Riskcore – Calgary – March 2017.

Projects, Risks and

Contingency

AACE Chinook Dinner Meeting

Calgary, Alberta, Canada

Quotes

He who is not

courageous enough to

take risks will

accomplish nothing in

life

The biggest risk is not

taking any risk... In a

world that changing

really quickly, the only

strategy that is

guaranteed to fail is

not taking risks.

Photo by J. Zhao 2011

About Me

Capital Projects

The value of Canada’s public infrastructure projects has

reached to $157.9 billion including Site C Clean Energy

Project (British Columbia), but in Alberta alone, the total

investment reached $120 billion back in 2013. Now at

$36 billion only (2016), the recent mega capital projects

such as Suncor Fort Hill and NWR Upgrader are coming

to the end in 2017.

Enbridge Line 3 and Trans-Mountain Pipeline are the

only multi-billion dollars projects on the books.

In Alberta we never have had good track records to

deliver major projects on time and on budget

Alberta Employment 2016

40,000 full time jobs lost

World Oil Imports

Renewable Energy Coal & Fossil Fuel Nuclear

46,000 jobs

By 2020 AB

Alberta Growth

June 2013 Fcast

June 2016 Fcast

CAPP Report “crude oil forecast, markets and transportation” 2016

Pipeline 4M

Pipeline 6M

Alberta Pipeline Capacity

2016 oil less than 4M bbl/day

2030 oil less than 5.5M bbl/day

Approved for construction 2016

Approved for construction 2016

Pending NEB Approval

It is almost certain that by

2020, the pipeline capacity

will exceed the projected

oil production in Western

Canadian crude supply

Alberta Projects Trends

$7.4B $7.5B

Oilsands: small sized sustaining projects and maintenance programs

Upgraders & Refineries: sustaining and major Turnaround (TA) projects

Oil Well Services: slow & moderate drilling for operations & infill wells

Pipeline: two mega-projects requiring 30Million to 40Million man-hours

Other: infrastructure, renewable energy, mining and power projects

Solutions?

Key Issue:

Big International oil companies are leaving Alberta oil

sands, and investments are shifting out and new capitals

are not coming in to AB. Hence fewer jobs can be offered.

Solution:

1) Change government policies for competitiveness

2) Owner companies lower their compensation structure

3) EPC and GCC to reduce their fees and overheads

4) Improve skillsets and versatility for different industry

5) Temporarily relocate to places where jobs are available

6) Lower your expectations to accept lower wages / rates

7) Enhance your business acumen & go back to school

8) Build network and broadcast your know-hows & skills

Alberta Projects

Numerous past mega projects

in Alberta have experienced

significant cost overruns in past

two decades, making Alberta

one of the notorious places in

the world for mega project

FAILURES.

An Anonymous Quote

Project Failures

Imperial said Kearl’s first

development phase will cost

$12.9-billion, up from $10.9-

billion estimated previously.

The latest estimate is 61-per-

cent higher than the original

calculation of $8-billion.

Alberta – 2013

NWR sanctioned the project

based on a preliminary estimate

of $5.7 billion. While the scope

of the project has not changed,

the cost estimate has been

revised to $8.5 billion due to

cost inflation and the inability to

capture cost savings.

Alberta - 2014

Estimate and Reality

By John Hollmann - 2012

50% overrun

Cost Overrun

Dr. B. Flyvbjerg highlighted the

causes of cost overruns for

mega projects in his “Mega-

projects and risk: an anatomy of

ambition” (2013). Megaprojects

paradox indeed exists.

50%

Good and Bad Projects

65% 0f the (300) mega projects studied failed

to meet their business objectives. And there is

an unexpected distribution of success with

most project outcomes being very good or very

bad with few projects in the middle.

- Edward G Merrow (IPA)

Conclusions:

-No contracting approach guarantees success and most

contracting approaches can succeed.

-The quality of the people and the effectiveness of the

project organization is much more important.

