Insight

Hydropower reinvestment: learning from asset management principles

Espen Odderbø

By Espen Odderbø

Oct 19, 2022

Throughout history, water has been a central hook for development. As technology evolved to harness water for electricity, a highly efficient and sustainable energy production method was created. The scale of hydro-electric production has grown over time to become the backbone renewable power as we know it today. In many parts of the world, it is the dominant source of planned sustainable power. In addition to being relatively stable and available on a large-scale, it is also one of the most cost-efficient sources of electricity.

However, perhaps because of the scale and the low-cost of hydropower, some utility owners have neglected the need to remain agile. As we progress toward energy transition, and fossil fuels are replaced with intermittent power sources including wind and solar, hydropower providers need to be ready to meet growing demand.

There are a number of areas that will bring hydro asset owners to a higher level of efficiency, making them better able to capture the full value of the market to come. A higher level of sophistication regarding risk management and value creation is one of these areas and can be obtained by addressing central asset management functions.

Optimising the value of hydropower through asset management

High, predictable, and flexible availability of production units is a fundamental prerequisite to optimising the value of water. This has always been the case, but it is increasingly important as we see the sustainable energy transition fuel higher volatility in market prices to levels, and hence values that were “unthinkable” only a short while back. Operations & Maintenance (O&M) as well as refurbishment activities in appropriate scale and timing are the main tools to achieve necessary availability.

Hence, unavailability management is increasingly important, and asset strategies must reflect efficiency as well as the right balance between commercial portfolio risks and the cost of mitigation.

It is vitally important that practical management of assets is based on sound commercial principles that have close links to revenue optimization.

To secure the assets’ value creation through asset management, the below basic value and risk concepts should be considered:

1. Alternative investments must be considered to optimise the value of the asset

The value of refurbishment (and in principle all maintenance activities) is conceptually highest at the time when the cost of risk exceeds the repair cost.

The cost of risk has two basic inputs. The first is the probability of failure, or rather the development of the failure probability over time. The second part is the estimated consequence of failure.

Understanding asset and component condition is no easy task, and using statistics is challenging for various reasons. Components have unique characteristics tied to each plant and it is also necessary to understand the interrelationship of components, and potentially other plants. However challenging, understanding assets’ condition as part of a system is a critical starting point for asset management.

It is not possible to evaluate an infinite number of risk mitigating alternatives, so success will depend on choosing the right ones to compare. Careful cost/benefit considerations must therefore be made.

In the consideration of alternatives, cash flow analysis must be employed. It is important to include discounted cash flow of the remaining (and developing) risk as a cost factor.

Optimisation models must be in use to capture the combination of different mitigation (and possibly capacity change) alternatives. Every action will impact the life cycle of the asset which means that timing for alternatives also change. The use of algorithms will help users understand the effects of complex scenarios.

2. A number of different risk and value aspects may be considered in the optimisation of O&M and refurbishment

  1. The value of the individual plants needs to be reflected in the Asset Management strategy. Accounting for value of potential, “out of the money” stations may be optimized with lower planned availability.

    Hydro production assets are often very profitable and consequently the question of value is often about comparing a very valuable asset to one of even higher value. In these cases, value of different assets can be of marginal importance.

    However, hydro portfolios may also be very diverse, and consist of assets that are of low value to the point where market price expectations render the assets non-profitable. In these cases, value of assets needs to be considered allowing for higher failure probability from reduced Opex and Capex in O&M and refurbishment.

  2. Investment decisions also need to consider the uncertainties of risk factors.

    All inputs into understanding risk and value will be uncertain and the ability for individual companies to carry the risks vary. Diversification reduces risk and increases the ability to carry risk in individual asset strategies.

    Risk should not only be considered in a 50 percentile (average, mean of “most likely”) perspective. The sensitivity of factors underlying risk is important to comprehend as it provides understanding of realistically possible scenarios. However, as asset risks in a portfolio are (to a large extent) discrete, larger and more diverse portfolios have the benefit of risk diversification. Hence, when considering risk, portfolio risk must be understood and the benefits taken out in individual asset planning.

  3. Investment decisions should leverage operational flexibility and consider current forward power price expectations to reduce investment cost.

    The real value of timing is of increasing importance as the volatility of electricity prices increase. A considerable part of both repair cost as well as cost of risk relates to loss of revenue (in all events that lead to unavailability). By having the operational flexibility to adapt to market conditions a significant value can be realised.

    Indeed, this currently has wide industry focus through “outage management” which often has a focus on timing within the budget year. This is a good example of how revenue management and asset management need to interact for decisions considering both revenue and cost, and the associated risks.

    However, when considering the timing value, a larger commercial potential may lie in the flexibility between years applied to large refurbishment projects that may cause unavailability for several months. This creates the added complexity of considering the risk of company annual results. Aiming for unavailability when prices are low certainly lowers project costs, but it also lowers profits when the expectation of profits already are low.

3. Relatively simple modelling may be adequate for total portfolio optimisation, but must be put into operational context

The potential for value improvement in the hydro industry is very high. Only the very best performing companies are heading towards a “best practice” capacity in asset management. However, the realization of the value potential is spreading, although still at an early stage.

Practically implementing “state of the art” asset management may seem like a monumental task. The practical implications can include changes in operational model, organisation, sourcing and storage strategies and IT systems. However, the benefits very often leave no doubt that significant investment in operational capacity is supported by a very sound business case. Good planning centres on subject matter insight and agile principles, which often reap early rewards.

About the authors

Espen Odderbø
Espen Odderbø PA energy and utilities expert

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