The Evolution of Risk Management

Failure to adopt risk management solutions that integrate an advanced understanding of human factors with technical management expertise will force power companies to compete on price alone, piling constant pressure on profit margins. But attitudes to risk management are growing up as PEi reports in this special interview with Mark Jarman, vice president for risk services, Lloyd’s Register Asia.

Chris Webb

In many industries ‘risk’ is an ugly word, but no matter what business you are in, risk is a vital ingredient. Operators of major power facilities, which provide an essential public service, must evaluate whether their risk strategies minimize uncertainties and maximize opportunities.

Mark Jarman, VP Risk Services, Lloyd’s Register Asia
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The key is to realize there is an upside to risk, as well as a downside. Successful companies in the power game are those which recognize that a risk management programme, properly integrated across the entire enterprise and innately embedded in its culture so all can understand it, is not just a protective tool; it can offer a significant competitive edge in an increasingly uncertain world. So says Mark Jarman, the man responsible for risk services for Lloyd’s Register in the organization’s Asia region.

“An effective risk management strategy à‚— one that addresses all risk exposures à‚— provides assurance for all stakeholders, from the multinational asset owner to the end user of their power products, the individual consumer,” says Jarman. So, has the perception of risk management changed significantly since the term was first coined? Jarman believes it has; the discipline has evolved over time. Yet a modern risk management programme still does what risk management has always done: it systematically identifies, measures, monitors, quantifies and reports risk. In addition, enterprise-wide risk management today does far more.

Building value

A properly designed, comprehensive risk management programme provides a business with a new kind of performance and compliance information that can be used to make strategic and operational decisions. It gives management the information and all-embracing risk overview needed to direct capital to the most productive uses in the business.

Risk management improves product and asset portfolio management. Furthermore, through its rigorous policies and procedures, risk management sets the basis for the confidence investors place in the stability and resilience of the company. All are value builders.

Lloyd’s Register is one of a growing number of assessors from leading risk management firms serving the power sector which have identified the need to consider both technical and human factors when providing solutions to manage potential threats. As an absolute minimum, risk assessors will have to include an integrated evaluation of a project’s or operating facility’s potential to impact on health, safety, the environment and the community à‚— including significant financial impacts à‚— to meet the needs and expectations of increasingly demanding modern stakeholders.

Taken a stage further, elite private or public sector clients à‚— by which is meant those who are determined to take ownership of their risks à‚— will insist on risk awareness being embedded in their companies’ thinking from the bottom of the corporate ladder to the top; risk management will be no longer the sole the responsibility of middle management.

Jarman likens the shift in attitudes towards risk management to the trend over the past 20 years which has seen the ownership and management of power facilities transfer to the private sector; as a consequence a greater proportion of future resources for risk assessments at established facilities will target operating expenditure (Opex) rather than capital expenditure (Capex).

The human element

Inherent in the increased use of risk services is suppliers’ desire for more reliable power supplies. Their scope will extend far beyond compliance with regulatory and corporate requirements. In times of economic austerity, such as those being experienced at present, Jarman says the approach is of utmost importance. “Improving performance of existing facilities will be the focus of power generating companies, a trend that will provide significant opportunities for risk management firms with the right integrated skill sets,” he said.

One of the most significant developments in the evolution of risk management culture has been the integration of human factors à‚— from corporate culture to employee training à‚— into the equation; “It adds strategic value to the future of risk management,” says Jarman.

Lloyd’s Register has recently invested further in that belief with the acquisition of Human Engineering Limited, a supplier of ergonomics and human factors technical services worldwide. It now employs some 200 risk experts.

The Capex to Opex shift

The current global economic crisis is one of the reasons companies are concentrating on their operational expenditure, Jarman says: “Right now, when times are hard, companies are cutting back on capital expenditure activities and focusing on Opex activities. What they’re trying to do is ensure that the assets that make them money are achieving the desired reliability, availability and P&L targets so that they can continue to survive.

The economic downturn means more power companies are using risk management as a basis to minimize asset costs, such as operational and maintenance costs
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“We find that companies are focusing more positively on the operating assets and risk reduction during these financial hard times than at times when [the economic situation] could be the reverse; then they’re focusing on both Opex and Capex activities.”

