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Risk Management & Monte Carlo Analysis

Risks appear in many forms: project and contract risks, cash flow risks and strategic risks.

A typical approach to contain project and contract related risks is to apply good practices and to hire experienced professionals.   

With cash flow risks, we refer to risks that affect projected cash flows of the business case which originate from market evolutions or parameters that generally cannot be contained at reasonable cost, e.g. energy prices, changing CO2 policies, changing subsidy requirements. To a certain extent, those risks could be hedged by either financial hedging mechanisms, or by smart project design.

Sometimes, future risk can be decreased by introducing options today. Such options can be integrated into the project at an early stage at relatively low cost, and may lead to a future risk reduction. These options need to be identified early, and are an element of smart project design.

Strategic risks refer to a correlated set of parameters that describe possible future “worlds”. They are usually analysed using a scenario methodology. The choice of such scenarios needs to be done carefully. Scenario methods often lead to option identification.

ENTRAS applies Monte Carlo Analysis to analyse cash flow risks. The main advantage of this approach is that a single graph describes the total risk profile. The sensitivity of individual parameters is readily identified. Key success factors are careful parameter definition and appropriate choice of probability distribution. 

An important insight is that every risk analysis remains a mathematical model – nothing more and nothing less. Risk assessment supports decision making but does not replace it.

ENTRAS has used risk assessment methodologies to support decision making for a number of clients, with projects including CHP (combined heat and power), CCGT (combined cycle gas turbine), biogas production and power-to-liquid business cases.

ENTRAS’s risk approach has been used for project decisions, for investment decisions and for subsidy setting.