Turmoil in the Contracting
Business
A Contractor’s Perspective
James F Davis, P.E.
SNC-Lavalin Houston
The information contained herein is gathered from public and
non-confidential sources and is offered only within the context
of this non-authoritative Presentation. The material is subject to
frequent and substantial change over time and some sources
cannot be independently verified. This information is not not
suited for technical basis of design nor for financial, business or
investment decisions. The format and content including forward
projections are that of the Author.
April 9, 2008
Overview
What is the Manifestation of this Turmoil?
What is Causing it?
Impact upon Capital Projects
What can be done about it?
What does the Future look Like?
April 9, 2008
Stating the Obvious
• Extensive capital project activity in infrastructure,
energy, power, refining
• Cost of Materials have increased by 25 – 90 % since
3rd Qtr 2004
• Equipment lead times have stretched out
• Competent and qualified consultants, engineers and
contractors are busy
• Lump sum turnkey (LSTK) with full wrap contracts
are very rare
• “Project Costs have risen by 35% from 2004 to 4th
Qtr 2007” – C.E.R.A.
$1 trillion by 2014
April 9, 2008
Turmoil in the Contracting Business
External forces have reduced stability in
equipment, material and labor cost and
equipment lead times to a point at which
traditional estimating and forecasting
methods utilizing historical information
(and financing) models may no longer
apply.
April 9, 2008
These external forces have upset the
supply / demand balance that caused
“perfect storm waves” in . . .
. . . availability, cost
and lead times
resulting in the loss
of predictability.
April 9, 2008
What Happened?
Relative
Capacity
Reduction of Sox and NOx
Fugitive Emissions-NESHAP
Low Sulfur Fuels
Greenhouse Gases
De-Bottlenecked Capacity
10%
1.0
8
0.0
5
85
April 9, 2008
90
95
00
05
10
15
43%
Sustained External Forces
•
Global & Regional Energy Capital Project Activity ($1.3 t USD)
– $100 b in Mid-East gas monetization: Gas production; LNG; GTL
– $65 b in West Africa gas & oil production
– 2 x $3.5 b U.S. refineries (Motiva; Marathon)
– Multiple oil sands projects in Canada
2010 = 2.9 mm bpd; $30+b CA
– ExxonMobil alone will spend $52 billion by 2012
•
Major Infrastructure & Energy Projects with Global Impact
– China: Three Gorges Dam; IGCC; CTL
– India: refineries, energy imports, transportation
– Russia: energy; infrastructure
April 9, 2008
5.8% annually
Unexpected External Forces
Ivan
$4.6 b
Rita
$9.2 b
Katrina
$5.8b
April 9, 2008
Nebraska, January 2007
Most Significant Impact
• Equipment & Bulk Material
– Turbines, pumps, compressors
– Alloy, structural steel shapes, cable
• Experienced Craft Labor
• Pressure vessel fabrication capacity
• Limited supply of experienced
engineers & constructors
April 9, 2008
Schedule Examples
Gas Turbines
Compressors
Gasifier Vessel
Hydrotreater Vessel
Air Separation unit
Ethanol Dryer
Field-erected Tank (306ss)
ANSI 900 Pipe
April 9, 2008
36 mo
30 mo
26 mo
30 mo
34 mo
22 mo
30mo
22 mo
CHANGES IN COST INDICES
70.00%
60.00%
50.00%
40.00%
BASIS =
2004
30.00%
20.00%
10.00%
0.00%
2004
Bldg. Matl.
April 9, 2008
2005
Concrete
Steel
2006
Alloy
2007(Feb)
Skilled labor
SOURCE: Nelson-Farrar survey, Oil & gas Journal, July 2, 2007, Volume 105.25, pg 65-67
Examples 2006 vs. 2002
• Craft Labor
–
–
–
–
Hourly USGC Rate from $17 to $25 ($24 to $34)
Availability of sufficient numbers: concrete, carpentry
Qualifications in critical skills: welding, pipefitters
South of Interstate I-40 is the same labor pool
• Engineering: Global Demand = Global Shortage
–
–
–
–
–
Delayed salary impact until late 2005 as slack absorbed
“Catch-up” rates Jan ’06 to Jan ’07 = +10% (Houston)
Forecast @ 8-10% annually through 2008 *
Aging workforce: estimated average age = 47
Competing projects in refining; coal; chemicals; renewables, E&P,
infrastructure
*Source: Houston E&C Salary Survey, Trace Consultants, Inc.
April 9, 2008
Gulf Coast Project Activity*
Company
Project
Value
Date
Construction
Hours-peak
Motiva
Refinery Expansion
$7.0 billion
2011
5,950
Eastman
Chemical
Coal Gasification Plant
$1.6 billion
2011
1,360
Marathon
Garyville Expansion
$5.0 billion
2012
4,250
Eastman
Chemical
Coal to Chemicals (2)
$3.6 billion
2012
2,550
Total
Refinery Expansion
$1.8 billion
2010
1,530
Valero
Refinery Expansion
$1.4 billion
2010
1,190
Sempra
LNG Terminal
$1.0 billion
2010
850
$20.2 billion
17,680
$1b over 24 months = 3.0 mm work hours = 850 peak; 700 avg.
April 9, 2008
* Modified for Regional Activity
NET EFFECT
Today’s capital market is in turmoil with
minimal opportunity to properly forecast
costs and schedules more than 2-3 quarters
in advance.
This lack of predictability must be considered
in every capital project decision to assure
continued financial viability.
April 9, 2008
Unless extraordinary actions are taken
to understand actual risk exposure –
- the absence of any reasonable degree
of predictability in the market will inevitably
result in significantly higher financial risk
and hence project costs.
