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The Capital Projects World in 2009 Let’s Use the Lull Wisely Business Presented to the Houston Roundtable January, 2010

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The Capital Projects World in 2009 Let’s Use the Lull Wisely Business Presented to the Houston Roundtable January, 2010. Ed Merrow. Questions to Ponder. Where have we been? What have we learned? Where do we go from here?. A Look at Where We Have Been.

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The Capital Projects World in 2009

Let’s Use the Lull Wisely

Business Presented to the Houston Roundtable January, 2010

Ed Merrow

questions to ponder
Questions to Ponder
  • Where have we been?
  • What have we learned?
  • Where do we go from here?
a look at where we have been
A Look at Where We Have Been
  • The 5 years ending in the 2nd Quarter of 2009 were the largest binge of capital spending in the collective process industries in history
  • Having finally adjusted to the feast, we are now asked to adjust to the famine
  • Capital excellence suffered some substantial damage in the boom, but we held our own as a community
  • Timely adjustment to the bust will be even more important because many of the core problems remain
the damage done in the boom
The Damage Done in the Boom
  • The hyperinflation in capital projects represents a huge loss of productivity because escalation in projects far outpaced general inflation
  • Projects executed in overheated labor-short environments suffered grievous harm more often
  • Generally, the larger the project, the more severely it was hurt by poor practices
  • The key problem was poor control
    • Inadequate owner cost estimating skills
    • Poor field controls
    • Weak construction management
  • The contracting industry is still a mess
practices have suffered
Practices Have Suffered
  • After years of steady improvement, some of the key leading indicators of performance have stagnated or even turned down
    • Front-End Loading (FEL)
    • Use of the Value Improving Practices (VIPs)
  • Controls is the only area showing any real improvement, and that was from a very poor base
the progress made in the boom
The Progress Made in the Boom
  • We got their attention!
    • The severe shortages of in-house engineering and project management competencies was a great shock to most businesses
    • Not everything could be done when they wanted it
    • Out of control projects made the weaknesses in the project systems painfully obvious in most cases
  • We were able to build some competencies in some cases
    • The virtues of owner estimating became apparent
    • The need for planner/schedulers and controls personnel became palatable again
the progress we didn t make in the boom
The Progress We Didn’t Make in the Boom
  • We only barely started to address the demographic mess created over the last 20 years
  • Although we got permission to hire—and that did help—we were not always able to hire well
  • And we did woefully little orientation, training, and skills development amongst those we did hire
  • Not much innovation occurred in the projects world, nor I do expect a great deal in the next few years
  • While I believe the integration between business and projects improved, it has a long way to go before it becomes healthy
  • Owner/contractor relationships improved not at all
questions to ponder8
Questions to Ponder
  • Where have we been?
  • What have we learned?
  • Where do we go from here?
what learnings accrue from the boom
What Learnings Accrue From the Boom?
  • Most companies—never all—learned:
    • We really are in the project management business
    • We really are in the engineering business
    • What owner people do really is notthe same as what contractor people do
  • We learned that regaining lost competencies is discouragingly difficult
  • In some cases, businesses learned that a runaway projects environment can be a business killer
  • We learned that contractors are faster adapters to market realities than owners
questions to ponder10
Questions to Ponder
  • Where have we been?
  • What have we learned?
  • Where do we go from here?
get recalibrated to the market quickly
Get Recalibrated to the Market Quickly
  • Even though we are beginning the worst global slump since the 1930s, project input prices will not likely collapse, at least in the short term
  • Each set of inputs markets needs to be examined separately:
    • Engineered equipment
    • Bulk materials
    • Craft labor
    • Contractor engineering and project management services
engineered equipment
Engineered Equipment
  • Equipment vendors raised prices sharply over past 5 years
  • But they did not increase capacity very much, and very few new players were added
  • Rather, vendors added work shifts; in some cases worked 24/7 to exploit the boom
  • Vendors are cutting shifts and overtime rather than prices
  • The equipment market actually peaked in December 2007 for longest lead-time items
  • Prices will only come down significantly if recession is long and deep (as is widely expected)
  • When equipment prices fall, they are likely to fall like a stone
  • Early lock-in of equipment is probably a very bad idea now
major equipment escalation mechanical equipment

Major Equipment EscalationMechanical Equipment

Global Trend from January 2003

(Jan. 2003 = 1.00)

Equipment data primarily include mechanical equipment (Examples: compressors, fans, blowers, and pumps).

