Financial and Economic Modelling for Business and Government Presentation to the Actuaries Institute June 2015
www.pwc.com.au Financial and Economic Modelling for Business and Government Presentation to the Actuaries Institute June 2015
Craig Fenton Presentation for today
PwC Our Approach Discussion of Examples
June 2015Financial and Economic Modelling for Business and Government PwC 2 PwC
June 2015Financial and Economic Modelling for Business and Government PwC 3 PwC
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June 2015Financial and Economic Modelling for Business and Government PwC 4 PwC Australia
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June 2015Financial and Economic Modelling for Business and Government PwC 5 PwC Australia …and me
Now Joined PwC in 2000, with a focus on economic, financial and commercial analysis and advice
Partner in the Australian firm, leading our • Economics and Policy services nationally • Government advisory services in Queensland
Before Commercial, regulatory and economic advisory positions for both Commonwealth and State Government organisations
June 2015Financial and Economic Modelling for Business and Government PwC 6 Our Approach
June 2015Financial and Economic Modelling for Business and Government PwC 7 A means to an end
Keep perspective • Economic and financial What is the • Project definition ‘question’? • Client engagement models are tools to support • Options definition critical business decisions. • Before modelling:
- understand the ‘question’ • Qualitative or quantitative How is it best • Data availability ‘answered’? - identify where quantitative • Model scoping analysis ‘fits in’ • During/after modelling: - interpret in context • Build model Deliver and • Testing and review - be clear on the limitations interpret • Analysis and reporting • Rarely a standalone deliverable
June 2015Financial and Economic Modelling for Business and Government PwC 8 Models to suit a client’s requirements
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 9 Let’s Discuss
June 2015Financial and Economic Modelling for Business and Government PwC 10 Model type Investment prioritisation
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 11 Investment prioritisation Overview
Business Issue Public resources are limited and always have Private Sector clients or alternative uses - a new project or policy means Government projects reallocation of these resources. Governments clients or projects must determine if this re-allocation is likely to make a net contribution to society.
Model Characteristics Risks and Challenges • Equity/distributional factors are irrelevant • Pricing the intangible benefits of a project • Focus is on marginal changes in markets for • Accounting for uncertainty of outcomes, and the outcomes from a project/policy forecasting future cash flows reasonably • Need to ensure that the reallocation of • Discounting future costs and benefits resources targets the problem not the appropriately symptoms • Ensuring all options to address issue are − is traffic congestion due to insufficient evaluated capacity (engineering) or inefficient use (demand management)?
June 2015Financial and Economic Modelling for Business and Government PwC 12 Investment prioritisation Example
Project South West Rail Link High residential growth area in South West Sydney required transit improvements to link to the city centre. Cost-benefit analysis model developed to evaluate four different options.
Modelling Task Key Challenges Managed A detailed model was developed to evaluate the • Broad literature review to identify relative merits of providing additional bus appropriate valuations of intangible benefits services, or combination of rail and road • Consulted with multiple stakeholders to infrastructure. develop an appropriate set of project options Benefits modelled included: • Scenario / simulation analysis undertaken to • De-crowding, ambience and reduced standing understand how model parameters affect travel times ranking of options • Environmental benefits • Increased workforce productivity
June 2015Financial and Economic Modelling for Business and Government PwC 13 Model type Economic and financial feasibility
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 14 Economic and financial feasibility Overview
Business Issue Investigate alternative investment or policy Private Sector clients or options to estimate comparative: Government projects clients or • affordability / funding requirements projects • financial performance • economic impacts
Model Characteristics Risks and Challenges • Need clear definition of alternative options or • Functionality requirements can change as scenarios options and scenarios ‘evolve’ • Require high levels of flexibility and • Preliminary model outcomes can ‘feedback’ ‘sensitisation’ into revised options or scenarios • Heavy dependence on forecasts • Format and structure of key inputs often • Relatively low levels of detail unclear until late in model development • Prefer ranges to ‘single point’ results • Avoiding undue reliance on quantitative outputs
June 2015Financial and Economic Modelling for Business and Government PwC 15 Economic and financial feasibility Example
Project Gold Coast Rapid Transit Project Develop a Business Case to compare value for money of alternative options for improving north-south public transport services on the Gold Coast.