Jarman says it is “absolutely” more important for companies to look at their risk management in a downturn than in the good times. “Companies are wanting to cut back on costs à‚— both people costs and asset operating costs; they want to minimize maintenance and operating costs and we’re finding more and more that clients are using risk management as a basis for identifying the critical items that they need to have operating correctly. The emphasis is on minimizing the risks with those critical items and on concentrating not only on the technical aspects of operating a power plant but also on integrating the technical aspects with the human focus.”

“If you look at the statistics on technical failures or operating failures, human error contributes about 80 per cent to the totality of the failure causes. That’s why we’re integrating both the technical risk management side together with the human factor side in our evaluations.”

The perception and deployment of risk management is not necessarily regionally defined, says Jarman. “How companies approach their risk management strategies bears is defined by the level of maturity of the regulations in the country in which they are operating; that’s not region-based. Look, for example, at the Asia region.

“If governments require performance-based approaches to risk management, then you have very good, mature regulations associated with managing risk. But if it’s prescriptive, then you have less mature approaches being applied and it’s normally seen then as a tick-in-the-box type approach. In the Asia region there are several countries that have performance based regulations and others that don’t.”

Statutory industry ‘standards’ should be considered the very minimum platform for building risk management strategy, Jarman believes. “Most ‘standards,’ are seen, and rightly so, as the base level or the minimum that you should aim to comply with. Because you design a particular power plant to a particular standard it doesn’t necessarily mean it is safe.

“It is the minimum standard at which you design something to. And because standards or designs have various ways of delivering a power plant, different designers will take different approaches towards achieving the minimum requirement of compliance with any particular standard. Moreover, when you come across novel ideas or different approaches that’s when risk analysis comes in to determine the acceptability of in the context of the plant.”

Challenges for the power industry

Asked how the power industry ranks against other industries in the risk management stakes, Jarman says it is “very difficult to get a straight line comparison.” He continues: “This is because different industries have different ways of managing things. And even companies operating in the same industry have different cultures, different methods and different approaches.

“What I can say is that a lot of companies, when they first embark on the risk management highway, find themselves in that situation because they’ve either had a series of accidents which are quite serious, they’ve lost a lot of money, or the regulators or governments are breathing down their necks to improve their performance.

“So if you look at the power sector, in government ownership they combined generation, transmission and distribution elements under one roof. Since then a lot of those government entities have been privatized and those three items of power generation, transmission and distribution have been hived off to different entities and the majority of those will be public limited companies as in listed on stock exchanges.

Lloyd’s Register is one of a growing number of assessors from leading risk management firms serving the power sector which have identified the need to consider both technical and human factors when providing solutions to manage potential threats
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“The requirements that you need to focus upon as a public listed company are very different to those applied to a government owned one. The structure of the chemicals or processing sectors is very different, because they’re populated by large companies with a global reach. So to compare a power generating company to a chemical company or a refinery or processing plant or an airline industry is actually quite difficult because you don’t have common benchmarks allowing you to make a generic comparison.

“But if you’re talking maturity in the risk business, that’s a different matter,” says Jarman. “The oil & gas and petrochemical industries have borne the brunt of incidents over the years and consequently started the journey down the risk management highway much earlier than other industries.

“Some power companies have definitely embraced the same risk management approaches that the process industries have. There are companies in Asia, the UK, Europe, US and in Australia that are adopting the higher level of what they call in the oil and gas and petrochemical industries ‘process safety management requirements’. We are seeing clients asking us for those services for the power industries now.”

The privatization effect

Jarman returns to the subject of privatization in the power sector. “Where privatization of assets has taken place there has been an appraisal of the changing landscape and the pressures to lay down basic standards for the utilities. An example is in Britain, where the British Standards Institution’s ‘Publicly Available Specification’ (PAS) approach has been helpful. PAS 55 for the optimized management of physical assets and infrastructure provides clear definitions and a 21-point requirements specification for joined-up, optimized and whole-life asset management systems.

