Living on borrowed time
Protecting utilities and the public from aging assets
It's now been 50 years since North American utilities made massive postwar capital investments. Many of these critical assets — electric grids, natural gas pipelines and water distribution systems — require urgent replacement to maintain safety and reliability.
The timing could not be worse: demand and use are flat, and regulators are more strongly scrutinizing, or flat out denying, rate case increases. As well, many utilities have already spent high amounts of capital to modernize the power grid and extend the interstate gas pipeline system to accommodate the new surge in shale gas production.
Water distribution systems are even older, as many in the US approach the century mark. With approximately 26% of water distribution system pipeline made of unlined cast iron and steel — and in poor condition — the US Environmental Protection Agency estimates that $138 billion will be needed over the next 20 years to maintain and replace existing drinking water systems.
1. What’s the issue?
Critical utility assets are reaching or have already exceeded their useful lives. Many utilities have programs in place to extend the lives of these critical assets, but time is running out.
Today’s tougher regulatory environment aside, basic logistics means it may take anywhere from 10 to 20 years to replace these aging assets. Deferring replacement is a necessary component of any short-term strategy, but utilities also need to have a long-term capital investment strategy to protect themselves and the public from the very real risk of critical asset failure.
2. Why now?
The age of an asset is one cause of its ultimate failure. Other causes include:
- Historical operating practices
- Location and exposure to outside forces
- Mistakes in repairs
Utilities have generally been effective in applying reliability-centered maintenance programs to manage the process of failure. But as the assets continue to age beyond their life expectancy, the probability of a wear-out failure grows exponentially.
3. How does this affect you?
According to the Department of Energy, power outages cost the US approximately $80 billion annually.
Given the lead time needed for planning, logistics, availability of skilled resources and capital requirements, utilities are facing a decades-long replacement strategy even as existing assets continue to age.
4. What’s the fix?
Reliability-centered maintenance programs are going to come under increasing pressure as the risk of wear-out failure grows exponentially.
These programs need to be supplemented with two parallel activities: a regulatory-accelerated replacement strategy and an operational risk management framework. The first focuses on accelerating and prioritizing replacement and financial recovery while the second focuses on a more formalized avoidance program and predictive assurance of response mitigations.
Implement a regulatory-accelerated replacement strategy
Regulators recognize the urgency to replace certain assets but struggle with the cost that will be passed on to ratepayers. As a result, the onus is on the utility to articulate the risk profile to the regulator and create awareness of the risks and mitigation plans.
The utility must empower the regulator with a compelling case for investment that aligns with the public’s need for reliable energy distribution.
A critical asset risk and investment plan allows utilities to quantify the potential financial consequences of a critical asset failure using the current risk profile and the proposed risk profile resulting from the replacement program.
Additionally, the IRS has recently issued guidance that will impact the tax treatment of these expenditures. Because the regulatory treatment of these tax conclusions presents risks and opportunities, a utility will need to carefully analyze the regulatory dimension of these tax issues.
Use a framework to manage the operational risk
An effectively designed and deployed operational risk management framework helps determine whether risk mitigation activities are working, particularly before an operational threat occurs. The framework encompasses four interrelated components:
- Periodic assessment
- Key indicators
- Loss data
It considers not only the unsafe event, but also the latent failures that may exist, such as organizational influences, unsafe supervision and other preconditions for the unsafe act.
Using advanced data analytics to enable framework activities gives utilities the ability to understand not only what has already occurred, but also why it happened and what may be lurking around the next corner. There are three levels of analytics to consider:
- Descriptive analytics mine past data to report, visualize and understand what has already happened (lagging indicators).
- Predictive analytics leverage past data to understand the underlying relationship between data inputs and outputs to understand why something happened or to predict what will happen in the future across various scenarios (leading indicators).
- Prescriptive analytics determine which decision and/or action will produce the most effective result against a specific set of objectives and constraints (modeling).
Utilizing a single Governance Risk and Compliance (GRC) platform to track, measure and monitor operational risks provides management and executives with a single point of view and the reporting to enable proactive decision-making when it comes to failing assets.
5. What’s the bottom line?
Utilities, and society at large, are living on borrowed time. The economic and public impact of a single, major infrastructure failure far exceeds the positive returns that risky assets left in the ground stand to provide.
Reliability-centered maintenance programs and associated replacement programs are both necessary, but they may not be enough. To protect the public and shareholders, and to forge an acceptable outcome with regulators, utilities need a multifaceted solution that considers regulatory-accelerated replacement and operational risk.