Modelling Task Key Challenges Managed A highly flexible model was developed to forecast • Multiple permutations of staging, corridor the net financial cost to the Queensland and design (e.g. station location) options Government comparing: • Joint funding involvement of the Federal, • rapid bus vs. light rail infrastructure options State and Local governments, requiring • alternative corridors − consensus on scenarios and assumptions • scheduling of up to five project stages − inconsistent analysis requirements • patronage and cost scenarios • Potential misinterpretation of key financial • private delivery and financing options principles by analysis recipients
June 2015Financial and Economic Modelling for Business and Government PwC 16 Model type Commercial and financing options
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 17 Commercial and Financing Options Overview
Business Issue
Investigate options for the commercial Government Private Sector structuring and/or financing of an investment: clients or clients or projects projects • ownership structure and responsibilities • contractual / pricing arrangements • debt and equity structures
Model Characteristics Risks and Challenges • Close interaction with legal and tax advisers • Logic requirements can change as detailed • Requires ‘allocation’ of project-level forecasts tax, structuring or financing arrangements between multiple investors / financiers are refined or redefined • Need clear definition of alternative options or • Require strong communication between scenarios model developer and parties defining • Financing structures can be complex and commercial and financing strategies based on strict prioritisation of cash flow • Potential for high complexity (or error) where ‘claims’ there is a high number of permutations of possible commercial / financing outcomes
June 2015Financial and Economic Modelling for Business and Government PwC 18 Commercial and Financing Options Example
Project LNG Value Train Support a client investigating optimisation of value of gas reserves, through options for participation in an integrated LNG project proposal.
Modelling Task Key Challenges Managed Develop models covering the full value chain of • ‘Dynamic’ modelling in an environment of an integrated Upstream – Midstream LNG preliminary project definition and options project to calculate: identification • tariffs for access to third party infrastructure • Integrating upstream and midstream • transfer prices for LNG plant and pipeline elements of analysis components • Allocating value under different participation • pricing for upstream gas and condensate rates (ownership shares) for multiple assets • JV participation rates in each component • Identifying gas monetisation (tax) points and allocation of historical ‘tax pools’ • Government participation, taxes and levies
June 2015Financial and Economic Modelling for Business and Government PwC 19 Model type Investment risk assessments
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 20 Investment risk assessments Overview
Business Issue Understand the probability of future outcomes in Private Sector clients or circumstances of risk or uncertainty, using Government projects relevant statistical measures (e.g. mean, mode, clients or projects confidence intervals, etc). Better understand and prioritise risks.
Model Characteristics Risks and Challenges • Typically based on ‘unrisked’ models, or • Requires understanding of specialised included as additional functionality functions in Excel • Rely on Excel ‘add-ins’ such as “@Risk” or • If risk or uncertainty cannot be reasonably “Crystal Ball” defined, analysis outcomes will be unreliable • Require definition of the probability of • Ensuring appropriate interpretation of uncertain events, and the distributions of risk statistical results impacts • Extensive application in very large models • Runs multiple (e.g. 10,000) randomised can cause extended ‘run’ or iteration times iterations for defined events
June 2015Financial and Economic Modelling for Business and Government PwC 21 Model type Demand modelling
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 22 Demand modelling Overview
Business Issue
Understand the drivers of demand for individual Government Private Sector products and services, in order to: clients or clients or projects projects • assess the effects of new taxes or tariffs, or measure responses to price changes • prioritise product introduction • forecast capital and operating expenditure Model Characteristics Risks and Challenges • Trade-off between model ‘richness’, and ease • Data may not be available to estimate the of computation, testing, and communication ideal theoretical model to others. − Not granular enough, or periodicity of the • Although complex technical criteria are data is too infrequent available to evaluate models, model selection • Possible that strong statistical relationships often based on more subjective criteria. between variables may not be identified • Demand drivers for the same product or • A good fit to sample data may not guarantee service may vary significantly between accurate forecasts when fitting model to new market segments. data
June 2015Financial and Economic Modelling for Business and Government PwC 23 Model type Procurement processes
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 24 Procurement processes Overview
Business Issue Evaluate competing bids for the provision of Private Sector clients or requested services or assets Government projects clients or OR projects Develop and submit bids for the provision of requested services or assets Model Characteristics Risks and Challenges • Focused on a lower number of project options • Models developed or evaluated in a ‘high • Relatively high levels of detail, supporting pressure’ situation (e.g. time constraints) ‘firm’ pricing of services • Errors can be ‘locked in’ through the bidding • Based on detailed quotes, commitments, process underwriting, etc • Model output formats to align to precise bid • Supported by detailed independent review information requirements • Supports ‘contract close’ and ‘financial close’ • Intellectual Property – models provided / • Tax structures and pro-forma accounts received as part of submitted bid materials
June 2015Financial and Economic Modelling for Business and Government PwC 25 Procurement processes Example
Project Property Development - Brisbane Financial and commercial advice for a bidder submitting a competitive proposal to the Queensland Government for a major central Brisbane property redevelopment.
