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ASSESSING THE VALUE OF AN OPTION IN PROJECT APPRAISAL


A350A recent conversation with a friend touched on the issue of making provision in a project for future development. Sometimes, although one knows that the current project scope will not meet the needs of the future, the organisation cannot afford that future provision just now. However it is sometimes obvious to those close to the project that there are relatively inexpensive ways of making it easier to realise a future project by making some provision in the current one. You may have heard the terms passive provision and active provision.

I think the boundary between passive and active provision is blurred. They are both steps in a current project which make it easier to realise a future project. Passive will be cheaper than active provision, and may be focussed more on ensuring that the future project is possible rather than building part of it now. An example near me is a section of the A350 where the existing  road has a corridor of land reserved alongside it. By not building on that corridor, we can say that passive provision is made for widening the road in the future. By building bridges which span both the existing road and the land reserved for widening we can say that active provision has been made.

The question is how can we assess the value of making provision now for a future development?

We can probably quite easily assess the cost of reserving the land, as land has a value. We can also assess the cost of building bridges of twice the span necessary now. But the value that it brings, how do we assess that? We are giving ourselves an option to widen the road in the future, and the financial world has a formula for valuing options. It’s called the Black-Scholes formula.

In the financial world a call option is the option to buy something, e.g. a share, at sometime in the future, at a price we can fix now (the exercise price).

The value of the option is a function of:

  1. The exercise price of the investment. How much would it cost now to build the wider road.
  2. The forecasted value of the benefits of the investment.
  3. The duration of the option
  4. The interest rate
  5. The uncertainty inherent in the future investment cashflows

The word “function” hides some interesting maths including logarithms, square roots and probability distributions. There are calculating tools on the web. For project sponsorship purposes the interesting things to grasp are that:

  1. The greater the uncertainty about what the future project is worth, the greater the value of the option. If you know now that the future investment easily pays for itself, do it now, why do you need to wait?
  2. The longer the length of time the option gives you to make your decision to invest, the more valuable it is.

Outcomes not Outputs


Another thumping good read dropped onto the doormat this morning in the shape of New Civil Engineer magazine. The problem of air pollution is brought into sharp focus by an OECD graph which shows that air pollution currently accounts for 3 million premature deaths globally every year, with that set to rise to 9 million by the year 2060. The EU and Russia are the only regions charted which show a significant fall in predicted air pollution deaths, whilst India and China deaths are predicted to more than double.

Another chart shows that UK CO2 emissions arising from power generation have fallen from 180 metric tonnes in 2005 to 100 metric tonnes in 2015. However transport hasn’t improved, with 130 Mt in 2005 and 130 Mt in 2015. So it is not surprising that other articles focus on how transport can be made greener.

There is an interesting piece on aviation with an eye-catching photo of a blended wing aircraft being developed by Boeing and NASA. The idea seems to be that by making the aircraft virtually all wing, and putting the seats in the wing, you end up with something much more efficient. Other, perhaps less ambitious developments, include making the drink and food carts lighter as well as other items like seats.

Of course we don’t have to be aircraft engineers to save a life. We can avoid unnecessary car journeys by walking or cycling where possible. Apparently just 20 minutes brisk walking a day brings us significant health benefits, yet only a third of Londoners report achieving this much activity. In Scotland physical inactivity results in 2,500 premature deaths a year, seven a day. There is a great article describing how we can make our city streets more pedestrian friendly through simple things like de-cluttering pavements to remove extraneous signs, improving crossings, providing seating and public toilets on walking routes.

I checked the front cover, when I wondered if I was the victim of an April fool story, but no, putting cat litter into concrete really is a way to cut CO2 emissions. There is a Bath University research project showing that the absorbent granules present in cat litter can be used to carry a material which can absorb or release heat depending on temperature, thereby helping to keep a building at a constant temperature.

In the editorial, civil engineers are asked to open their (our) minds and learn more quickly what people need; to be focussed on outcomes rather than outputs. Sounds like Project Sponsorship to me.

