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Managing project costs - by keeping on top of data

Thursday, October 2, 2014

We have all heard that the oil and gas industry often sees costs escalate on major projects - the answer could be better tools to keep track of the reasons costs rise, writes 8over8's Clare Colhoun

The largest capital projects are increasingly complex and unpredictable.

Projects have more stakeholders, more investors, and are typically in frontier areas of the world with national government involvement.

The result is major projects today that are fraught with risk and change, due to significant growth in communications traffic laden with instructions, authorisations and vital content for decision- making. Even the best design team that produces the front-end engineering design (FEED) would never foresee and conceive of 100 per cent of what is required to deliver the project, so contractors will always instigate change orders.

The change orders and variation requests made in communications from contractors take time to filter through to the financial teams and treasuries of owner operators.

These can fester and grow to significant levels overtime, and ultimately result in costly claims later on in projects, when it is harder to establish the origin and validity of the changes.

The industry's record of managing cost overruns has something to be desired. For example, Schlumberger reports that 35 per cent of capital projects budgeted at over $5bn will blow out by more than 50 per cent.

The average project size in the oil and gas industry currently stands at about $1.9bn and continues to rise as more 'super-sized' mega projects come online. There are also several oil and gas projects valued at over $30bn that have suffered significant delays and cost overruns, an example being the $50bn Kashagan oilfield development in Kazakhstan, which is estimated to hit $1.5bn in cost overruns.

Unplanned cost overruns and poor cost recovery not only impact directly on the owner operator's financial performance, they place shareholder value at risk.

With large capital projects in the oil and gas sector increasingly characterised by several venture partners sharing both risk and return, the contracts that underpin them have many interdependencies.

Clear rules of engagement must be defined in advance, both amongst the venture partners and between the venture and its contractors.

Successful contract execution in ground- breaking floating LNG (FLNG) projects, such as Shell's Prelude for example, involves developing a suite of project contracts across the FLNG value chain that creates an effective alignment of interests among each of the relevant project parties, whilst eliminating or mitigating risk.

Open channels
Many interdependencies also mean many open channels of communication. These channels are absolutely critical, but are risk laden in that they can drive unnecessary change into the project.

The inherent risk only becomes manifest when the owner operator looks to cost-recover a percentage from a joint venture partner, but discovers that the communications surrounding the change are untraceable.

So instructions and the thread of communications that trigger a contractual change must be recorded meticulously.

Contractual risk management entails de-risking the commercial engagement by ensuring that the chaotic communications that exist on a large capital project are streamlined and controlled, whether they are a communication about an instruction, an obligation, potential change, or site query.

Making communications structured
Imagine that time is a constant represented by a horizontal axis. Capital is deployed in increasingly larger amounts as construction of the project progresses over time.

That capital is deployed via contracts, but without a system of engagement to provide a disciplined way of managing the risk inherent within those contracts, the entire process is left open to change due to unnecessary, unstructured and cluttered communications channels.

This occurs both internally with the owner operator and its partners, and externally with contractors.

Now imagine the application of contractual risk management as being like a coil that wraps around the project timeline. The 'coil' is a system of record. When it's switched on, it aggregates all communications across the project timeline. Here, unstructured communications become structured under specific categories.

Crucially, the timeline and the coil are intertwined, much like a DNA sequence, to provide an indisputable record of all formal contract data, communications, contractual obligations, review decisions and decision response times.

By being able to retrieve, as required, auditable and irrefutable evidence held within a 'DNA sequence', owner operators are able to reduce instances of claims and maximise cost recovery to ensure all project and contract stakeholders bear their appropriate share of legitimate unplanned costs.

Using analytics
Applying analytics to a combined system of engagement and system of record, where disciplined and structured communications are stored within a single platform, owner operators can start to act on the business intelligence available.

For example, if a variation order request on a major project is received from a contractor and has a significant value associated with it, that communication can be routed to those that need to see it and, more importantly, to those that need to take the decision on whether or not to approve it.

A further benefit is that owner operators can measure the riskiness of a particular project.

Should a large volume of variation order requests come in over a short period of time, they can be escalated to appropriate stakeholders to notify them that scope is a problem and as such the project is at risk of blowing out.

Action can then be taken to avert significant value leakage and scheduling overruns in commercial relationships with contractors, which current in-house systems are simply unable to achieve.

Single platform
Instructing contractors, partners and stakeholders to use a single formal commercial platform (software system) for communicating with owner operators whilst executing contracts and to adopt the oil company standards is a must.

All instructions and communications to and from the contractor and owner operator teams flow through this one channel in a pre-defined, organised way.

It connects the engineering world with the commercial world by insisting all technical queries, instructions and otherwise are routed through the commercial channel for review, checking alignment or disparity with the contract, and then to the contractor and owner operator's technical teams.

You can gain significant insights by analysing the commercial communication traffic that highlights priority areas of the engagement that need attention.

This is a new 'early warning' focus on potential change requests. It allows owner operators to accept necessary changes, but importantly, allows them to avoid unnecessary changes that can blindside a project when they fester to significant levels and result in claims.

One international oil company (IOC) that implemented a contractual risk management solution to drive capital discipline across 25 projects reduced its actual outcome versus final investment decision cost target by some 65 per cent from a previous period. Another firm, a lead operator, recovered over $1.7bn from partners on a major capital development programme in Africa.

Meanwhile, an oil major managing a $12bn mega project recently completed the development with zero successful claims from contractors. In other words, not a single dispute or unapproved variation was accepted. Such a recovery was previously unheard of in the oil and gas industry.

One oil and gas independent has even deployed a contractual risk management solution based on the business case of recovering $1m per day in enhanced cost recovery

Ultimately, by managing key contractual risks, owner operators benefit from connected decision-making through improved capital discipline, and therefore realise a much more predictable commercial outcome.

Clare Colhoun is CEO of 8over8, a rapidly growing company with offices in Europe, North America, Australia and the Middle East.

Head-quartered in the United Kingdom, 8over8 provides contractual risk management solutions to owner operators of large capital projects in the oil & gas, mining, infrastructure and the evolving smart infrastructure development sectors.

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