1. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu1 Flexibility versus Robustness What’s in a Name?

2. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu2 Flexibility versus Robustness System Characteristic Responding to Uncertainty Analysis Methods RobustnessProbabilistic Design FlexibilityFlexibility in Design Robustness: the ability of the system to respond to fluctuations in the behavior of its components or its environment with minimal degradation in its performance [Taguchi]. Flexibility: the ability of the system to be actively managed against uncertainty by hedging risk and exploiting upside opportunities in order to maximize a system’s value over its lifecycle [inspired by RO literature].

3. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu3 Case Study Embedding Flexibility in Off-Shore Oil Pipeline Networks Deployment

4. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu4 Off-Shore Oil Pipeline Networks Maximize NPV Determine  production facility location  pipline sizes  production rates over 3 stages

5. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu5 A Rigid Design - Optimized

6. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu6 30 45 304515 304515 304515 0.25 0.50 0.25 0.15 0.350.500.35 0.250.150.50 Stage I Stage II Stage III Recognizing Uncertainty in Future Oil Prices!

7. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu7 Rigid Design Evaluated under Price Uncertainty E(NPV) does not change because price change is symmetric and no constraints

8. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu8 Designing for Robustness

9. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu9 More Robustness …

10. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu10 Designing for Flexibility In financial markets, options have been adopted as proven mechanisms for coping with uncertainty. A financial option gives its owner the right, but not the obligation, to take a particular course of action in the future. Options provide flexibility in the decision making process with the objective of limiting downside losses while capitalizing on potential upside opportunities. “Flexibility” has been emerging as an approach that applies ideas from quantitative finance to engineering projects.

11. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu11 Designing for Flexibility (notice path dependence!) Financial MarketsEngineering Projects

12. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu12 Flexibility Demo

13. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu13 Highest E(NPV) Design

14. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu14 Low E(PV(CapEx)) Design

15. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu15 Solution Quality RigidRobustFlexible IFlexible II Solution Quality for the Uncertain Oil Price Problem Formulation E(NPV)822 M$695 M$929 M$900 M$ STD285 M$159 M$165 M$334 M$ E(PV(CapEx))1006 M$579 M$969 M$688 M$

16. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu16 Recognizing Uncertainty in Reservoir Volume! 670 335 6701005335 0.50 0.25 0.15 0.500.35 0.250.50 Stage I Stage II Stage III 6701005335 1005 6701005335 0.25 0.50 0.35 0.15

17. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu17 Highest E(NPV) Design

18. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu18 Solution Quality versus Computational Cost E(NPV)753 M$1010 M$ STD283 M$214 M$ E(PV(CapEx))970 M$992 M$ Design Variables1991 Design Space268 x 10 6 411 x 10 60 RigidFlexible Computational Cost Solution Quality for the Uncertain Oil Volume Problem Formulation

19. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu19 Words of Wisdom on Flexibility Flexibility is a means, not the objective, which is to improve system performance. Flexibility neither means nor is only achievable via staged deployment Flexibility is not revenue management in engineering projects Traditional financial analysis and valuation approaches, i.e. Black- Scholes formula and derivatives, do not apply to engineering design. Target curves offer a simple, transparent, but powerful approach to valuing flexibility in engineering projects. Flexible designs do not necessarily require larger initial capital expenditure as compared to rigid designs. Flexibility is not the enemy of optimality.

20. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu20 Uncertainty Classification Robustness: the ability of the system to respond to fluctuations in the behavior of its components or its environment with minimal degradation in its performance [Taguchi]. Flexibility: the ability of the system to be actively managed against uncertainty by hedging risk and exploiting upside opportunities in order to maximize a system’s value over its lifecycle [inspired by RO literature]. Flexibility = Active Robustness Type of UncertaintySystem Characteristic Responding to Uncertainty StaticRobustness DynamicFlexibility

21. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu21 Static Uncertainty Addressed by Robustness System Performance Metric PDF Variations in subsystems or from external factors System Model expected value of system performance metric must exceed a certain limit with high probability Probabilistic Design

22. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu22 Static Uncertainty Addressed by Robustness System Performance Metric PDF Variations in subsystems or from external factors System Model The majority of the outcomes are bounded by imposed limits Robust Design

23. © Rania Hassan; adapted by R. de Neufville rhassan@mit.edu23 Dynamic Uncertainty Addressed by Flexibility System Performance Metric Dynamic PDF System Model Period 1 Period 2 ……….. Period N Period 1 Period 2 ……….. Period N collapse using discounting Modify/Optimize System Quantify System Value TIME Variations in subsystems or from external factors