Discussing the causes and schedule of megaproject overruns, the consequences and what strategies can be used to combat these issues.
Posted by Geoscience Adm… on Wed, 03/27/2019 - 12:56

Article by Adam Becis, Principal Reservoir Engineer

Megaprojects are defined by their size and scale, often classified as such if project development cost is over US$1 billion. The immense complexity of large-scale petroleum projects results in hundreds of staff being involved in the planning, designing and financing stages, whilst construction can require a workforce into the thousands.  Historically, they have also often been characterized by their propensity to overrun budgets and suffer schedule delays.

Over the last decade such projects have been big news. The low oil price environment since the 2014 price crash appeared to have tempered the industry’s enthusiasm for these high cost developments. However, with prices now becoming stable, it’s likely we’ll see more of these types of projects in the coming years. In 2014 Ernst and Young estimated that 64% of oil and gas megaprojects were facing cost overruns. A prime example is the 46% increase in capital expenditure for Chevron’s Gorgon LNG project since commencement, equivalent to US$17 billion. It is rare to hear of a megaproject being lauded as on schedule and under-budget.

In this article we will discuss the causes of budget and schedule overruns, try to understand the subsequent consequences and then assess methods and strategies to combat the issues.

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Causes

  • Ambiguous Objectives and Milestones

It can be difficult to reach targets that are ill-defined or unclear. If tasks or their resultant outcomes are not properly defined, then appropriate resources cannot be assigned. This also holds for the delegation of responsibility for different project roles. Uncertainty in what needs to be done causes confusion in staff responsibility, results in vague timelines and can result in a blurred critical path.

  • Poor Scheduling and Forecasting

When allotting task time or budgeting costs, the precision and accuracy of estimates is often poor. Estimation requires a solid understanding of the project phase and task, as well as the resource inputs required for execution. Without this understanding, both costs and timing of a project may be different to the best estimate, and even outside the predicted outcome range.

  • Environmental Changes

There are a range of environmental factors that can affect a megaproject. These can apply on a local or national level, or extend to a regional or global scale. Additionally natural phenomena including volcanoes, earthquakes, tsunamis and climate change can alter project conditions. Changes in the environment often cannot be avoided but their effects may be mitigated.

  • Lack of Skills & Expertise

Lack of aptitude in personnel can be a problem across a project workforce. Senior managers may lack the skills to manage the scale and complexity of the project, whilst labourers may not have the requisite skills or experience to operate equipment or fabricate project-specific plant. Unqualified or unsuitable employees in any role require training or replacement, which can increase costs or cause delays. This can be accentuated in megaprojects due to their complexity and wide scope, exacerbated during periods of high oil prices when a large number of megaprojects stretch the global energy workforce.

  • Vendors & Contractors

Companies typically rely on vendors or contractors to carry out a wide range of planning, design and construction work on many projects, which can be amplified on megaprojects. These contractors bid for contracts to supply expertise, resources and manpower to a project. Tender bids may be unrealistic as service and supply firms seek to win market-share from their rivals. Unrealistic contract tender bids, different work cultures, multiple levels of contractors and sub-contractors, and misaligned incentives and objectives are some of the issues an operating company may face.

  • Poor Implementation

Poor execution of a project can also be the result of poor project management or control. This may include a lack of monitoring of the project with the required diligence to ensure tasks are completed on time and to the necessary standards, especially when vendors or contractors perform a large proportion of the project. Particular focus should be placed upon Health, Safety & Environmental (HSE) standards, not just project quality and schedule requirements. Finally, undertaking changes in project scope or detail “on the fly” can result in additional time and cost being assigned to a project.

  • Partner/Investor Differences

Megaprojects often have myriad investment partners, who provide the scale of funds required, and to diversify risk. For example, the PNG LNG project in Papua New Guinea has seven joint venture participants. However, with these benefits comes the complication of satisfying a variety of partners who may have different expectations and motivations for the project. These differences may often escalate into substantial disagreements leading to approvals or funds being withheld until resolution. Development of the giant Kashagan oil field in the Caspian Sea is one such project plagued by partner disagreements.

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Consequences

There are a number of negative outcomes that can result from the issues described above:

  • Health, Safety and Environment

There is a danger that personnel can be hurt or even killed during development or operation of a megaproject. Serious injury  has a truly devastating impact, not just for the individual, but also to their friends, colleagues and family HSE and the impact to personnel, community and the environment should be at the forefront for any project, not just megaprojects. Irrespective of this, there is obviously a direct, negative flow-on from HSE issues to project cost and timing.

  • Reduced Net Present Value (NPV)

Delays in project execution and cost overruns negatively impact the project economics, delaying the revenue stream and reducing the net present value of the project. The opportunity cost of this delay will similarly reduce project NPV. Significant reductions in NPV can threaten project viability, and negative NPV can lead to management deferring or cancelling a project.

  • Higher Cost of Borrowing

Poor megaproject outcomes can have additional financial repercussions. The perceived financial risk of large scale projects due to poor development management can make financial institutions wary of lending funds. To alleviate the risk, financial lenders require increased compensation in the form of a higher interest rate when financing the company’s future projects. This will subsequently increase interest payments and reduce company profits on these projects.