MY HEROES, KEVIN COSTNER AND VILLAGE PEOPLE


I live in a pretty village, not chocolate box pretty, but pretty nonetheless. It has a church, village hall, village shop, recreation field and the best pub in the world, where everyone knows your name, and you know them. It has community. When we moved here from the city, where we knew a few friends from across town, but nobody in our street, we loved the community here. I naively thought community just happened, but, of course, it takes a lot of hard working heroes, or more often heroines. Take Maureen, for example, who recently passed away and left a huge hole here. She worked for decades on every committee, in every office. She coerced Claire, my wonderful wife onto many committees. Claire is currently hard at work organising a progressive supper to raise funds for the church. When some problem occurs she misses Maureen’s sympathetic ear and wise counsel. Then there’s Kay, the dynamo of the village hall committee. Amongst many events she has organised film nights, put on by a man with a screen and projector who tours villages like ours and shows the best films, once a month. I think it’s a passion as much a business. But as much as he has passion for it, the audiences were not large. Each night he would protest that this really must be the last night, as the numbers were too small. But Kay, with her “Field of Dreams, screen it and they will come” faith, carried on. Last month I couldn’t help thinking he was right, as with minutes before curtain up (there is no curtain, but you know what I mean) there were just the committee and me there. Then the door opened and in they poured. Bridget Jones’s Baby had a full house. It’s a community you see.

Project Sponsor in Project Management


This appears to be one of the most popular search queries on Google, so I will explain. A project manager is tasked to deliver a project with a specified performance level and within a set budget and timescale. He or she then organizes a team to do that.

The Project Sponsor is the person who has assumed the role within the organization of identifying and defining the project, such that it delivers a required change consistent with corporate strategy that adds value to the organization.

For an amusing, and hopefully informative article on the difference between the Project Manager and Project Sponsor see my post

The Project Sponsor – Project Manager Relationship. Butch & Sundance or Laurel & Hardy?

And for much, much more take a look at my book on project sponsorship

Alternative Energy & Storage


In this week’s New Civil Engineer magazine (NCE) there are some interesting articles on exciting alternative energy schemes. These include the Swansea Tidal Lagoon, the Meygen Phase 1A tidal turbines in the Pentland Firth and a floating Solar array on a reservoir in Walton on Thames, which although more costly than covering fields with solar panels, seems to me to be a better use of space.

For each scheme there were figures quoted concerning cost, capacity, lifespan and the number of homes which could be powered. There were also comparisons with the Hinkley Point C nuclear scheme.

I played around with the data and a few comparisons struck me. Firstly if the generating capacity of the Swansea Tidal Lagoon is around a tenth of Hinkley C, why can it power a fortieth of the number of homes? Similarly the floating solar panels have a similar generating capacity to the tidal turbines, yet power half as many homes. Well, the good thing about nuclear power is that you crank it up to optimum operating power and it delivers that power hour after hour, day after day. The tide varies hour by hour and according to the phase of the moon. So although it is highly predictable, it is only delivering its maximum capacity for a fraction of the time. Nevertheless, that predictability is very useful because solar and wind power are nothing like as predictable.

Swansea Tidal Lagoon Tidal Turbine Meygen Phase 1A Hinkley Point C Nuclear Floating Solar Panels
Capacity MW

320

6

3,260

6.3

Lifespan

120

25

60

25

Homes powered

155,000

3,500

6,000,000

1800

Cost / MW / YEAR

£33,854

£345,333

£92,025

£44,444

Cost / Homes Powered / YEAR

£70

£592

£50

£156

Homes / MW

484

583

1,840

286

The big problem with electrical power is demand following. I looked at the UK power demand statistics for 2012 and 2013 and the summer minimum demand occurs at about 5AM and is around 27 Gigawatts and the winter maximum is around 58 Gigawatts at about 5PM. In 2015 the total electrical demand was 308,000 GWh equivalent to an average of 35GW per hour over the whole year. So you have to cater for this minimum 27GW, average 35GW and maximum 58 GW scenario. That is before you start worrying about what the demand is going to be in however many years it takes to build new power stations.

