Refining the Business Case for Sustainable Energy Projects Using Palisade @RISK and PrecisionTree: A Biofuel Plant Case Study (PRESENTATION) - SARK7 more

2011 Palisade Risk Conference Refining the Business Case for Sustainable Energy Projects Using Palisade @RISK and PrecisionTree: A Biofuel Plant Case Study 10:00 – 10:45 Tuesday, March 29th 2011 Compagnieszaal West Indische Huis, Amsterdam Scott Mongeau Lead Consultant Biomatica BV Cell +31 (0)6 42 353 427 Email scott@biomatica.com Web www.biomatica.com TNT Explosion Group! All original content ©Biomatica BV 2011 Attributed sources used for nonprofit educational presentation purposes only 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Concluding comments 6. Questions and comments 7. Appendix: References Slide 1 Biomatica BV 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Observations & comments 6. Concluding comments 7. Appendix: References Slide 2 Biomatica BV Welkom in Amsterdam! • Where are we? – Dutch East India Co. (VOC) (1602) • • • • Globalization Genesis of modern stock exchange Derivatives (futures & options) Perpetuities http://blog.sunan-ampel.ac.id/auliyaridwan/ – Below sea level (-4M) • Overview 1. Profitable sustainable energy projects 2. Palisade as facilitating tool 3. Biofuel project as example • Scott Mongeau – – – – Independent int’l consultant (NL-based) Decision and risk management Strategy, analysis, simulation, systems Finance, biotech, insurance, start-ups ©2009 USA Today Biomatica BV – www.linkedin.com/in/smongeau Slide 3 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Concluding comments 6. Questions and comments 7. Appendix: References Slide 4 Biomatica BV Global Energy: Outlook for Change Depletion of fossil fuels • Finite resource • Growing demand • Declining reserves World Energy Sources * ● Fossil (86%) ─ Petroleum (~40%) ─ Coal (~23%) ─ Natural gas (~23%) ─ Bitumens ─ Oil shales ─ Tar sands ● Nuclear (8%) ● Renewable (6%) ─ Biomass ─ Hydro ─ Wind ─ Solar (thermal & photovoltaic) ─ Geothermal ─ Marine ● Exotic hypotheticals - 50 years left at rate of current consumption - Peak production: 2015 * - 2016 onwards: several % per year decline - 2030 onwards: dramatic supply crisis / gap +30% primary energy needed * 2006 figures: Demirbas, A. (2008). Biofuels. • Costly exploration: deep sea, oil sands, polar • 2/3 new exploration wells drilled are dry Reuters / US Coast Guard Slide 5 Biomatica BV Growing Demand + Growing Cost of Recovery Source: OECD/IEA World Energy Outlook 2004 http://www.world-nuclear.org/education/ueg.htm http://en.wikipedia.org/wiki/Oil_reserves Geopolitical • Middle East: 63% global reserves • Growth world population • Growth developing nations http://www.feasta.org/documents/energy/rationing2007.htm Environmental • Carbon emissions (98% from fossils) • Greenhouse effect 1950: 315 PPM CO2 2010: 390 PPM CO2 Slide 6 Biomatica BV Uncertainty: Timing of Decline? http://www.eia.doe.gov/pub/oil_gas/petroleum/feature_articles/2004/worldoilsupply/oilsupply04.html • • • • • 2000 Global Supply Analysis: US Geological Survey (USGS) and US Energy Information Administration (EAI) Steady global demand growth trend of 2% per year (highest trend in developing world, India & China in particular) Reserves to Production (R/P) ratio of 10 (US) used for all nations as ‘peak level’ Three scenarios use varying recoverable reserve estimates remaining, in Billions of Barrels (BBbls) Asymmetric ‘plunging’ decline hypothesized Slide 7 Biomatica BV Uncertainty: Marginal Tipping Point? • ‘Energy return on energy invested’ (EROEI) ratio – Oil: 16-to-1 (and falling) – Tar sands: 7-to-1? – BioEthanol: 4-to-1? Negative? • Unknown point: where marginal cost of next average barrel of oil yields less energy