Short Explanation Monte Carlo model

Example: How to set-up a model with uncertainties and events

Thijs Raaben
26-07-2016

Short Explanation Mote Carlo model

Explanation event*: General examples

Standard template for discrete distributions: Risk Events
Explanation normal uncertainty*: General examples
How to include uncertainties in MC model (linked to cost estimate)
Total Monte Carlo model

* The definitions event and normal uncertainty are quit confusing. Because a risk has always uncertainty (also events) and the term normal uncertainty can be confused
with a normal distribution. So it is recommended to adjust the definitions to prevent future confusion.

Explanation event

Risk / Opportunity Event

An uncertain future event with a potential negative or positive impact on the project. The
characteristic is that the event will / will not occur.

Example: There is a lottery with 10 lots in total and you bought 1 lot. There are two possible outcomes:
1. Not winning the lottery
- Probability 90%
- Impact: gaining 0,2. Winning the lottery
- Probability 10%
- Impact: gaining 100, So, we need a discrete distribution
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Event

Standard template for discrete distributions: Risk Events

The attached excel file: standard Format MC analysis Thijs shows a standard approach to compute the risk events in the Monte Carlo model. Please note that this is only a model of one
person. All steps will be explained in the next slides.

Event
Step 1: Include the uncertainty in probability of occurrence for the initial risk
Why: For many risk, the probability of occurrence is not exactly known. Specialist tell the risk engineer that the probability of occurrence of a
certain risk is between the 10% and 25%. In a deterministic approach this knowledge will get lost. However a probabilistic approach is
capable to handle with uncertainties. Therefore, do not ignore the uncertainty in probability of occurrence in the model.
How: The screenshot of the excel file shows a link between the category (1-5) that is filled in in cell I4 in the standard mc model.
If prob = 1 -> Uniform distribution between 0 and 0.01 (0 and 1%)
If prob = 2 -> Uniform distribution between 0.01 and 0.1 (1 and 10%)
If prob = 3 -> Uniform distribution between 0.1 and 0.25 (10 and 25%)
If prob = 4 -> Uniform distribution between 0.25 and 0.5 (25 and 50%)
If prob = 5 -> Uniform distribution between 0.5 and 1 (50 and 100%)
What if I overwrite the predefined category?: For some risk there is data or other more information available which can be a reason to
overwrite the predefined categories of the Van Oord risk management process. In this case you can overwrite cell AD with a more precise
distribution. Just use =RiskUniform(lower_boundary, higher boundary)
Why do we use a uniform distribution: There is no information available (in the standard case) that the middle of the range will be more
likely than the boundaries. Therefore, we use a uniform distribution. If you have information that a another distributions suits better, then use
a different distribution.

Event
Step 2: Repeat step 1 for residual probability
Do the same as in previous slide. However, refer to the cell where the residual probability is defined.

Event
Step 3: Include the uncertainty in probability of occurrence for the initial risk
Why: For many risk, the potential impact is not exactly known. Specialist tell the risk engineer that the impact a certain risk is for example
between the 3M and 5M. In a deterministic approach this knowledge will get lost. However a probabilistic approach is capable to handle
with uncertainties. Therefore, do not ignore the uncertainty in potential impact.
How: The screenshot of the excel file shows a link between the category (1-5) that is filled in in cell I4 in the standard mc model.
If prob = 1 -> Uniform distribution between 0 and Lower boundary of category 1 (defined in tab RCM)
If prob = 2 -> Uniform distribution between lower and upper boundary of category 2 (defined in tab RCM)
If prob = 3 -> Uniform distribution between lower and upper boundary of category 3 (defined in tab RCM)
If prob = 4 -> Uniform distribution between lower and upper boundary of category 4 (defined in tab RCM)
If prob = 5 -> Uniform distribution between lower and 1.5* lower boundary of category 5 (defined in tab RCM) -> Advice: Do not use category
5
What if I overwrite the predefined category?: For most of the risk there is data or other more information available which can be a reason
to overwrite the predefined categories of the Van Oord risk management process. In this case you can overwrite cell AQ with a more precise
distribution. Just use =RiskUniform(lower_boundary, higher boundary) or another type of distribution.
Why do we use a uniform distribution: There is no information available (in the standard case) that the middle of the range will be more
likely than the boundaries. Therefore, we use a uniform distribution. If you have information that a another distributions suits better, then use
a different distribution.

Event
Step 4: Repeat step 3 for residual potential impact
Do the same as in previous slide. However, refer to the cell where the residual potential impact is defined.