Nuclear is not good at demand following, that is you can’t turn it up and down as easily as with gas or coal fired power stations. And we already know that the tide is what it is and the wind and sun are very unpredictable, in the UK anyway. So that’s where energy storage comes in. The NCE article also focussed on new grid battery scheme in Leighton Buzzard. It covers the area of 3 tennis courts, cost £13m, and has a power capacity of 6MW and an energy capacity of 10MWh.

There was also a piece on a cryogenic facility in Manchester that uses surplus energy to freeze air into liquid air at -196 degC and stores in insulated tanks. When required it can be converted to gaseous air again at 700 times its liquid volume and drive turbines to produce electricity.

So, conveniently ignoring energy losses, and spare capacity for maintenance outages and future growth, you could deliver the 2015 UK electricity requirements with something like 123 Swansea Tidal Lagoons (or 11 Hinkley Point C’s) and 2,166 Leighton Buzzard style battery banks. You wouldn’t of course, you’d want a good mix of generation, but storage of one sort or another is key.

The process of deciding how you invest in energy infrastructure is complex. Whilst nuclear looks like the cheapest option for baseload, it has significant disposal costs down the line. Investment in certain technologies might provide a competitive advantage in selling that technology elsewhere in the world. The process of deciding on an investment strategy and making the case for it is project sponsorship. If that’s of interest to you, see my book here.

 

Project Sponsorship and the Third Runway at Heathrow


There is an interesting article in this week’s New Civil Engineer concerning the recent government decision that Heathrow is the best place to build additional runway capacity in the South East. In an interview with Phil Wilbraham, Heathrow Airport Ltd’s programme director and Tony Caccavone, co-programme director, amongst many good things they say “And crucially, operations people are in from the start. We had some very painful learning after the Terminal 5 opening.”

I used Heathrow T5 as an example in my book to illustrate the point that once the Project Sponsor has engaged a Project Manager, and is happy that the Project Manager has got to grips with delivering the project, the Sponsor’s attention should shift to preparing for the day the facility opens. A multitude of people and organisations must be focused on ensuring that the benefits of the project are realised.

Climate Change and the Case for Agile Project Sponsorship


 

According to the National Needs Assessment of the UK’s infrastructure, the disruption caused by flooding costs the UK £1 billion per annum. I understand that Donald Trump plans to scrap the International Climate Change Agreement, and since there is no wall that Trump or anyone can build to confine the impact of greenhouse gases, that cost is likely to rise alarmingly. On the positive side, it was reported last week that for a 24 hour period the UK generated more electricity from solar than from coal. It’s the first time that has happened. There is also much progress being made in smart technologies that can predict periods of peak demand and manage both supply and demand accordingly. Similarly, the emergence of driverless cars offers the possibility of releasing much needed capacity on our road networks. Unfortunately the range of estimates of climate change are quite wide. Princeton University predict a repeat of Hurricane Sandy between now and 2100 is between 3 and 17 times more likely due to climate change. Similarly the best estimate for mean global sea level by 2100 is between 0.2m and 2m.

Project Managers often come in for criticism when costs escalate. Pity though the poor Project Sponsor, who has to estimate a project’s benefits, which in the case of infrastructure, may be over a 100 year lifespan. The case for a particular solution may be founded on environmental or technological assumptions which can completely change very rapidly. We have seen how political, social and economic assumptions can also be turned on their head, all too recently.

The practice of project management has being undergoing something of a revolution with agile techniques. These prioritise communication over standard procedures; delivering a working solution, over thorough documentation; greater collaboration with clients; and openness to change.

The fundamentals of project sponsorship remain valid. But I think some things can benefit from speed. Stakeholder management could be more scrum-like. Ten minute morning video conferences, rather than monthly board meetings. Regularly updated, scenario based business cases could span a wide range of possible futures rather than a sensitivity test. Project Sponsors will need to be ready to change tack dramatically as events unfold.

