Thought Leadership

Eight Ways to Establish Prudent Management for Large Capital Projects: Success Factors Part 1

Category: Thought Leadership
Carrie Okizaki • October 20, 2022

Investment_recovery

This post is the first in an ongoing series about success factors – the keys to achieving your goals when managing large capital projects.

In recent years, the increasingly urgent need for clean energy solutions coupled with a wave of innovation has led to bubbling interest in new nuclear power generation. Now, with the passage of the Inflation Reduction Act, legislation and funding exist to support getting an influx of new builds off the ground.

Utilities exploring large capital projects must consider expending significant sums in an environment that – despite the sudden positive shift in mood – remains risky. The company’s ability to succeed and to obtain a return on its investment requires that it exercise prudent management in making its decisions in the planning and execution of these projects.

While questions of prudence are most often associated with rate cases, we note that boards of directors, external stakeholders and investors have increasingly adopted the same kinds of tests of management’s prudence. Thus, management should be prepared to ask and answer these challenges regardless of whether the company is regulated by a state commission.

Decisions about investments in large projects include weighing many external factors such as fuel choice, regulatory uncertainty, anticipating the wholesale market, project complexity and the like. Prudent management requires that a utility’s decisions are sound, considering the circumstances surrounding the decision.

Whether the company’s current goals involve applying for a loan, attracting venture capital funding, or recovering your investment, the principles of prudent management should apply to all capital projects. No matter the political and economic climate, prudent management is always a utility’s best approach.

Prudent Management and Rate Recovery

The concepts behind prudent management are rooted in rate recovery cases. Regulated utilities are faced with a very difficult reality: they must invest to replace or refurbish aging plants in a very unpredictable market.

State public service commissions are typically required by statute to base their opinions regarding a utility’s investment recovery on management prudence. Many regulated states have adopted mechanisms such as pre-determination, trackers, and surcharges for utility ratemaking.

However, even where the commission has given “preapproval” of a utility’s large capital expenditure, the company must show that it prudently managed the project to have its investment included in its rate base.

In the context of managing large capital projects, commissions determine management prudence based on an examination of the company’s decision-making process. The critical questions for determining prudence often include:

  • Was the company’s decision timely?
  • Was the decision based on timely, high-quality information?
  • Did the company weigh alternatives before making this decision?

Beyond their use in the context of rate recovery, these principles should underpin high-level planning for proper execution of any capital project.

Eight Proven Methods for Establishing Prudent Management

Regardless of the nature of the investment, the jurisdiction or other considerations, there are eight proven, tried-and-true methods for exhibiting prudent management:

  1. Commit to Transparency: Early communication and transparency with regulators and external stakeholders is the first step in executing a successful project. Once the project is announced, keeping the stakeholders informed of project risks throughout is a key to prudent management. Companies show they are prudently managing the work by sharing with regulators the project’s risks, the potential impacts, and reasons for changes to the original plan. Providing transparent and unambiguous real-time information supporting the management of the project also provides a counterpoint to future second-guessing of a project’s goals and success.
  2. Develop a Strategic Approach: Utilities that use available means (statutory, regulatory or otherwise) to bring the regulators and external stakeholders in at the earliest possible stage tend to reap the benefits. Preapproval of the project by regulators in some manner can result in the utility securing financing on reasonable terms and eliminate a potential source of disallowance, though such a strategy does not excuse imprudence.
  3. Internal Company Alignment: As projects develop, it is important that the company’s goals and strategy are internally vetted before information is externally released. As an example, senior management and regulatory affairs leaders need to understand how project cost and schedule estimates were prepared so that they can properly communicate with external stakeholders, their board of directors, and regulators. Consideration should be given to quantitatively communicating risks and uncertainties. This also means committing adequate financial resources to match project needs.
  4. Properly Characterizing Early Cost, Schedule and Scope Definition: Projects are often haunted by preliminary estimates that were not properly contextualized. Utilities who use industry-available tools for progressing cost and schedule estimates and who properly identify risks see the benefits. Appropriate classification of the maturity (and therefore accuracy) of the estimate has been successful with commissions and external stakeholders. Early communication of project goals, contracting strategies, budgets and schedules can only be effective when combined with a proper explanation of the basis of that information.
  5. Reporting Ongoing Status of Major Project Goals: External shareholders and regulators care most about utilities keeping to project cost and timelines. If companies invest in establishing budgets and schedules, updating progress against those baselines and identifying the project’s ongoing risks should be a fairly routine exercise. Doing so breeds confidence among the regulators and stakeholders that the company is properly and prudently managing the work as it progresses.
  6. Commercial Alignment with Contractors: Companies need to develop a contracting strategy with their major contractors that fits the needs of the project, allows the owner to actively manage the work, and includes appropriate contract language that requires the contractors to transparently report their progress.
  7. Active Owner Management: Companies often make the mistake of over-relying on contracts and litigation to remedy problems after the fact rather than actively managing and mitigating issues as they occur. Regardless of the contract method or terms contained within the contracts, utility management is always held responsible by its regulators and other constituents for the project’s ultimate success. Owners embracing this responsibility maximize recoveries by instituting methods for overseeing the project’s progress, understanding and mitigating risks, and making timely and well-reasoned decisions when cost or schedule changes occur. Companies that engage in active management can inform regulators of ongoing progress and eliminate potential surprises.
  8. Active Assessment and Reporting of Project Risks: To mitigate risk throughout the project, management must validate the progress the contractors are reporting, what is occurring in the field, and likely consequences of certain actions or inactions. Companies need to show their actions are within industry best practices and that risks are being managed and mitigated.

Regardless of the circumstances surrounding the new build, successful execution depends on several factors, including developing tools for transparently reporting and properly characterizing the project’s budget, schedule and key risks; implementing a commercial strategy that focuses the contractors on the owner’s needs for transparency; actively managing those risks and taking timely action to mitigate potential overruns; and properly documenting and informing the commission and interested parties of the company’s management prudence throughout the project.

Originally published: June 2016. Fully updated: October 2022.