april 9, 2008 turmoil in the contracting business a contractor’s perspective james f davis, p.e....
TRANSCRIPT
April 9, 2008
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?
85 90 95 00 05 10
1.0
15
Relative Capacity
850.0
43%10%
Creeping Demand Growth
Low Sulfur Fuels
Greenhouse Gases
Fugitive Emissions-NESHAP
Reduction of Sox and NOx
De-Bottlenecked Capacity
Un-satis
fied D
emand = New C
apacity
April 9, 2008
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
– 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
2010 = 2.9 mm bpd; $30+b CA
5.8% annually
April 9, 2008
Unexpected External Forces
Ivan $4.6 b
Rita $9.2 b
Katrina$5.8b Nebraska, January 2007
April 9, 2008
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 ExamplesGas Turbines 36 mo
Compressors 30 mo
Gasifier Vessel 26 mo
Hydrotreater Vessel 30 mo
Air Separation unit 34 mo
Ethanol Dryer 22 mo
Field-erected Tank (306ss) 30mo
ANSI 900 Pipe 22 mo
April 9, 2008
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
2004 2005 2006 2007(Feb)
Bldg. Matl. Concrete Steel Alloy Skilled labor
BASIS =2004 15.6 %
SOURCE: Nelson-Farrar survey, Oil & gas Journal, July 2, 2007, Volume 105.25, pg 65-67
CHANGES IN COST INDICES
103
%
April 9, 2008
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*
* Modified for Regional Activity
Company Project Value DateConstruction 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
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
??? = Risk = $$$
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.
April 9, 2008
Major Project Cost BreakdownCategory $ %Equipment 650 52Bulk Materials 225 19Transportation 35 3Construction Mgmnt 75 6Craft Labor 175 14Engineering 80 6
Total 1240 100Project Risk* 384 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
Conceptual -Conceptual -Preliminary Preliminary AssessmentAssessment
Feasibility -Feasibility -Detailed Detailed
AssessmentAssessment
ProcessProcessDefinitionDefinition
FEL 1 FEL 1
ProjectProjectDefinitionDefinition
FEL 2 FEL 2
FEED –FEED –ValidationValidation
FEL 3 FEL 3
EPCM-EPCM-ImplementationImplementation O & MO & M
Pre-FEED - DefinitionPre-FEED - Definition
Class V +50%/-40%
Class IV+35%/-30%
Class III+25%/-20%
Class II@30% eng.+15%/-15%
Class I@60% eng.+10%/-10%
ScopingCurve / Order of
MagnitudeBudget DefinitiveControl
Process Objectives Feedstock selectedProduct Mix setPrelim. H&M Bal. Prelim. PFDPrelim Equip ListLicensor selectionSite LayoutSpecificationsMat’l of Construct.UtilitiesPrelim. emissionsDesign Basis Memorandum.
Project Objectives H&M Bal. PFDPrelim P&IDSized Equip ListLicensor PDPEquip. LayoutElectric One-lineUtilitiesFire ProtectionFlare systemEmissionsPipe rackMajor piping runCable runsBuildingsFEED ScheduleDCS I/O CountHAZID
Project ObjectivesTechnology OptionsBusiness PlanProduct MixFeedstock OptionsCapacity OptionsSite AlternativeBlock Flow Diagram
Business Model
Project Objectives
Economic Model
General Location
1 - 2 mo. 3 – 4 mo. 7 - 9 mo. 10 - 14 mo. 30 - 40 mo.
Detailed Design ProcurementConstructionMechanical CompleteProject closeoutPunch ListTurnover
Proj. Object.* Process Design* P&ID*Equip. layout*Site Prep*Civil Design*Structural*Piping*Safety / Fire*Equip. Datasheet*DCS Spec.*HAZOP ReviewConstructability EPCM ScheduleFEL Rating
*Client approved for design
Factored
Training
Commission
Start-up
Operate
Maintain
- Major Review
April 9, 2008
• 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
Quantitative Risk Assessment*
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
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)
$40 mm
= 97% of TICRi$k
April 9, 2008
Deferred Conversion ContractsAlternative Approaches during FEED• Commitment / order of major equipment
• Order certain bulk items: pipe, steel
FEED EPC
50% eng.
Equipment
Bulk Material
Convert toFixed price
GapFunding
FixedPrice
Risk Capital
FINANCIALCLOSE
+/-15%
+/- 10%
Extend
$20mm $35mm
April 9, 2008
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
Self-Limiting Scenario
0
10
20
30
40
50
60
70
80
90
100
2Q06 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10 3Q11 2Q12 1Q13 4Q13
Unconstrained
Realistic
1st Qtr 2007 = 1.0
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