  • Government Dissatisfaction

Many governments rely on resource income in the form of royalties or taxes from projects within their borders. This income becomes especially significant if the size and scale classifies a development as a megaproject. For example, ExxonMobil has stated that its PNG LNG project has contributed US$4.3 billion to the government and local businesses. A delay in project commencement may lead to increased governmental pressure, or in extreme cases negatively amending the fiscal terms of the project. An example was the dispute between the Kazahkstan government and the Kashagan project partners over the stake for state-owned JSC NC KazMunaiGaz.

  • Company Reputation

A poor record in megaproject development obviously leads to reputational damage, causing hesitation by potential partners and host governments when bidding or partnering for future opportunities.

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Megaproject Strategies

So what have we learned from the last decade of assisting with megaprojects?

  • Clearly Define Objectives

Project targets need to be unambiguous and well defined. Even small project steps need to be divided into segments with multiple, achievable objectives. This will enable more accurate estimation of project timing including clear definition of the critical path, and, with effective communication of these objectives, lead to better execution. Additionally, allocation of both staff and other resources will be made easier.

  • Improve Forecasting

When estimating costs and schedules, a realistic range should be placed on possible schedule and cost outcomes around a best estimate for each, using statistical methods if required. Senior management often put in place aggressive targets for costs and schedules, but care should be taken to balance aspirational targets against likely realistic outcomes.

  • Experienced & Skilled Managers

A consistent theme across all recent coverage of large scale project management is the importance of experienced and skilled managers. Talented managers are able to work with schedulers in the planning phase to determine appropriate timelines and budgets, then manage project complexities and cope with issues that arise during implementation and commissioning. Communication skills are also crucial, not only ensure coordination within the project, but to manage information to external stakeholders.

  • Risk Management & Scenario Planning

In the planning stage the project team should identify all possible outcomes for each project phase and attach a probability to each scenario. These should include planning for environmental changes that are beyond the control of the project or company. Subsequent plans of action for each outcome should be developed prior to project implementation. This will assist in the identification of further preventative measures and ensure plans are in place to address problems as they arise to mitigate the risk of cost increases or time delays, and enable staff to react quickly to problems.

  • Communication

Vertical and horizontal communication within a project organizational structure is crucial. Regular meetings and informational updates allow the different inter-project teams as well as senior management to track progress and integrate different segments of the project. It also allows any issues or opportunities to be shared across the various project segments. Just as crucial is communication to partners, investors and government ensuring they are aware of and understand the key challenges and issues.

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  • Contractor/Vendor Management

A critical part of forecasting is to ascertain if tender bids are realistic from contractors and vendors, to ensure their capability of fulfilling supply of service or resource within the specified time frame and cost. Additionally, once a contract is signed, there must be alignment of the operator, contractor and sub-contractor objectives to project goals. Limiting the layers of subcontractors below major contractors can also reduce the possibility of goal misalignment. Integrating contractor/vendor personnel into operating company project teams will assist in alignment of work cultures, which is crucial for ensuring high levels of performance, especially for HSE.

  • On-Site vs Modular Construction

Due to the size and scale of megaproject plant and equipment, modular construction off-site should be evaluated as opposed to full construction on location. Petroleum megaprojects locations are often in undeveloped areas and geographically isolated, hence constructing large sections of plant offsite and integrating onsite may lower cost and reduce construction time. An example is the North West Shelf Joint Venture Train 5 LNG project which was constructed in Indonesia then transported to and fabricated in north-western Australia. There are some key considerations to modular construction including reduced construction investment in the home nation, weather transportation windows for large plant sections, supply chain logistics, modular fabrication capability and modular transportation costs.

  • Lessons Learned

Large organisations are involved in multiple developments and a key challenge is to transfer knowledge and best-practices from one development to the next. Documentation of both project issues and successes is vital, as well as an open and learning culture in both operator and contractor staff bases.

With oil prices stabilising, the age of the megaproject may arrive again. By identifying the propensity for problems, assessing repercussions, then applying the strategies outlined above, a company can enhance the probability of fulfilling a megaproject on budget and on schedule.

 

References

  1. Milne, P. (2017) ‘Do your homework: Chevron’s outgoing chief John Watson learns from Gorgon mistakes’, The West Australian, 30th October 2017, [Online], Available: https://thewest.com.au/business/oil-gas/do-your-homework-chevrons-outgoing-chief-john-watson-learns-from-gorgon-mistakes-ng-b88643593z
  2. ESSO Highlands (2019) Co-Venturers, [Online], Available: https://pnglng.com/About/Co-venturers
  3. Soldatkin, V. & Gordeyeva, M. (2013) ‘World’s costliest oil field arrives, but Kazakh dreams shrivel’, Reuters, 11th September, [Online], Available: http://uk.reuters.com/article/2013/09/11/kashagan-idUKL5N0H63VM20130911
  4. Murtaugh, D. & Clark, A. (2018) ‘Pacific Islanders want a bigger slice of Exxon’s gas profits’, Bloomberg, 23rd May, [Online], Available: https://www.bloomberg.com/news/articles/2018-05-22/exxon-won-first-round-of-island-gas-prize-now-locals-want-more
  5. Smith, C. & Bowtell, G. (2007) ‘The First Modularisation of an LNG Plant: North West Shelf Venture Karratha Gas Plant Phase V Expansion Project’, [Online], Available: http://www.ivt.ntnu.no/ept/fag/tep4215/innhold/LNG%20Conferences/2007/fscommand/PO_26_Smith_s.pdf