Cost escalation trends are displayed in US dollars.

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major equipment escalation typical project mix of equipment

Major Equipment EscalationTypical Project Mix of Equipment

Global Trend from January 2003

(Jan. 2003 = 1.00)

Equipment data include a diverse mix of fabricated and mechanical equipment with some E&I.

Cost escalation trends are displayed in US dollars.

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bulk material prices will fall faster
Bulk Material Prices Will Fall Faster
  • Simple bulks, such as concrete and carbon steel, will be first to fall
  • Materials with more engineering and labor, such as fabricated pipes and standard valves, have stabilized and will fall in coming months as current demand works through
  • High-alloy materials costs will stay up longer but will very likely fall by mid-year in most cases
bulk materials escalation mix of trades

Bulk Materials EscalationMix of Trades

Global Trend from January 2003

(Jan. 2003 = 1.00)

Bulk Materials data include 50 percent piping and steel and 50 percent measurement instruments(Examples: metal valves, wiring devices, concrete, and insulation materials).

Cost escalation trends are displayed in US dollars.

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IPA Process Plant Escalation IndexEscalation Comparison

Global Trend from January 2003

(Jan. 2003 = 1.00)

Data are a composite escalation index for various types of projects.

Cost escalation trends are displayed in US dollars.

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construction labor cost and productivity
Construction Labor Cost and Productivity
  • Effective labor rates will only fall appreciably in the former hot spots
  • Effective labor rates are coming down now as overtime, traveler allowances, and other adders are being removed
  • The most serious problem with labor costs, however, has been erosion of labor productivity caused by poor owner and contractor management
  • The productivity problem is not guaranteed to disappear completely as the market cools—big opportunities here for the smart owner
slide19
Labor Escalation Comparison

Global Trend from January 2003

(Jan. 2003 = 1.00)

Cost escalation trends are displayed in local currency.

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engineering project services are the big unknown
Engineering/Project Services Are the Big Unknown
  • Cost of global engineering services is up sharply since 2003
  • Contractor fees are much higher on reimbursable work, and risk premiums are much higher on hard money work
  • Engineering productivity has declined sharply in the past 2 years in most parts of the world after a very long period of improving productivity
engineering and project services
Engineering and Project Services
  • Contractor capacity has not increased, and the demographics are very poor in OECD* even for sustaining current capacity
  • Contractor market remains consolidated and will consolidate further in the downturn
  • Medium and small projects will see relief the fastest; that market is inherently more competitive; we noted the softening in this market at IBC 2008
  • Very large projects may never see a large downturn in engineering costs unless the recession is dreadful

*Organisation for Economic Cooperation and Development

slide22
Engineering Price Index

Global Trend from January 2003

(Jan. 2003 = 1.00)

Cost escalation trends are displayed in US dollars.

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restore lost productivity
Restore Lost Productivity
  • Get the conservatism, the escalation, and the hidden contingency out of estimates immediately
  • Once again become very cost conscious, remembering that the best and only durable means of cost-savings are sound practices
  • Schedule is generally much less important today than 6 months ago—even for turnarounds!
  • We need to monitor and supervise contractors more closely now than even in the boom, as the need and desire to crank hours will increase again
  • We need to reevaluate contracting strategies without simply reverting to the bad old days of abusing the contractors
  • Contractor claims will again be very important; keep improving controls and construction management
  • Sadly, plan for further cuts by improving project portfolio management both at the center and the plants
build capability in the downturn
Build Capability in the Downturn
  • Over the past 5 years, hiring competent project people has been extremely difficult
  • The downturn will inevitably put some very competent people in the job market; it already has
  • If you have skill areas that need bolstering, smart companies will seize staffing opportunities during this time
  • Highly skilled professionals will be leaving at a rapid rate to retirement over the next few years

Time is of the essence

use the time to train and educate
Use the Time to Train and Educate
  • Now is the time to bring the staff hired over the past 5 years fully into your organizations
  • Training on the contracting process and environment is essential and it is essential that it happen quickly
  • Finally, educate your businesses once again around basics:
    • What is the role of the gated process in the governance of capital?
    • Why is the FEL 2 gate (end of Scope Development) so important?
    • How can we improve the business/engineering interface?
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