Managing high-cost projects

Opportunities abound in large-scale, capital-intensive projects, but company executives must be alert to risks associated with market and economic factors, as well as an array of situations that could increase costs and drag down rewards.

Sam Youdal and Jason Brown, Ernst & Young LLP, Houston

With average oil prices upward of US$100 per barrel and with improved technology, the oil and gas industry continues to move deeper into emerging assets, including unconventional resources such as tight gas sands, gas shales, coalbed methane, and oil sands. Over the next few years, significant exploration and production (E&P) spending increases are expected, with the Big Six (BP, Chevron, ExxonMobil, Royal Dutch Shell, Total, and ConocoPhillips) projected to increase international spending by an average of 18%, an impressive increase following a year in which spending for the group was virtually unchanged from previous-year levels.

Barclays Capital's report, Original E&P Spending Survey, forecasts that worldwide E&P spending budgets will rise by 11% in 2011 to US$490 billion, up from 2010 budgets of US$442 billion.

Recovering the reserves from these assets will require high levels of transparency and investment. With new developments come new risks, and ramping-up projects on the scale necessary to commercialize new reserves often requires a delicate balance of multibillion-dollar capital expenditures and multi-party governance. The combination of leading-edge technology, new geographies, high capital outlays, and the complexities of governance means that these projects require high levels of assurance, particularly in the areas of cost, timeline, and risk management.

Common project pitfalls

The requirements to manage large capital projects, together with today's market and economic factors, are giving rise to a range of opportunities that affect short- and long-term project performance. This in turn begs the question: Why do so many companies tend to overlook the impact of capital project lifecycle management? Why not plan your projects with the expectation that you will encounter certain risks and pitfalls along the way? Indeed, knowing what and where those pitfalls lie and factoring them into strategic project management is a first step to avoiding them.

The current uncertain economic situation demands a more systematic and pragmatic risk management approach that makes project owners and stakeholders keenly aware of the pitfalls up front. Following are some of the most common pitfalls that arise in the planning and execution of major capital projects:

• Finance and credit risk: Unconventional energy resources are more expensive to produce than conventional resources. A risk strategy not prepared for cost volatility and credit risks in a fragile, recovering economy will not necessarily be supported for success.
• Schedule delays: Failure to implement appropriate schedule management and time-tracking tools could lead to significant delays and an inability to identify at-risk activities and their impacts, areas of uncertainty, insufficient assumptions or potentially deficient scheduling methodologies.
• Ineffective cost management and lack of financial transparency: Cost containment cannot be understated, especially as material and service costs are on the rise. Costs continue to be the biggest factor in oil sands production. In addition, ineffective contract administration and monitoring of contracts cause a lack of visibility that complicates cost planning for reporting and budgeting.
• Inertia and a lack of urgency: When a project becomes a process, it can be problematic. Momentum can be lost if the cumulative impact of not hitting critical project milestones (regulatory, financial, operational, contractual, and long-lead equipment) is not adequately addressed and if management accepts a fatalistic attitude about future impacts.
• Unclear definition of roles and responsibilities: One of the big pitfalls of a joint venture is unclear governance, often leading to unacceptable risks. The cause is typically attributable to a combination of failing to assess the risks thoroughly, clearly defining and communicating all roles and responsibilities for parties involved, and building healthy contract and governance structures.
• Operational impact: Operating and maintenance strategies are rarely planned at the design phase and built into the ongoing project management strategy. Once the project team has executed the handoff, the maintenance and support organizations may find that the policy and procedural foundation is missing, the right people are not in place or are unfamiliar with systems in place.
• New operational challenges: Companies' increased focus on development in the unconventional areas means more projects in challenging environments, requiring a new generation of technical and operational solutions as well as different training and support for personnel in the field. The costs and physical dangers far exceed previous levels and add to the owners' risk, with little or no assurance that prices will continue to justify heavy investments in these areas.

Consequences of risk

The oil and gas industry would not exist if not for risk-takers. One key to separating success from failure is having a clear definition of what constitutes "acceptable risk" for a project, then avoiding or mitigating the risk that remains. Being caught in the common pitfalls or failing to address risk in a way that is proactive, realistic and transparent can lead to consequences that span the spectrum from mere inconvenience to grave danger. Following are some of the consequences, many of which are avoidable and all of which are manageable with proper planning and forethought.

