July 2012

Oil & Gas

Critical Asset Risk and Investment Planning

Reducing your asset risk

In the early evening of 9 September 2010, when many residents of the San Francisco suburb of San Bruno were arriving home from work or sitting down to dinner, a natural gas pipeline that served the community ruptured and burst into flames. The explosion and fire ripped through the Crestmoor subdivision, destroying 38 homes and damaging many more. Eight people were killed. For the people of San Bruno, the experience was a life-altering tragedy, one that will never be forgotten. For the company that operated the pipeline, the explosion was a catastrophic financial event, one expected to wipe out an estimated 15 to 20 years of earnings. Approximately 70 separate lawsuits were filed in the case, representing more than 100 plaintiffs. In addition to expected payouts to those impacted, the company continues to suffer from negative impacts to its stock price, corporate reputation and relations with regulatory agencies. The section of pipe that failed in San Bruno had much in common with many other pipelines buried underground in major cities and towns across the United States. Aging infrastructure, much of it installed from the 1930s to the 1960s under different manufacturing and construction processes and without consistent regulatory oversight, is a looming issue for many companies in the utility and energy industries. For example, cast iron mains and service lines, which were prevalent from the 1830s until after World War II, are prone to failure due to graphitization or brittleness. Many major urban areas such as Philadelphia, Boston, Detroit, Washington, DC, and more still have cast iron pipe under ground. Plastic pipe, too, can fail prematurely due to cracking. Even steel pipelines and connectors can break or rupture due to corrosion, stress, settlement or cyclic fatigue. Regardless of material used, aging and the effects of soil and water on pipelines take their toll. According to the Pipeline and Hazardous Materials Safety Administration, only timely repair, rehabilitation and replacement of high-risk pipeline infrastructure can prevent the types of tragedies suffered in San Bruno. Yet distribution lines rarely receive the same level of inspection and maintenance that major interstate pipelines do, despite the fact that they face the same corrosive conditions. Some of this is due to technological reasons unlike major interstate transmission pipelines, many older distribution lines, especially those that service

A split-second failure of equipment or facilities can lead to years of enormous expense, loss of reputation and difficult relations with stakeholders. Using Critical Asset Risk and Investment Planning (CARIP) can help your company better understand and mitigate risks related to energy assets.

numerous homes and businesses, cannot be pigged, or inspected by remote devices. In addition, interstate lines typically have well-marked right-of-ways that can be visually inspected by air or by crews on the ground. Those types of right-of-ways and inspections are impossible inside the city gate. It is just common sense that aging assets are more likely to break down or cause problems. So why is there delay in replacing old infrastructure? For companies in the regulated utility industry, one reason has been the reluctance of ratemakers to grant cost relief for capital-intensive replacement plans, especially during economic downturns. Another is simply the shortage of available, skilled resources to administer such a large program. For unregulated oil and gas companies, it may be as simple as not having a good understanding of the organizations totality of assets and their age and relative level of risk. This is often tied to a lack of asset-oriented focus in their enterprise risk programs. And some companies simply choose to take comfort in the low probability of such an event. For energy companies that operate in or near populated areas, these delays or oversights are a recipe for disaster. It only takes one small failure to create a major public tragedy that can impact the company for years to come. To minimize the possibility of failure, managing asset risk is critical, and increasingly, regulators are asking companies to develop formal programs for understanding and mitigating catastrophic risk. It is only a matter of time before insurance companies, state and federal officials and the investment community begin asking the same oil and gas companies.

senior management with the data needed to understand the level of risk facing the company and to quantify the actual value of asset replacement, enhanced maintenance or inspection programs, and other risk management measures. Put simply, CARIP can inform the executive team which assets are most likely to fail next, what it will cost the company when they do fail, and where the company should invest its money and staffs time to help ensure that the failure never happens. CARIP provides a portfolio-level view of significant asset risks facing the company, as well as an accurate accounting of the potential cost of those risks. CARIP gives senior managers the tools they need to understand the significance of risk the company faces each day and to measure the changes in the companys risk profile over time.

How CARIP works

Obviously, predicting the exact failure date of an asset such as a section of pipe or an offshore drilling rig is impossible. Energy companies with aging assets must be guided by what can be known or reasonably estimated. CARIP uses proprietary predictive modeling tools to identify critical assets with a potential for failure, and categorizes that risk so that companies can prioritize their response. For energy companies, regulatory strategy can then be formulated to isolate the highest priority assets and make the case for risk mitigation recovery or settlements. Or in the unregulated world, significantly improve their asset risk mitigation plans by enhancing maintenance programs or capital planning activities.

Understanding critical asset risk

At Ernst & Young, we use a process called Critical Asset Risk and Investment Planning (CARIP) to help energy companies identify, account for and mitigate the risks involved with deployed assets, both above and below ground. This fully informed and comprehensive approach is centered on helping companies mitigate the risks inherent with assets where regulatory compliance or cost recovery are deemed inadequate to ensure safe, reliable operations. Through this process, we help companies shift their investment and recovery strategy from one driven by regulatory mandates the traditional approach to one that is underpinned by a quantified impact assessment of highrisk, mission-critical assets. The objective of CARIP is to provide
2 Reducing your asset risk

Here is how a typical CARIP process works: First, the companys full range of critical assets are identified and divided into three categories. The first category includes all assets in the traditional compliance management system. Investment planning for all assets must remain adequate to maintain full compliance with federal and state regulations. The second category is populated by all critical assets in high consequence areas. These assets are then analyzed, using a relative likelihood of failure study, to determine their risk profile. Any assets with a risk profile outside the companys corporate threshold are placed in a third group.