than alternative sources? • Compounded issue of systematized efficiencies related to oil value chain (i.e. refining, transport, trading) • Political risk: waiting causes oil marginal value to reduce while development costs for alternatives remains high • ‘Boiling frog’ syndrome Slide 8 http://www.motherearthnews.com/renewable-energy/net-energy-zm0z10zrog.aspx Biomatica BV Energy and Realpolitiks… • Systematized dependence • Embedded surcharge attached to virtually all transactions • Systemic efficiencies have evolved via market forces Sean Gallup/Getty Images • Pushing the envelope • • • • Deep sea drilling Oil sands Polar exploration Regional military pressures http://tinyurl.com/6hbuyrg http://www.topnews.i n/law/region/tripoli • Alternative solutions • Will remain marginal if ‘one offs’ • Need for deep systemic economic analysis and engineering (financial) Oil industry: biofuel plays (liquid) • Shell & Cosan • BP & Verenium • Chevron & Weyerhaeuser Slide 9 • http://oilandglory.foreignpolicy.com/category/wordpress_tag/saudi Biomatica BV 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Concluding comments 6. Questions and comments 7. Appendix: References Slide 10 Biomatica BV Sustainability & Palisade Decision Suite TOOLKIT… • Simulation • Sensitivity analysis • Optimization • Correlation • Econometrics • Decision Trees • Real Options • Plant / processing optimization • Commodity price uncertainty • Cost control – Sampling, regression analysis and optimization • Integrated FCF / NPV analysis • R&D decision / project management • Commercialization/market simulation • Competition & product pricing – Modeling new product profitability via regression & sensitivity analysis, simulation – New product profitability simulation – Simulation based on uncertain market competition parameters Biomatica BV – Monte Carlo sensitivity analysis for uncertain, multi-stage programs – Decision tree analysis to determine best path – Project portfolio optimization via analytic hierarchy process and optimization Slide 11 Modeling Method: Staged Process Uncertainty Categorization 1. Target process(es) to employ • Associated costs? Analytical Process 1. Valuation (NPV) analysis – Three processes – Product strategies 2. Product strategy • Associated revenues? 2. Volatility simulation – Monte-Carlo simulation 3. Revenue forecasting • Competition, economic factors? 3. Real Options Analysis – Use range of NPV end-points – Add volatility (probability) – Add key decision points 4. Process cost analysis • Productivity variability? 5. R&D planning / decision making • What decisions, made when? Slide 12 Biomatica BV Integrated Analysis for Sustainability Projects Slide 13 Biomatica BV Practical Implementation • METHODS – Qualitative: comprehensive interviews & stakeholder mapping – Quantitative: multivariate uncertainty aggregation, correlation – Techniques: Monte Carlo simulation, computational optimization, formal decision analysis, sensitivity analysis, optimization, regression analysis, econometrics… • ORGANIZATIONAL – Decision portfolio management – Decision Trees = managerial flexibility – Decision architecture / audits • ‘The Decision-Driven Organization’ Harvard Business Review, June 2010 Slide 14 Biomatica BV 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Concluding comments 6. Questions and comments 7. Appendix: References Slide 15 Biomatica BV Overview: BioEthanol • Ethanol (EtOH) – Blended into petrol (most autos can run on 10% blend) – 5.4% ethanol component in global gasoline (2008) – 90% world supply produced between US & Brazil – Increasingly target of mandates & subsidies – Basic process similar to beer brewing – Particular processes, feedstock, catalysts & agents vary – Feedstock-based (i.e. corn, sugarcane) => backlash! – Cellulose-based: structural component green plants & algae – Most common organic compound: ~33% of all plant matter – Indigestible by humans – Genetically altered microbal agents => still in lab stages Biomatica BV •1st gen •2nd gen •3rd gen Slide 16 Modeling: Operating EtOH Plant • PPE costs • Capital costs per gal output • EtOH & byproduct prices • Feedstock costs Slide 17 • Enzyme and yeast pricing • Fixed & variable oper. costs • Byproduct / subsidy • Terminal value Biomatica BV Sensitivity & Optimization MONTE CARLO SIMULATION - Iterative development working with engineers / experts - US NREL research - - U. Oklahoma CEtOH model Slide 18 Biomatica BV Sensitivity & Optimization • • • • Dynamic NPV analysis Probability distributions for all major variables Multiple outcome simulations run (1000’s of times) Aggregate probabilities and sensitivities emerge Slide 19 Biomatica BV Volatility of Project NPV Outcome -63.09 24.56 112.20 199.85 287.50 Slide 20 Biomatica BV Sensitivity Analysis: Tornado Graph Slide 21 Biomatica BV Cost Anlysis & Optimization Slide 22 Biomatica BV Risk Optimization: Profit vs. Risk % Chance of Positive NPV 120% 100% 80% 60% 40% 20% 0% 0.0 0.1 0.2 1.0 1.1 1.2 1.3 2.0 2.1 Sharpe Ratios (Profit vs. Risk) 300% 250% 200% 150% 100% 50% 0% -50% 0.0 0.1 0.2 1.0 1.1 1.2 1.3 2.0 2.1 Slide 23 Biomatica BV Comparative: Commercialization Slide 24 Biomatica BV Integrative: Structured Finance • Structured finance / project finance – – – – Insulates sponsor from risk during development Isolates asset liabilities from balance sheet Funds R&D via external investment Vehicle for debt guarantees & subsidies • Pre-negotiated contracts – – – – All contracts pre-negotiated Lowers project risk for investors and banks Consequently lowers cost of funding / capital Restricts potential downside and upside (acts as hedge) Slide 25 Biomatica BV Strategic: Decision Tree Analysis 1. Add management decision points, investments required, and probabilities (i.e.: chance of technical success) NPV valuation of each node in scenarios (DCF) Work backwards to probabilistic ‘inherent value’ of management option to expand/contract at each step Choose for highest NPV value at each decision point Revise as probabilities, decisions, and values as time progresses Biomatica BV Slide 26 2. 3. 4. 5. PrecisionTree: Proof-of-Concept Biomatica BV Slide 27 PrecisionTree: Commercialization Biomatica BV Slide 28 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Concluding comments 6. Questions and comments 7. Appendix: References Slide 29 Biomatica BV Natural Capitalism • Status quo: ‘the lurking crisis’ 1. 2. 3. 4. 1. 2. 3. 4. ‘Business as usual’ approaches & models Token populist and cynically reductive responses Survival thinking / rationing Lack of ‘systemic’ vision & leadership Increase productivity of natural resources Shift to biological production models Solutions-based business models Reinvest in natural capital Lovins, Lovins & Hawken. A Road Map for Natural Capitalism. Harvard Business Review, July – August 2007. • Shifts advocated in business practices • Solutions are at hand – require systemic thinking, deep analysis & coordination Slide 30 Biomatica BV Concluding Themes •Economic phenomenon • Sustainability project characteristics – Drive to marginal optimality – Perverse incentives – ‘The tragedy of the commons’ and free-riders – Marginally profitable – Highly sensitive – Requires systemic engineering / optimization – Core NPV variance analysis – Profitable systemic market scenarios – Transcend politics and sentiment – Need for market-based solutions – Outside democratic political cycle – Outside career cycle • Coordinated management of systemic complexity • Leadership