Most Impactful Factors on Major Projects

Impact Factor Name Ranking Comments

Inadequate size, skills & experience of

project management team

94 9.2% (interface &

integration plan)

Underperforming Contractor or key

subcontractors (EPC or GC)

90 8.8% (clear scope &

contract model)

Optimism Bias 84 8.2% (complacency)

Unavailability of qualified labor force 77 7.5% (in good time)

Logistical Challenges 61 5.9% (multiple sites)

“Successful Delivery of Mega-Projects”

by Construction Industry Institute – 2015

Why did Mega Project Fail?

1. Sponsors is not to share risks and rewards with others.

2. Unrealistic schedules for engineering and construction.

3. Insufficient preparation of investment proposal & definition

4. Insufficient upfront investment planning and preparation.

5. Unrealistic budget reduction / cost estimate cuts.

6. The contractor should carry the RISK; – “Most of the time,

however, relatively little risk is actually passed but a

substantial premium is paid nonetheless.”

7. Beat up project managers for overruns

- Edward G Merrow (IPA)

Prescription for Solutions

• Construction driven by a high performance owner

organization with clear vision and defined outcomes.

• Accountability for decision-making and supporting

execution of such decisions to satisfy stakeholders

• Structured for consistency but agile for changes that

drive the integrated task force team to the success

• Plan the execution per the defined Scope of Work and

carry out by highly qualified contractors

• Encourage professionals to challenge mpossibilities,

to explore opportunities & to excel their expertise for

project success.

• Play the rules of the game during the game.

Against the Gods

The revolutionary idea that defines the boundary

between modern times and the past is the mastery of

RISK:

Risks and History

Pascal and Probability (mid 17th

Century):

-Theory became a branch of mathematics

-Rising of insurance industry (trans-ocean ships)

Modern Probability Theory (1900 and WWII):

- Debate on definitions (uncertainty vs. risk)

-Manhattan Project in 1942 (Stanislaw Ulam)

Influence Curve - Risks

Risks are inherent in all projects, the longer you wait

- the higher your risk response action costs;

- the less your risk manageability;

RISKS RFO

Is Project Risk Management useful?

PRM is useful only

when you Believe In it.

- Risks are subjective and often heuristic based;

- You must be very disciplined to apply PRM practice;

- PRM is a complex multi-disciplinary interface process;

- It is interpretive, combining sciences and some arts;

- QRA is not a mathematic calculation but simulation.

Risk in Action

The delivery of the reactor from Japan to site (exposure) will

be likely (probability) delayed (hazard) due to inability to

book production with 36 months lead time (trigger)

resulting in postponement of MC by 6 months

(consequence).

“Reactor may be late arriving to site causing MC delay”

Probability (P?) x Consequence (C?) + Manageability (?) + Vulnerability (?) = ??

Background: Kuwait Refinery booked 40+ reactors in 2007 / 2008 from

Japan for their 600,000 BBL refinery; the engineering was in FEED phase.

Risk Response Action (chosen):

4) Mitigation: A) Engineering house to accelerate FEED study

and to book reactors using preliminary design data

B) To pay Japan expediting fee and cut into queue

Unacceptable Workable

Acceptable

High Impacts

I

High Probability

R Contingency

Risk: Incomplete modules may be

shipped for offshore installation

due to lack of stringent onshore

QC resulting in increased costs.

Initial Ranking: P5 x C4 =20

Action: A dedicated QC inspector

will reside in module Fab Yard for

checking / signing off.

Monitor: Effectively lowed risk.

Residual Ranking: P2 x C4 = 8

Residual risk level is now

acceptable to project team. A cost

contingency is also included.

Residual Risk

Actio

n

P

C

Contingency

contingency is generated to cover the costs of

intangible and uncertain items that objective and

deterministic calculations may not be able to yield

any meaningful answers; and it is produced through

stochastic simulation method, which by definition is

based on subjective judgements and good senses of

heuristic factors.

Contingency Explained

- Adding contingency to an estimate does not improve estimates’

expected accuracy or change estimate classes (AACE 18R-97);

- Adding contingency to an estimate however does increase the

probability of project’s cost underrun or confidence of underrun;

- Contingency could be positive or negative amount to an estimate

though it is a rarity to take money out of the estimate / allowances;

- The contingency at chosen confidence level represents a project

team’s risk tolerance level or risk attitude; P50 represents risk

neutral position but most owner firms choose to sanction projects at

higher confidence level, e.g. >P70

- With contingency at P50 added to an estimate, the final actual cost

should fall within the expected accuracy range for the class of the

estimate IF the quantitative risk analysis is rigorously performed.