“It came about from a number of unrelated incidents but the Royal Commission decided there needed to be an approach equivalent to that adopted in the oil and gas and petrochemical industries. PAS 55 has been used in the power industry and embraces all three elements of generation, transmission and distribution. I see that as a watershed in being able to align different companies internally; to be able to assess their operating entities and assets on a uniform basis. It also has strong potential for other power companies to measure themselves against their competitors, which is an interesting concept.

“Another consequence of privatization is the much higher level of transparency and visibility that a company’s assets will be subjected to, compared with those same assets in government ownership. Not to mention the very high level of investment required to purchase and maintain the power plant in the first place. Then there’s public accountability, and by that I mean looking at whether customers are satisfied, not satisfied or marginally satisfied with the reliability of the delivery of service.

“Companies listed on a stock exchange have to produce annual reports and have to comply with the risk management guidelines or standards of that stock exchange. And that’s where risk management comes in; you have to have identified all of your major risk exposures to the delivery or the performance requirements of your assets. It follows that you have to demonstrate that risk management programmes are in place to ensure the appropriate level of availability to your customers.”

Listed power companies operate in a different environment to governments. “One of the worst things that can happen is for negative press to emerge where, for example, accusations have been made about the reliability or availability of the company’s assets; that can hit the bottom line hard, and a robust risk management strategy can help avoid that.”

“I’ve seen situations where companies may have paid too much for a particular plant or asset, which means that in order to get a return on their investment they have had to cut back on Opex for, say, maintenance activities. Those actions may not be immediately apparent in terms of visibility to the public or the customer but when it does occur à‚— maybe one or two years later à‚— a curtailment of maintenance activities will very probably have led the company concerned into an area of instability in terms of availability and reliability of that asset.”

Again, says Jarman, a risk management programme can identify the pitfalls and guard against them. “Generally speaking, however, if a facility is in private hands, as opposed to publicly owned, there’s far more scrutiny. But operating assets have to perform to the level to which they’re designed, regardless of whether it’s a government-owned entity or privately-owned entity.”

Returning to the current economic climate, Jarman stresses the lack of money which is needed for new projects. “They’re the first thing to be mothballed, in some cases. All of the forecasts that companies have done for increasing downstream demand requirements fly out of the window. So what companies are doing instead is securing the supply of their existing assets to make sure that they continue to operate reliably and there is power available to the maximum efficiency in order to keep generating cash flow and profits.”

“This is commonly referred to as ‘sweating the assets’. At some stage there is going to have to be a catch-up but at the moment we’re seeing a decrease in power supply requirement, compared to what was forecast 18 months ago. Companies find themselves in a different situation now, and they recognize that they need to use different approaches; the more mature power companies are using risk management not as a separate cost centre but integrating it into their operational and management style within the organization.

“Once they start on the risk management highway there is definite intensification of using risk approaches. Companies want to know at all levels and for all assets within their organization what their risk exposure is, whether the risk exposure is acceptable, and if it’s not what can be done about it. Integration is the key à‚— bringing together the technical and the human factors. Not just the ergonomics, but also the safety culture of how a company operates and how it wants to do business.”

There is no such thing as zero risk. It depends on the level of risk acceptability to determine how it is managed within different entities. Different entities will always have different levels of risk tolerance and risk appetite. That is why the concept of risk will continue to evolve.

Case Study à‚— India

Risk is a reality, present in virtually every industry, geography, business process and supply chain relationship. Yet most companies could be more resilient and risk tolerant.

India’s power companies currently have some 20 GW worth of major infrastructure, including turbines, boilers and pressure vessels, on order with Chinese suppliers, representing equipment worth billions of US dollars.

While the Indian government and private sector are under pressure to buy domestic-made products, in reality only Chinese suppliers, which are accepted as having a cost advantage, currently have the production capacity to deliver such a volume of power infrastructure in time.

The situation is acute. With the present supply of traditional power falling between 9-13 per cent short of demand, it is estimated that the world’s most populous nation will need another 78 GW worth of infrastructure in the next five years.

With tens of billions of dollars on the line for Indian buyers, the demand for third-party assurance services to protect their investments is soaring as capital-intensive goods destined for one regulatory environment are sourced from another.

Lloyd’s Register Asia’s Jarman says the company has a 75 per cent share of this important Sino-Indian power sector.

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