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.
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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.
$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.
• 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.