Event
Step 5: Compute discrete distribution event
Characteristic of a risk event is that the risk will/will not
occur. Therefore, a discrete distribution should be used.
See presentation Quantitative risk assessment.
Define probability of occurrence
If risk occurs: Refer to cell AO to include probability of
occurrence (with uncertainty included; see slide 4)
Probability of not occurrence: 1-P_occurs. In the attached
excel file: 1-AS
Define potential impact
If risk occurs: Refer to cell AQ to include potential impact
(with uncertainty included; see slide 6)
If risk not occurs: 0

Define discrete distribution:

Refer to cells with the red and blue box:
RiskDiscrete(AU4:AV4,AS4:AT4)

Event
Step 6: Repeat step 5 for residual risk
Refer to the right cells

Event
Step 7: Repeat step 1 till 6 for every risk and sum

SUM

SUM

Event
Step 8: Keep thinking!
CONSIDER THAT:
Correlation between risks must be included. This is maatwerk, statistical correlations can be best
included by using if statements.
There can be several reasons for specific risks to use other distributions than mentioned.
This is no perfect model, it is only a first start model of one person. Improve the set-up
each time you do a analysis.

Now the part of the model for the events is finished. It is important to include all
uncertainties in one model. So link this part of the model to the cost estimate where you
include the uncertainties.

Uncertainties (examples)

Risk / Opportunity Normal Uncertainty

Definition: A possible deviation from an estimated value. The characteristic is that there is (an almost
certain) deviation from the estimated value. However, the direction and magnitude are uncertain.

Examples
What is the height of the VO office (above parking lot)?
Right now, we estimate that it is around the 16m. However, it could be 13 till 19 meters. We can reduce this
uncertainty by measuring it.

What is the cost of 1L gasoline? And a week, month and year from now?
We know the current price level, but we do not know for sure what the price is a week, a month
and a year from know. The uncertainty increases with a larger timeframe.

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Uncertainties (distributions)

Risk/Opportunity Normal Uncertainty

Normal Uncertainties can be modelled with a continuous probability distribution. Most
common continuous distributions:
Normal distribution

Triangular distribution

Another common continuous is the uniform distribution

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Uncertainties in MC model
Example: How to include uncertainty in quantities in MC model
Find the source cells in the cost estimate for the uncertainties

Link all uncertainties to the cost estimate (production estimate is already included in cost estimate). This file contains all links from individual cells
to the project cost price. It is very important to incorporate the continues distributions for the uncertainties at the source to have the right model,
otherwise the model might show distorted results. Again, this is the basis of the cost estimate and these cells are linked to the project cost price.
For example, the quantities are usually defined in the tab Qty as shown in the screenshot below. Link the probability distributions to this tab, the
excel file automatically links the uncertainty in from the Qty tab to the total project cost price. The best way is too link the uncertainties to the source
because then the uncertainty is defined for all options etc.

Choose the right distribution

Common continues distributions are a triangular distribution, a normal distribution and a uniform distribution. Select the right distribution that fits
the problem. Choosing the wrong distribution can have an significant influence on the outcomes, especially for important uncertainties like
production uncertainties.

Link distribution to the source

Uncertainties
Distribution normal with = expected
value and = half of possible
deviation. This means that more than
95% of all iterations are +/- 1* . The
mean is defined using a cell reference
to keep all links in the cost estimate
intact! This is important for a reliable
model
Define uncertainty for quantity in the tab Qty. This will
be linked to the project cost price. Try to compute the
probability distribution as close to the source as
possible for the most reliable model

Uncertainties
Example: How to include uncertainty in weather delay in MC model
Recommendation risk engineer (short term feasible)
Do not use expert judgement of 1 person as indication of the risk profile for weather delays
Use the wave data as indication for the uncertainty in weather delays (since the vessel limits
are fixed) for now
Determine the risk profile for weather delays per month together with the coastal engineer
and production estimator
Incorporate weather delays in the MC analysis in the right work sheet of the cost estimate
How to incorporate workability uncertainty in the planning MC analysis in the right way:
What if activities shift to another month etc.

, defined as cell reference!

If you overwrite the cell reference with a
number, links with previous uncertainties
can get lost! Therefore, leave all links in
the cost estimate and define probability
distributions using cell references!

RiskNormal(H6,0.1*H6)

, defined as 10% of .
This can also be a
number.

Uncertainties
Recommendation risk engineer (short term feasible)
Apply the same procedure as in sheet 16 and 17 for all normal uncertainties. Frequent normal
uncertainties in dredging projects are:
Production rate (m3/hour)
Workability (especially weather delays)
Total quantities
Volume split-up subsoils
Mob/demob
Also focus on project specific uncertainties
Use data to quantify the uncertainties where possible; for most of the uncertainties there is a
lot of data available
Always use the cost estimate as basis for your model; this file contains all links to the project
cost price
Always check whether the results are logic; experiences (Cherbourg) showed that using a
triangular distribution instead of a normal distributions can have an huge impact on the end
result

Total model: events + uncertainties

Insert the model of slide 10 in the cost estimate with uncertainties and sum the project cost
price (incl. probability distributions for uncertainties) with the sum of the events and run the
model.