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Big capital projects are inherently risky. In addition to the significant investment at stake, organizations also put their reputations on the line when they take on a major, multi-year, capital-intensive project. Given the increased volatility in the marketplace and transparency when things go wrong – it is harder than ever to evaluate. But to create long term value and transform market position, they remain a critical success factor for organizations globally.

In fact, such projects are proliferating. According to estimates from the Organization for Economic Co-Operation and Development (OECD), by 2030, the combined annual infrastructure investment requirements for telecommunications, road, rail, electricity and water are likely to total an average of 2.5 percent of world gross domestic product (GDP). If electricity generation and energy-related infrastructure investments in oil, gas and coal are included, the annual share of GDP rises to around 3.5 percent.

The cost and accessibility of financing, the difficulties of partnerships with contractors and/or joint venture participants, potential labor unrest, and the proliferation of regulations related to health, safety and environmental matters all increase the risk profile of major capital projects. Effective risk management practices can add substantial value in assessing, measuring and monitoring the inherent risks of large-scale, capital-intensive projects, helping companies make better decisions in choosing the right projects and in completing them without “fatal” disruptions.

The first key element of capital project risk management is a strong governance structure. Strong governance is crucial regardless of the stage of investment, size of the project or complexity of the financing structure. It drives accountability at the operational level, and, at the management level, it allows accurate comparison and integration of risks in the process of making large investment decisions.

The operational perspective of managing risk associated with each project should be integrated with the strategic view of managing project portfolio risks. This helps to ensure overall portfolio balancing (such as the percentage of large projects in the portfolio, the contract mix, and the geographic diversification of projects) while managing enterprise-wide risks.

With the governance structure in place, there are a number of other practices that are important in modeling the risks of a large capital project, including:

• Establishment of a project scoring methodology that takes into account geographic and technical differences among projects

• Documentation of risk analysis procedures
• Creation and maintenance of a Project Risk Register
• Evaluations of actual versus estimated projections, and
• Performance of quality control assessments

The collaborative creation of a Project Risk Register – enumerating risk categories, types of impact, associated probability and potential causes – is also useful in forming a comprehensive picture – of the risks being analyzed. Once a Project Risk Register is created, it can be re-used on multiple projects of a similar nature. Each element of the register should include a procedural aspect to reinforce standardization.

Creating a clear and standardized process around risk modeling, however, is not enough. Leading companies systematically analyze risk estimates against actual data to foster continual improvement in risk modeling. Quality control assessments further enhance the accuracy of risk models. These processes reveal the reliability of certain methods; learning from actual data and situations serves to improve future modeling efforts across the organization.

Because of the complexity and high financing costs of such projects, it is critical for project management to have transparent, easy-to-understand, consistent and comparable information within the project. At each stage, risk budgets should be presented clearly via financial indicators and should be part of “go/no-go” decisions.

We have also seen companies employing risk measurement and modeling techniques used in other areas of finance – such as derivatives trading – to assess capital projects risks. Companies use stress testing for models, Monte Carlo simulations and back-testing techniques for measuring risks in large-scale capital projects.

Global companies that have built strong processes and used high-powered models find that these tools and methods prove their worth in helping management make key decisions. They can be invaluable, for example, in determining when to abandon a project whose profitability targets seem weak. Ultimately, these modeling techniques provide visibility into long-term, capital intensive projects that are fraught with many kinds of quantifiable risk.

But at the end of the day, the models and tools are only inputs to the process. It is the regular interaction between the project team, risk management and the leadership that ultimately work to identify the options and threats and continue to course correct throughout the lifecycle that best ensures the successful outcome of these high profile and highly complex undertakings.