• Regulatory noncompliance: Failure to develop appropriate project controls could result in non-compliance with government, legal and other regulatory bodies. Similarly, failure to properly track and adequately forecast costs could result in misstated financial statements or inadequate disclosures filed with the Securities and Exchange Commission (SEC).
• Damage to reputation: An unexpected event that leads to environmental concerns is a key focus area for governments and the public in general, and can lead to loss of profitability and reputational damage. Prominent oil spills are a good example.
• Loss of competitive advantage: Companies must continue to adopt new technologies to mitigate the risk of losing their competitive advantage. This calls for a strategic commitment to research and development. Companies that operate as "technologically agnostic" are better able to maintain flexibility and allow alignment with leading practices evolving in oil and gas and other industries.
• Claims and disputes: Undertaking a comprehensive assessment of contract claims risk requires recognizing the interdependencies of the contracts, people, processes and technology across the program. Owners should assess the risk associated with contractor and subcontractor claims and develop an "owner's team" methodology to mitigate, defend and manage claims as a project develops.

The right information at the right time can turn a risk into an opportunity when the owners properly allocate between themselves and their vendors not only financial risk but also the risks associated with quality, safety, control, and reputation.

Considerations for successful capital projects

Given the range of disparate factors that comprise the oil and gas landscape and the challenges and pitfalls inherent in capital projects, is it possible to develop an integrated project team approach that can help these projects succeed? The short answer is yes, as long as the framework of the deal and the framework for project management are part of the process from the beginning. The enemies of a successful project can be costly: excessive unplanned downtime, lack of project controls, missed milestones and overall operational underperformance. If a capital project is to survive it must be grounded in an integrated process with critical success factors built into the DNA of the project management plan.

Since the beginning of the upturn, oil and gas companies have demonstrated an increased focus on the entire lifecycle of a project, including a deeper commitment to beginning the planning process earlier and holding the quality of the execution to a higher standard relative to cost, schedule and execution. These are some of the capabilities that, when executed well, can prove to be game changers on large capital projects:

Project management: Make sure the plan is designed to be focused on and integrates safety, costs and scheduling. All project parties should be represented and on board at the outset. The plan should be fluid, including processes for evaluating progress to enable informed decisions about next steps to help minimize rework on front-end engineering and design, improving cycle time and to see the project through to hand off.

Cost reduction: Look for cost reduction opportunities, along with opportunities to reduce planning budgets, engineering hours and cycle time, at every stage of the lifecycle. Emphasis should be placed on budget control, approved corporate budget changes and internal budget transfers.

• Safety: Safety risks evolve throughout the capital project life cycle, so those risks must be considered at each stage of development. Management must make decisions that allow for the safe construction of the project as well as its safe operation. Equipment or control failure could impact personal safety as well as hinder the operations of a facility. An approach to safety on all fronts needs to be an integral and proactive component of ongoing project management, not just an emergency response.
• Supplier performance: An improved approach to risk and exposure on costs and delivery and improved management of stakeholders and suppliers can help optimize third-party performance and keep relationships with stakeholders on an even keel.
• Handover management: To avoid the impact of poor handover management, operating teams must be mobilized at the right time and given ample opportunity to work with the project team at appropriate stages in the project lifecycle. Likewise, equipment needs to be easily serviceable and standardized wherever possible, with bills of materials, and operating and maintenance instructions accurately captured and readily accessible.
• Regional execution: Integrated oil companies and national oil companies are increasingly investing in new projects through joint venture arrangements, with the national oil companies offering more concession agreements to the integrated oil companies for the rights to their reserves. These agreements are excellent candidates for comprehensive risk reviews.
• Total cost of ownership: The total cost of ownership (TCO) for a capital project includes the total of all costs to design, purchase, construct and operate, as well as the price the client paid the supplier. In order to truly transform a procurement strategy, an understanding of the major contributing elements of TCO is essential.
• Governance, controls, policies and procedures: Processes and procedures must be proactively enforced by monitoring, detecting, preventing and reporting actions that risk the confidentiality, integrity and availability of project information. Systems must be designed to identify and manage current risks and evaluate current performance, including the appropriate use of resources.
• Operating model design: Many different internal and external factors drive businesses to undertake organization redesign. The impact of their decisions can be both positive and lead to outstanding growth, or negative and lead to a further need to restructure. There is no single solution when designing an organization; a "fit for purpose" solution is required in every instance.

Conclusion

With the increase in significant investment in emerging assets and unconventional resources, oil and gas companies need to plan carefully, establish a good foundation for capital projects management, and be prepared to adapt to industry and economic changes quickly. Successful companies will apply lessons from the global financial crisis and operate more efficiently than ever before.

By being aware of the project pitfalls and considering characteristics of successful capital projects, operators investing in unconventional projects and technologies will be better prepared to deal with the likely return of rising costs, lack of available labor, and the project delays and budget overruns that were prevalent leading up to the financial crisis. This awareness will pave the path for global growth in unconventional development.

NOTE: The views expressed in this article are those of the authors and do not reflect the views of Ernst & Young LLP or any other member of Ernst & Young Global Limited.

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