Understanding the inherent risk in the full range of infrastructure assets, including rigs, pipelines, gathering facilities, storage facilities, refineries and more, is a necessity in todays world.

The assets in this third grouping undergo a rigorous risk mitigation analysis to determine the costs of failure, mitigation and replacement. This third category can then be positioned with regulators or other decision-makers as high-risk, high consequence assets that require priority replacement or other risk mitigation activities beyond mandated compliance. The investment planning for each category will vary. The first category of assets, which contains all critical assets, will continue to be maintained to the highest level of compliance. Assets in the high consequence category will be monitored and maintained for future risk mitigation activities and to help ensure that the level of risk does not increase. Assets in the high-risk, high consequence category become the highest priority and should be managed accordingly. Mitigation costs will likely affect many operations and maintenance and shared services cost centers across the company, and the CARIP program is designed to identify, document and incorporate these costs for recovery in each category of assets.

Who can benefit from CARIP? The modeling and methodology that Ernst & Young uses in its CARIP processes can be applied to a wide range of assets. Today, the commercial airline industry and the nuclear power industry are excellent examples of businesses that are benefiting from similar methodology to fully understand their asset base and to take proactive measures to mitigate high consequence risks. The airline industry, for example, frequently replaces compliant airframes with new models to manage its catastrophic risk. Today, energy delivery companies are beginning to recognize the predictive modeling benefits of CARIP, especially as it relates to helping companies plan and execute well-designed pipe replacement programs. But across the energy space, many other types of companies are also asset-intensive, and face tremendous risks every day in operations around the globe. Understanding the inherent risk in their full range of infrastructure assets, including rigs, pipelines, gathering facilities, storage facilities, refineries and more, is a necessity in todays world. Ultimately, a CARIP approach to asset management mitigates the risk to shareholders by producing data through detailed modeling and simulations that accelerates replacement of aging assets and other risk mitigation actions. That information can help companies plan investments in maintenance, testing and replacement; improve the alignment of staff with critical risks; and justify capital improvement programs. Companies using CARIP can take a giant step toward ensuring that they are never faced with the tragic consequences of an event like the one in San Bruno.

The CARIP process is carried out in four phases. Phase 1: Frame In this phase, the context, scope and objectives of the CARIP program are set, the criteria for evaluating alternative risk management strategies are agreed upon and all relevant stakeholders are identified. Phase 2: Gather Next, critical information about potential risk events is consolidated and assessed, and current mitigation efforts are evaluated. Phase 3: Evaluate Using qualitative assessment data related to event probability, impact and correlation, the companys residual risk is quantified and risk events are modeled. In addition, potential alternative risk mitigation strategies are identified and evaluated. Phase 4: Recommend In the final CARIP phase, the company gains a better understanding of its residual risk and evaluates potential alternative risk mitigation strategies. Monitoring mechanisms are designed, action plans are developed and plan approval is received.

Reducing your asset risk

Our Risk Advisory Services

Many organizations have invested heavily in personnel, processes and technology to better manage their risk. But these investments often do not address the more strategic business risk areas. To successfully turn risk into results, companies need to become more effective at managing scarce resources, making better decisions and reducing the organizations exposure to negative events. Whether were helping a business with internal audit, internal controls, information security or an enterprise-wide issue, we start by helping organizations answer some key questions, such as: What are your key risks and how are they being managed? Do you have overlapping risk functions or gaps in coverage? Have you optimized the use of technology? We can then work with companies to drive better business performance by helping to: Enhance the risk strategy Embed risk management Optimize risk management functions Improve controls and processes Enhance communications to achieve stakeholder confidence

Ernst&Young Assurance | Tax | Transactions | Advisory

About Ernst&Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. How Ernst & Youngs Global Oil & Gas Center can help your business The oil and gas industry is constantly changing. Increasingly uncertain energy policies, geopolitical complexities, cost management and climate change all present significant challenges. Ernst & Youngs Global Oil & Gas Center supports a global practice of over 9,000 oil and gas professionals with technical experience in providing assurance, tax, transaction and advisory services across the upstream, midstream, downstream and oilfield service sub-sectors. The Center works to anticipate market trends, execute the mobility of our global resources and articulate points of view on relevant key industry issues. With our deep industry focus, we can help your organization drive down costs and compete more effectively to achieve its potential.

Other key areas of focus

Underpinning our performance improvement capabilities are our strengths and skills in day-to-day operations, management and strategic decision-making. These skills are concentrated in the four supporting areas of: Strategic direction Performance technology People and organizational change Program management

Learn more
To learn more about our experience advising global, national and local oil and gas companies, contact one of the following Ernst & Young professionals. Roy Ellis Phone: +1 919 981 2939 Email: roy.ellis@ey.com Matt Chambers Phone: +1 713 750 5944 Email: matt.chambers@ey.com
2012 EYGM Limited. All Rights Reserved. EYG no. DW0174 WR no. 1206-1370794
This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

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