Project Sponsor Role


The role of a the Project Sponsor, or Project Executive, is to act as guardian of the project business case, and ensure that the project is able to deliver the benefits predicted, outweighing the costs. The Project Sponsor should appoint the Project Manager, and thereafter the Project Sponsor and Project Manager must work very closely together. I liken the project structure to an hourglass in which the Project Sponsor and Project Manager sit at the neck of the hourglass. The Project Manager directs the bottom half i.e. all the consultants and contractors delivering the project, whilst the Project Sponsor coordinates the top half, all the departments of the investing organization such as operations, marketing, finance, HR etc.

The key project sponsor’s responsibility is for the business case. Projects are conceived to add value to the investing organization. If the project becomes delayed or is heading over budget the Project Sponsor must re-asses the business case and decide whether it should continue or not.

The Project Sponsor should be someone who understands the business of the investing organization very well. He or she should command the attention and respect of the board and have direct access to all of the departments mentioned above. Ideally the Project Sponsor will have a good understanding of corporate strategy and project appraisal techniques. Once the Project Manager is appointed and fully briefed the Project Sponsor should start to plan for the day when the project is handed back. That is the way to ensure that the benefits are fully realized.

If you would like to know more please check out my book.

wpid-Photo-12-Oct-2010-0939.jpg

 

Europe & Passion


Having recently returned from our summer sailing holiday and before starting our European rail odyssey I reflect on the Brexit vote and why I’m so very upset about it. I’m a passionate europhile and have been for as long as I can remember. Why? Well, in part I’ve enjoyed a reasonably successful career which has been, in no small way, enabled by the ease of doing business which the EU provided. I also may have listened to all the countless experts advising against Brexit. But that doesn’t explain the passion, for that you have to go back to childhood. My father was conscripted into the 1st Battalion Rifle Brigade on 13th June 1940 and demobilized on 16th July 1946. He was a desert rat, part of Seventh Armoured Division and fought in North Africa at Tobruk, El Alamein and in many other battles too. Then he took part in the first of two amphibious assaults at Salerno in Italy and fought his way up via Naples to Sorrento. Then he landed in Normandy on D-Day +1 and fought through Villers Bocage, Caen and on finally to Hamburg. I learnt all his war stories at his knee. The only story he was reluctant to tell was of Belsen, the horror must have been too much.

So having fought the Germans and Italians and experienced such horror, you might imagine he’d had enough of Europe? Not a bit of it. My childhood holidays were caravanning all over Europe. Dad simply loved Europe and loved the people. Everywhere we went dad could be found sharing a beer or wine with Germans, French, Italians. I remember him drinking with two Germans of roughly the same age. When one of them didn’t want to talk about his war, dad reached across the table and pulled up his sleeve to reveal the SS tattoo. “Macht nichts, it doesn’t matter” dad said. That was the past and it was important to be friends, work together and ensure it doesn’t happen again. And I guess some of that rubbed off on me.

A couple of thoughts about #BREXIT


Something that puzzles me is the argument by leave campaigners that we must leave the EU in order to make our own laws. Two acts passed in recent years which have changed centuries, or millennia even, of the status quo are the Constitution Reform Act 2005 and the Marriage (Same Sex Couples) Act 2013. As far as I’m aware neither of these were either initiated by or opposed by the EU. We already make our own laws and will continue to do so either way.

On the YouGov website there is some interesting information about the demographics associated with recent opinion polls on the UK electorate’s view on remaining in or leaving the EU. There appears to be no gender bias one way or the other. University graduates prefer to remain by 62 to 38 and you are much more likely to want to leave if you read the Daily Express or Mail than if you read the Times or Guardian. But age is the biggest differentiator with 18 to 29 year olds in favour of staying in by 63 to 37 and those over 60 in favour of leaving by 56 to 44. Depending on your point of view it may or may not be unfortunate that the over 60’s are much more likely to vote than those under 30. Quite why an electorate would want those with most of their life behind them to decide the future of those with most of their life ahead of them, I don’t know. Maybe it’s the village elder principle or the apathy of youth. I would simply urge all those with a vote to use it in June.

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