gap: • 2030 syndrome • Palisade evolution: Multi-Agent Simulations Slide 31 Biomatica BV 1. Overview 2. Global energy quandy 3. Palisade Suite approaches 4. Biofuel plant case exemplar 5. Concluding comments 6. Questions and comments 7. Appendix: References Slide 32 Biomatica BV Questions? Comments! Slide 33 Biomatica BV 7. REFERENCES Slide 34 TNT Explosion Group! Source: Economist Staff, September 2nd 2010 References: Palisade Suite • Murtha, J. (2008). Decisions involving uncertainty: an @RISK tutorial for the petroleum industry. Ithaca, New York, USA: Palisade Corporation. • Rees, M. 2008. Financial modelling in practice. Wiltshire, UK: Wiley. • Schuyler, J. 2001. Risk and decision analysis in projects. Pennsylvania, USA: Project Management Institute, Inc. • Shockley, R., Jr., Curtis, S., Jafari, J., & Tibbs, K. 2001. The option value of an early-stage biotechnology investment. Journal of Applied Corporate Finance, 15 (2), 44-55. • Winston, W. 2007. Decision making under uncertainty. Ithaca, New York, USA: Palisade Corporation. • Winston, W. 2008. Financial models using simulation and optimization. Ithaca, New York, USA: Palisade Corporation. • Winston, W. 2008. Financial models using simulation and optimization II. Ithaca, New York, USA: Palisade Corporation. Slide 35 Biomatica BV References: Sustainability • Campbell, C., and Laherrère, J. (1998, March). The end of cheap oil? Scientific American, March 1998. • Demirbas, A. (2009). Biofuels: securing the planet’s future energy needs. London: Springer. • Demirbas, A. (2008). Biodiesel: a realistic fuel alternative for diesel engines. London: Springer. • Economist Staff. (June 2010). Inhuman genomes. The Economist, June 17, 2010. Retrieved September 2010 from http://www.economist.com/node/16349380 • Economist Staff. (September 2010). Ethanol’s mid-life crisis. The Economist, September 2nd 2010. Retrieved September 2010 from http://www.economist.com/node/16952914?story_id=16952914 • Hawken, P., Lovins, A., and Lovins, L. H. (2008). Natural capitalism: creating the next industrial revolution. New York: Back Bay Books. • Johnson, M. W., and Suskewicz, J. (2009, November). How to jump-start the cleantech economy. Harvard Business Review, November 2009. Last retrieved March 2011 from http://hbr.org/2009/11/how-to-jump-start-the-clean-techeconomy/ar/1 • Lovins, A. B., Lovins, L. H., and Hawken, P. (2007, July). A road map for natural capitalism. Harvard Business Review, July – August 2007. Last retrieved March 2011 from http://hbr.org/2007/07/a-road-map-for-natural-capitalism/ar/1 Slide 36 Biomatica BV References: Decision Mgmt/Real Options • Arnold, T. & Shockley Jr., R. (2001). Value creation at Anheuser-Busch: a real options example. Journal of Applied Corporate Finance, 14 (2), 52-61. • Blenko, M. W., Mankins, M. C., & Rogers, P. (2010, June). The decision-driven organization. Harvard Business Review, June 2010, p 54 – 62. • Faulkner, T. (1996). Applying ‘options thinking’ to R&D valuation. Research Technology Management, May – June, 50-56. • Hammond, J. S., Keeney, R. L., and Raiffa, H. (1999). Smart Choices: A Practical guide to Making Better Decisions. Boston: Harvard Business School Press. • Kodukula, P., & Papudesu, C. (2006). Project Valuation Using Real Options. Florida, USA: J. Ross Publishing, Inc. • McGrath, R., & Nerkar, A. (2004). Real Options reasoning and a new look at the R&D investment strategies of pharma firms. Strategic Management Journal, 25. • Mun, J. (2006). Real Options Analysis (2nd ed.). New Jersey, USA: John Wiley. • Shockley, R., Jr., Curtis, S., Jafari, J., & Tibbs, K. (2001). The option value of an early-stage biotechnology investment. Journal of Applied Corporate Finance, 15 (2), 44-55. Slide 37 Biomatica BV