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Capital Projects: Meeting the Challenge of Predictability

Westney Consulting Group, Inc.

www.westney.com

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Introduction to Westney Consulting Group Founded 1978

Alberta Oil Sands

Deepwater GOM

Angola LNG

EG LNG

Qatar LNG

Newfoundland oil & gas

Deepwater Brazil

North Sea

Oman Petrochemicals

Alaska Gas Pipeline

Shanghai Ethylene

North American REGAS

Caspian Production

Deepwater Drillships

Gulf Coast Refineries

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Representative Client List

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Westney Consulting Group’s Energy CAPEX Risk Management Services

Ensures that strategic and tactical cost & schedule

risks are framed, assessed, funded and mitigated using

CAPEX VaR™ techniques

Provides Execution Planning at Program

and Project levels using DDDC strategic planning process

Benchmarks organization capabilities and supports improvements to the Project Delivery System

Risk Resolution

CAPEX Management Consulting

Strategic Project Planning

CAPEX Performance Management

Provides Non­Operator Project Oversight

Provides Operator’s Competency Assurance

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Total CAPEX for Energy Infrastructure 2005 ­ 2030

• Total: $20 Trillion ($800G/yr)* – Oil & Gas: $8.2 T ($328G/yr)

• Upstream E&P: 5.3T ($213G/yr) – $80G in oil­sands projects over next 10 years

• Midstream (incl. LNG) $1.7T ($69G/yr.) – Capacity will double; avg. of 31 sanctioned projects = $2.4G – North American gas projects = $1.2T

• Downstream $1.2 T ($46G/yr) – Power: $11.3 T ($452G/yr)

• Generation $5.2T ($208G/yr) • Trans. & Dist. $6.1T ($244G/yr)

• 2006 – 2010 Oil & Gas = $2.1 Trillion

Source: “World Energy Outlook 2006”; International Energy Association

*All figures in 2005 US dollars; “G” indicates billions

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Achieving Predictability in a World of Black Swans

Bob Norlund & Ric Massie

Consulting Group, Inc. www.westney.com

HBR Project Management Forum

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Hunting Black Swans

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The Impact of the Highly Improbable

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Avoiding the Turkey Trap

Thanksgiving!!!

Apologies to Bertram Russell

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The Industry Today

• Poor project performance is not acceptable when capital markets are looking for predictability & strong returns

• >50% of execs are dissatisfied with project performance (eg 40% of projects overrun) – more­so than ever

• … cannot afford to miscalculate capital project risks – yet do not have a good grasp of how to manage (them)

Source: Capital Project Execution in the Oil & Gas Industry – Booz Allen Hamilton

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Is Self Delusion Necessary?

ABSOLUTELY !!!!!!

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Slide Left Blank on Purpose

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Managing Risk Requires Expanding the CAPEX Envelope

1990 2000 2010

Average project size,

risk & com

plexity

HAVE: Conventional HAVE: Conventional Project Management Project Management

NEED: Strategic NEED: Strategic Program Management Program Management

Top 86% of current sanctioned projects average $5 Billion*

*Source: “World Energy Outlook 2006”; International Energy Association

PROJECT MANAGER & TEAM

EXECUTIVE MANAGEMENT

today

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Capital Project Estimating Techniques

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Source: Cambridge Energy Research Associates

IHS­CERA Project Capital Cost Index

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Managing Risks at the Right Level

Risk Tactical Strategic

Authority / Accountability

PMT

Man

agem

ent e.g.: • Political • Global economic trends • Partner / NOC issues • Organizational alignment

e.g.: • Project definition • Contractor performance • Pricing • Logistics

e.g.:

• Unmitigated strategic risks become tactical problems for PMT

e.g.:

• Management intervention in PMT tactics leads to internally driven risks

Governance

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Caging Black Swans Core Concepts

• Strategic vs. Tactical Risks • Risk Exposure • Risk­Conditioned Investment Value™ • CAPEX VaR™

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The World of Project Uncertainties Background or

Strategic Risks ­Any risks to the expected project outcome not otherwise considered

Tactical Risks

­ Risks defined from the

deterministic estimate and schedule

Increasing Levels of Uncertainty

Source: Courtney, H., J., and Viguerie, P.: McKinsey and Co., “Strategy Under Uncertainty,” Harvard Business Review, Nov.­1977

Skewed or Discontinuous

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Understanding the Outcomes of Megaprojects, Rand Corporation, March 1988, Edward W. Merrow

“Cost estimates tend to be optimistic primarily because it is difficult to estimate aspects that are not apparent when using the “bottom­up” cost and schedule estimating approach usually practiced in the engineering and construction industry. In the absence of specific information, such estimating methods usually fix at zero, costs and time requirements for things that are not readily apparent. Contingency allowances are not designed to adjust for the major sources of bias and therefore rarely do.”

Why Identify Strategic Risks?

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Risk Exposure

Estimate (incl. Contingency)

+

Risk­ Conditioned Investment Value TM

Tactical Risks

Strategic Risks

Addressing the Risks

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A Process for Resolving Risks

Financial Financial Close Close

Risk Framing

Strategic Planning

Risk Brokering

• Probabilistic Analysis

• Risk – Conditioned Investment Value

Risk Assessment

• Risk Collar

• Risk – Resolved Contracts

• Risk­Driven Strategic Project Plan

Risk Validation

• Risk Exposure • Risk Management Ø Risk Balance Sheet ØMitigation Actions

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The Road to Sanction

The “First

Number”

The Project Budget Including

Contingency

Strategic Risk Actions

Strategic Risk

Exposure

Risk Exposure

Development (Shaping FEL1 FEL2 FEL3)

Sanctioned RCIV* & CAPEX VaR TM

*Risk Conditioned Investment Value TM

Preliminary RCIV* & CAPEX VaR TM

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Conventional vs. Strategic Risk Analysis

Conventional Risk Analysis assumes that all risks “tunnel” to an acceptable level at sanction and continue to decrease to closeout.

Time

Strategic Risks are considered outliers (i.e., “Black Swans”) and ignored (until they occur).

Conventional Risk Analysis assumes that all risks “tunnel” to an acceptable level at sanction and continue to decrease to closeout.

Time

Strategic Risks are considered outliers (i.e., “Black Swans”) and ignored (until they occur).

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CAPEX VaR™

A calculation of project risk exposure at the portfolio level.

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A Closing Thought ...

One of the best lessons children learn through video games is that standing still will get them killed quicker than anything else.

Jinx Milea, USC

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END

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Black Swans in the World of Capital Projects

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CERA Curves

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About the CERA Curves

Upstream

The IHS/CERA UCCI tracks the costs of equipment, facilities, materials, and personnel (both skilled and unskilled) used in the construction of a geographically diversified portfolio of twenty eight onshore, offshore, pipeline and LNG projects. It is similar to the consumer price index (CPI) in that it provides a clear, transparent benchmark tool for tracking and forecasting a complex and dynamic environment.

Downstream

The IHS/CERA DCCI tracks the costs of equipment, facilities, materials, and personnel (both skilled and unskilled) used in the construction of a geographically diversified portfolio of more than thirty refining and petrochemical construction projects. It is similar to the consumer price index (CPI) in that it provides a clear, transparent benchmark tool for tracking and forecasting a complex and dynamic environment.