Modelling Task Key Challenges Managed A flexible and detailed model was developed • Constrained development timeframes within a very constrained timeframe to support • Commercial and financing structures not analysis of bid structuring and pricing options: resolved until ‘test run’ phase of modelling • multiple precinct urban design strategies • Bid consortium participants with differing • different realisable property product investment strategies outcomes and pricing • Ambiguous financial information • different JV ownership by development asset requirements in bid documentation • funding public realm (cross-subsidisation) • Fully developed pro forma accounts including development financing, GST accounts, etc
June 2015Financial and Economic Modelling for Business and Government PwC 26 Model type Contract negotiations and support
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 27 Contract negotiations and support Overview
Business Issue
Understand the financial implications of Government Private Sector different negotiating strategies or proposed clients or clients or projects projects clauses in legal agreements, such as: • pricing structures • penalty provisions • termination payments Model Characteristics Risks and Challenges • Tailored to a specific project or commercial • Clearly aligning model formula structures to situation discrete calculation steps reflected in contract • Needs to precisely align with the financial materials (i.e. transparency) logic and methodology represented in • Identifying potential ambiguity in contract contract provisions, or ‘heads of agreement’ drafting (i.e. should be no methodology • High transparency and capability for assumptions in the model) reconciliation to specific contract provisions • Model may be provided to contracting • May require capability to provide ‘worked counterparties to support understanding of example’ outputs for contract materials proposed commercial terms
June 2015Financial and Economic Modelling for Business and Government PwC 28 Model type Pricing
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Feasibility Negotiations Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 29 Pricing models Overview
Business Issue Calculate pricing or charges for services provided Private Sector clients or by a business or asset. For example: Government projects clients or • Regulated or ‘quasi-regulated’ infrastructure projects • Cost recovery or sharing for joint ventures • Transfer prices for non-arms length entities
Model Characteristics Risks and Challenges • Based on specific pricing or charging • Model methodology must precisely (and methodologies (often contractual) transparently) reflect specified pricing • Often reflects a mix of historical and forecast methodologies data • Can be relatively large and complex (e.g. for • May have a relatively ‘long life’, to be used for large regulated infrastructure projects) regular pricing ‘resets’ or ‘true-ups’ • May be highly dependent on the application • Often specified as being subject to disclosure of capital asset pricing theory, and subject to to third party price/charge payers for ‘academic challenges’ independent review or ‘audit’ rights • Subject to scrutiny by third parties and government regulators / taxation agencies
June 2015Financial and Economic Modelling for Business and Government PwC 30 Model type Geospatial economic modelling
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Negotiations Feasibility Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 31 Geospatial Economic Modelling Overview
Business Issue
Decisions are being made for local regions using Government Private Sector state-wide or industry-level data. clients or clients or projects projects • Government agencies want to understand gaps between demand and supply of services. • Businesses are deciding the location of their next stores Model Characteristics Risks and Challenges • Combines multiple data sets to generate • Requires detailed understanding of holistic view of regions, including data across: geographical mapping in data − Economic, demographic, labour force • Technical expertise required across a range of − Retail, transport, industry and climate platforms, e.g. data analysis, databases, GIS • Provides spatially consistent data, results • Managing significant volumes of data, e.g. 20 from granular regions sum to larger areas industries, 2114 locations, 15 years of data • Consistent with ABS measurement and from 5 data sources accounting methodologies • Incorporating revisions to ABS geographical classifications
June 2015Financial and Economic Modelling for Business and Government PwC 32 Geospatial Economic Modelling Example
Project Ergon Energy peak demand modelling Ergon’s state-wide peak demand forecasting model suggested growth was flat-lining in aggregate, and wanted to identify specific areas of growth in order to prioritise capital investments. Modelling Task Key Challenges Managed Used PwC’s Geospatial Economic Model to • Worked closely with Ergon econometricians allocate historic and forecast input data used in and GIS specialists to understand forecasting Ergon’s state-wide peak demand model to methodology and map Ergon regions to ABS individual network regions. data Used these more detailed inputs to develop • Calibrated uncertain Geospatial Economic region-specific peak demand models to identify model parameters based on the high growth areas in the network. improvements to peak demand model fit
June 2015Financial and Economic Modelling for Business and Government PwC 33 Model type Operational and policy decisions
Investigation Implementation Support
Investment Prioritisation Procurement Processes
Economic and Financial Contract Negotiations Feasibility Models
Commercial and tailored to Pricing Financing Options the business challenge Investment Risk Geospatial Assessments Economic Modelling
Demand Modelling Operational or Policy Decisions
June 2015Financial and Economic Modelling for Business and Government PwC 34 Operational and policy decisions Overview
Business Issue
Support recurring or one-off business and policy Government Private Sector decisions, such as clients or clients or projects projects • cost of capital benchmarking • business/asset valuation • taxation or financial assistance programs
Model Characteristics Risks and Challenges • Highly unique and tailored to a specific • Ensuring consistency between data, business, policy or financial issue particularly where ‘blending’ historical and • Less likely to have any clear commonality in forecast data methodology between models of this type • Facilitating ‘roll forward’ of historical data • More likely to involve managing a ‘mix’ of where model management spans time forecast and historical data • Developing ‘reasonable’ methodologies for • May have a relatively ‘long life’ where the unstructured issues issue to be assessed is recurring
June 2015Financial and Economic Modelling for Business and Government PwC 35 Questions...
Contact:
Craig Fenton Partner +617 3257 8851 [email protected]
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