Escalation Defined

Different from CPI (commodity Price Index) driven inflation, which

is defined as “a persistent rise in the prices associated with a

basket of goods and services that is not offset by increased

productivity”, the escalation refers to “a persistent rise in the

price of specific commodities, goods, or services due to a

combination of inflation, supply/demand, and other effects such

as environmental and engineering changes.

Project contingency is technically subject to escalation. The cash-

flow projection of contingency's use should follow the draw-down

plan, not the overall project cash-flow curve.

And the escalation however is NOT subject to the contingency

AACE RP 58R-10; 68R-11

Escalation

Cost Escalation in the construction market is real. Project

owners need to become more flexible and more willing to

work with contractors to absorb some of the risk of the

rapidly fluctuation construction materials markets, and

project teams must become more collaborative and more

able to deal with risk and changes quickly and effectively.

Escalation, therefore, comes from the interplay of

changes, real or anticipated, in input costs,

perceptions of risk, and perceptions of the

competition.. More often than not, however, it comes

from the formation of market opinions, which may or

may not have a basis in fact.

CSC.06.2 AACEi 2006

Contingency Basis

• Certainty: Facts are known to decision makers

- mathematical calculation

- management decision

• Risk: Only partial facts are known

- decision tree or risk based KT

- simulation technique (Monte Carlo)

• Uncertainty: Little or no facts are available

- regretting Table

- utility theory / delay decision-making

Estimate as Basis for Contingency

Dr. B. Flyvbjerg

If a cost estimate is questionable and deceptive, the estimated

Total Installed Cost (TIC) will not be reliable REGARDLESS of

rigorous quantitative risk analysis process and contingency.

Estimate Elements

Specific Risks - Range Estimate

P10 (the best case)

Compared to the base estimate ($1M),

there is 10% chance that only $0.85M

will be spent (15% less than budget);

P90 (the worst case)

Compared to the base estimate ($1M),

there is 90% confidence that the

budget will not exceed $1.4M (40%

over-run);

P? (the most likely case)

The base estimate, that professional

cost estimators think, will be most

likely to achieve (including

contingency).

Base

Estimate

P10 P90

Cost

Probability

$1M

$1.4M $0.85M

Systemic Risks - Risk Register

Using discrete distribution, simulated sum of independent

risks will yield an aggregated project contingency.

- Systemic risks are

identified in the

project register

- Probabilities are

ranked in numbers

- Mitigation costs

are quantified

- Risks are generic

and systemic in

nature having

impact the whole

project.

Monte Carlo Demystified

A - Identifying Risks or Variables

B - Assigning Probability Ranges for the “variables”

C - Conducting Monte Carlo random simulation

D - Determine “Contingency Amount” at selected risk tolerance level (P70)

Risk Practice in Tendering

Project team prepared the base tender estimate of $187.5M

After risk analysis, it is decided to add contingency to cover the risks

Do they add $19.9M for P50 or $23.4M for P80?

The Schedule Risk Analysis

Procedural Steps of SRA

For Capital Projects

Output of SRA

Probability vs. finish date

Tools: Primavera Risk Analysis (PertMaster), Polaris, Acumen, Safran, etc.

Riscor Modelling

Riscor Quantification.

Quantifying the probabilities of a project or an overall program

schedule delays would provide the Leadership with an assurance

and planning for necessary risk mitigation actions.

Critical risk drivers would be identified through the QRA process

to offer the most effective risk mitigation strategy; appropriate

contingency and escalation amounts simulated for risk profiles.

Management Reserve

John Zhao Palisade Conference Calgary 2015 presentation

Projects, Risks and Contingency

- Capital projects all aim to complete on time, under

budget and to meet project business requirements.

- But all projects have inherent risks; understanding

and managing these risks successfully are the PM’s

primary responsibility.

- We often accept the project risks or the residual

risks, it would be one of the risk response strategies

as long as we have contingency (funds and plans) in

place.

Project Risk Analysis