??? = Risk = $$$
April 9, 2008
Major Project Cost Breakdown
Category
$
Equipment
650
Bulk Materials
225
Transportation
35
Construction Mgmnt
75
Craft Labor
175
Engineering
80
Total
1240
Project Risk*
384
%
52
19
3
6
14
6
100
31
* Contingency, escalation, growth, risk fee - from historical project experience
April 9, 2008
New Objective
Minimize the uncertainty in both final cost
and schedule of capital projects:
– Step-wise / gated project development
procedure
– Quantitative risk assessment of design
– Shared-risk contracts
April 9, 2008
Owner’s Biggest Mistakes
1. Owner does not understand the complexity of
the project and that it is a “custom” design.
2. Owner wants a Class I estimate for the price
and in the time frame of a Class II estimate.
3. Owner does not allocate sufficient funding to do
the proper extended FEED.
4. Owner underestimates the permitting
challenges.
April 9, 2008
Pre-FEED - Definition
Conceptual Preliminary
Assessment
Feasibility Detailed
Assessment
Class V
+50%/-40%
Scoping
Business Model
Project Objectives
Economic Model
General Location
April 9, 2008
Curve / Order of
Magnitude
Project Objectives
Technology Options
Business Plan
Product Mix
Feedstock Options
Capacity Options
Site Alternative
Block Flow Diagram
1 - 2 mo.
Process
Definition
FEL 1
Class IV
+35%/-30%
Factored
Process Objectives
Feedstock selected
Product Mix set
Prelim. H&M Bal.
Prelim. PFD
Prelim Equip List
Licensor selection
Site Layout
Specifications
Mat’l of Construct.
Utilities
Prelim. emissions
Design Basis
Memorandum.
3 – 4 mo.
- Major Review
Project
Definition
FEL 2
Class III
+25%/-20%
Budget
Project Objectives
H&M Bal.
PFD
Prelim P&ID
Sized Equip List
Licensor PDP
Equip. Layout
Electric One-line
Utilities
Fire Protection
Flare system
Emissions
Pipe rack
Major piping run
Cable runs
Buildings
FEED Schedule
DCS I/O Count
HAZID
7 - 9 mo.
FEED –
Validation
FEL 3
EPCMImplementation
O&M
Class II@30% eng. Class I@60% eng.
+15%/-15%
+10%/-10%
Control
Proj. Object.*
Process Design*
P&ID*
Equip. layout*
Site Prep*
Civil Design*
Structural*
Piping*
Safety / Fire*
Equip. Datasheet*
DCS Spec.*
HAZOP Review
Constructability
EPCM Schedule
FEL Rating
Definitive
Detailed Design
Procurement
Construction
Mechanical Complete
Project closeout
Punch List
Turnover
Commission
Start-up
Operate
Maintain
*Client approved for
design
10 - 14 mo.
Training
30 - 40 mo.
Quantitative Risk Assessment*
• Fair & balanced allocation of risk
– Identify all major risks: formal process
– Quantify and Prioritize Impact upon Project
– Resolve: design out, mitigate, insure, fund
– Probabilistic (Monte Carlo) quantification
– Allocate mitigation to appropriate Party
Risk Value – Net Mitigation – Funding = Net Risk Exposure*
* Risk Resolution White Paper; Westney Consulting Group;2007
April 9, 2008
Deferred Conversion Contract
“Open book” conversion from reimbursable extended
FEED into fixed price EPC:
– Continue FEED (pre-EPC) on reimbursable basis
against Class II (15%) estimate at end of typical FEED
– Execute 50-60% of detailed engineering to fix bulk
$40 mm quantities – order pipe & steel (19%)
– All major equipment ordered (52% of TIC)
– Fix engineering and project management (12% of TIC)
– Fix craft labor costs (14% of TIC)
Ri$k
April 9, 2008
= 97% of TIC
Deferred Conversion Contracts
Alternative Approaches during FEED
• Commitment / order of major equipment
• Order certain bulk items: pipe, steel
Fixed
Price
$20mm $35mm
FEED
50% eng.
+/-15%
Extend
Convert to
Fixed price
EPC
Equipment
Bulk Material
FINANCIAL
CLOSE
April 9, 2008
Risk Capital
Gap
Funding
+/- 10%
New Approach - Owner
• Negotiated contracts through an extended FEED
to achieve “true” Class I estimate
–
•
•
•
•
•
$30mm - $35mm vs. $18mm - $20mm
QRA to quantify risk and identify Fuzzy areas
Early order / commitment of equipment
Contingent Equity – Gap Financing
Neutral balance payment programs
Contingency financing for residual risk
April 9, 2008
New Approach - Contractor
• Put fee at risk with capped LD’s
• Accept limited “make good” for errors
• Fix services: engineering, construction
management, project management
• Fix quantities: selected bulk items
• Negotiated contracts benefit from open
communication lines.
• Neutral balance payment programs
April 9, 2008
What does
The Future
Look Like?
April 9, 2008
Self-Limiting Scenario
100
90
80
70
60
50
40
30
Unconstrained
1st Qtr 2007 = 1.0
Realistic
20
10
0
2Q06 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10 3Q11 2Q12 1Q13 4Q13
April 9, 2008
Summary
• The capital project market is in turmoil
• Major capital projects can be financed w/
marginal projects deferred / cancelled
• Limited resource scenario is a 4-5 year
self-limiting plateau vs. bubble
• Owner, contractor and lender relationships
are changing
April 9, 2008
Thought of the Day
Intellect distinguishes between
the possible and impossible;
Reason distinguishes between sensible
and senseless.
Even the possible can be senseless.
Max Born
- AUTHOR UNKNOWN
April 9, 2008