to benefits that are more uncertain, so their influence on the total balance is not overestimated. Similarly, lower discount rates can be applied to costs that are less certain, so they are not underestimated.
  2. Price differentiation range and trends: the results of the market and price development analysis are translated in a relevant range of component prices.
  3. Unforeseen engineering is a standard budget item meant to cover engineering aspects that have not been foreseen. Usually this mainly relates to the complexity of a project.
  4. Project contingencies are budget components reserved for mitigating and compensating measures that may be needed because of uncertainties in the project’s functioning.
  5. Option value management determines the management or use values, which the option for a specific asset can provide over the entire costing period.
  6. Performance premium: given once an alternative has on average lower total life cycle costs compared to a reference alternative when tested under a bandwidth of scenarios.

4. Design and communication

The logical next step is to see how cost figures may hint to design optimisation by identifying those components that represent the largest investments, cost uncertainties and/or additional benefits.

  1. Elements for design optimisation: based on the valuation, design elements allowing for optimisation and risk management are identified and related recommendations are made.
  2. Elements for co-financing and acceptance: based on the valuation of extra benefits (in addition to the primary function) elements in the design can be identified that may yield co-financing and broad acceptance of the project. One may consider design optimisation in order to increase co-financing opportunities.
  3. Engineering: design optimisation that takes into account uncertainties and important cost components.

Innovative elements compared with the ongoing practice of costing are:

  • The differentiation in discount rates. The use of lower discount rates in order to attribute more weight to future costs and benefits is a point of discussion among ecological economists.
  • Functional risk analysis where interdependencies play a role. Many BwN projects include natural processes that often involve mutual cause-effect relations.
  • A lifecycle performance analysis that assesses the performance of a project under various scenarios.

Advice and recommendations

Costs are an important argument in decision-making and consequently should also be important in the design process. Uncertainties, risks and qualities that govern costs and benefits are therefore important, as well, and should be given due attention. Most large projects should start with a risk assessment in order to identify major project management needs. There are possibilities to connect these risks assessments with design frameworks and costing sheets, which will help to identify important risks that need to be handled. Also in the initial and scoping stage of a project, risk analysis will help to identify major risk components as a design challenge. Often risk analysis starts when a project has already been designed. However, risk analysis can and should start by assessing risks in the existing (ecological, economic and social) system, yet without a proposed intervention, as a starting point.