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Turmoil in the Contracting Business A Contractor’s Perspective

Turmoil in the Contracting Business A Contractor’s Perspective. James F Davis, P.E. SNC-Lavalin Houston.

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Turmoil in the Contracting Business A Contractor’s Perspective

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  1. Turmoil in the Contracting BusinessA 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.

  2. 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?

  3. 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

  4. 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.

  5. 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.

  6. What Happened? Relative Capacity Reduction of Sox and NOx Fugitive Emissions-NESHAP Low Sulfur Fuels Un-satisfied Demand = New Capacity Greenhouse Gases Creeping Demand Growth De-Bottlenecked Capacity 10% 43% 1.0 85 0.0 85 90 95 00 05 10 15

  7. 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

  8. Ivan $4.6 b Rita $9.2 b Katrina $5.8b Unexpected External Forces Nebraska, January 2007

  9. 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

  10. Schedule Examples Gas 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

  11. CHANGES IN COST INDICES 103 % BASIS = 2004 15.6 % SOURCE: Nelson-Farrar survey, Oil & gas Journal, July 2, 2007, Volume 105.25, pg 65-67

  12. 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.

  13. Gulf Coast Project Activity* $1b over 24 months = 3.0 mm work hours = 850 peak; 700 avg. * Modified for Regional Activity

  14. 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.

  15. 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. ??? = Risk = $$$

  16. Major Project Cost Breakdown Category$% Equipment 650 52 Bulk Materials 225 19 Transportation 35 3 Construction Mgmnt 75 6 Craft Labor 175 14 Engineering 80 6 Total 1240 100 Project Risk* 384 31 * Contingency, escalation, growth, risk fee - from historical project experience

  17. 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

  18. Owner’s Biggest Mistakes • Owner does not understand the complexity of the project and that it is a “custom” design. • Owner wants a Class I estimate for the price and in the time frame of a Class II estimate. • Owner does not allocate sufficient funding to do the proper extended FEED. 4. Owner underestimates the permitting challenges.

  19. - Major Review Pre-FEED - Definition Conceptual -Preliminary Assessment Feasibility -Detailed Assessment Process Definition FEL 1 Project Definition FEL 2 FEED –Validation FEL 3 EPCM-Implementation O & M Class V +50%/-40% Class IV +35%/-30% Class III +25%/-20% Class II@30% eng. +15%/-15% Class I@60% eng. +10%/-10% Curve / Order of Magnitude Scoping Factored Budget Control Definitive • Project Objectives • Technology Options • Business Plan • Product Mix • Feedstock Options • Capacity Options • Site Alternative • Block Flow Diagram Proj. Object.* Process Design* P&ID* Equip. layout* Site Prep* Civil Design* Structural* Piping* Safety / Fire* Equip. Datasheet* DCS Spec.* HAZOP Review Constructability EPCM Schedule FEL Rating *Client approved for design Detailed Design Procurement Construction Mechanical Complete Project closeout Punch List Turnover • Business Model • Project Objectives • Economic Model • General Location Process Objectives Feedstock selected Product Mix set Prelim. H&M Bal. Prelim. PFD Prelim Equip List Licensor selection Site Layout Specifications Mat’l of Construct. Utilities Prelim. emissions Design Basis Memorandum. Project Objectives H&M Bal. PFD Prelim P&ID Sized Equip List Licensor PDP Equip. Layout Electric One-line Utilities Fire Protection Flare system Emissions Pipe rack Major piping run Cable runs Buildings FEED Schedule DCS I/O Count HAZID Training Commission Start-up Operate Maintain 1 - 2 mo. 3 – 4 mo. 7 - 9 mo. 10 - 14 mo. 30 - 40 mo.

  20. Quantitative Risk Assessment* • 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

  21. Ri$k 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 TIC

  22. 50% eng. $20mm $35mm FEED EPC Equipment Bulk Material Gap Funding Deferred Conversion Contracts Alternative Approaches during FEED • Commitment / order of major equipment • Order certain bulk items: pipe, steel Fixed Price Convert to Fixed price +/-15% Extend FINANCIAL CLOSE +/- 10% Risk Capital

  23. 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

  24. 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

  25. What does The Future Look Like?

  26. Self-Limiting Scenario Unconstrained 1st Qtr 2007 = 1.0 Realistic

  27. 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

  28. Thought of the Day Intellect distinguishes between the possible and impossible; Reason distinguishes between sensible and senseless. Even the possible can be senseless. Max Born - AUTHOR UNKNOWN

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