Nick Lavingia 1

Total Cost Management

Dr. Nick J. Lavingia, P.E.

Chevron

Project Management Consultant

APEGGA Annual Conference, Calgary

April 26-27, 2007

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Dr. Nick J. Lavingia, P.E.Project Management ConsultantChevron

Nick has over 30 years of Global Project Engineering, Management, Consulting and Training experience in the Energy industry. As a Project Management Consultant at Chevron, he provides Consultation and Training to Project Professionals worldwide.

Nick has a B.S. and M.S. in Chemical & Petroleum-Refining Engineering and a Ph.D. in Engineering Economics & Management from the Colorado School of Mines. He is a registered Professional Chemical Engineer in the State of California.

Nick is a member of Project Management subcommittee for Athabasca Oil Sands expansion project. He has published and presented many papers at technical organizations and is a recipient of industry award from Pathfinder for outstanding Contribution to the advancement of Project Management Technology and Chevron Chairman’s award for implementing Value Engineering throughout the corporation.

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Agenda

Total Cost Management:• Economic Analysis• Cost Estimating• Planning / Scheduling• Benchmarking• Contracting / Procurement• Performance Measurement• Cost Control / Forecasting• Progress Reporting• Finance / Audit

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•Contracting/Procurement (Strategy)

•Cost Control/Forecasting (WBS)

•Progress reporting

•Finance/Audit

Total Cost Management

Phase 1IDENTIFY & Assess

Opportunities

Phase 2SELECT fromAlternatives

Phase 3DEVELOP Preferred Alternative

Phase 4EXECUTE

(Detail EPC)

Phase 5 OPERATE &

Evaluate

• Economic Analysis (NPV, ROR, Payout)

• Cost Estimating (Conceptual)

• Planning/Scheduling (Milestone)

• Benchmarking (Cost / Capacity)

Legend: AFE = Appropriation for Expenditure NPV = Net Present Value PFD = Process Flow DiagramD = Decision Point ROR = Rate of Return P&ID = Piping & Instrumentation DiagramEPC = Engineer, Procure & Construct CPM = Critical Path Method WBS = Work Breakdown Structure

P&ID$

EST AFEPFD D D D D D$

EST

(Funding +/- 10% Accuracy) (Definitive)

(CPM Bar Chart) (CPM Resource Loaded) (Monitor & Update)

(Pre-Funding Assessment) (Post-Project Assessment)

(Pre-Qualification) (Award / Monitor)

Performance Measurement (Establish Progress Payments)

(Earned Value)

(Establish Cost Accounts & Budgets) (Trend / Forecast)

(Closeout)

(Cost Collection / Analysis)

(Set Pacesetter Target)

(Asset Accounting) (Capital versus Expense)

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Safety is an underlying value!

Safety is the foundation on which we build projects & conduct our business:

Technology selection Facility layout Detailed design / procurement Construction Commissioning & start-up Ongoing operation

We manage safety as a fundamental part of conducting our business

Cost

Schedule Quality

Safety

Tradeoff Between Cost, Schedule & Quality

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Economic Analysis

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Net Present Value (NPV)… “Show Me The Money”

Definition: • Sum of the Net Cash Flow discounted to time zero using a

discount rate

Benefits: • Incorporates time value of money ; easy to understand;

recognizes magnitude of profit• Can be used for screening and ranking

Disadvantages: • Independent of the size of the cash flows

Profitability Criteria

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Profitability Criteria

Rate Of Return (ROR)…“Interest Rate”

Definition: • Discount rate which equates the sum of the Net Cash

Flow after tax to zero

Benefits: • Incorporates time value of money • Easy to understand• Easy to compare with the cost of capital

Disadvantages: • Independent of the size of the cash flows• Can be difficult to determine• Assumes reinvestment at same rate

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Profitability Criteria

Payout… “Time The Money Is Hanging Out There”

Definition:

• Time for Cumulative Net Cash Flow after tax = Investment

Benefits:

• Simple

• Indicator of investment risk

Disadvantages:

• Ignores time value of money

• No indication of what happens after payout

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Profitability Criteria

Discounted Profitability Index (DPI)…“Bang For The Buck”

Definition: • DPI = 1 + (NPV of Net Cash Flow / NPV of Investment)

Benefits: • Accounts for the relative size of the cash flows• Used for screening / ranking • Recognizes magnitude of profits

Disadvantages:• Does not give as good an indication of sensitivity to additional

investment as NPV

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Cost Estimating

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What is a Cost Estimate?

• Realistic representation of final project cost at any stage of project development to meet a specific project objective

• Basic Components:

Base Estimate +

ContingencyTotal Cost Estimate

Accuracy around the total

}

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Quality of Estimate

Estimate PROJECT PHASE

ENGINEERING CONTINGENCY

Phase 1 Identify < 1 % 30 - 50 %

Phase 2 Select 1 - 5 % 15 - 40 %

Phase 3 Develop 15 - 30 % 5 - 10 %

Phase 4 Detailed Design

50 - 80 % 5 - 10 %

Phase 4 Construction 90 - 95 % 5 - 15 % of unexpended funds

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Estimate Methods

• Phase 1 Estimate--Cost/Capacity curves

• Phase 2 Estimate--Factored estimate based on major equipment costs

• Phase 3 Estimate--Detail estimate based on bids for major equipment and bulk takeoffs

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Estimating & Contingency Determination

Estimated CostFinal Actual

Cost

ContingencyVariance Base Estimate

+/- 50% +/- 25% +/-10%

Phase Phase Phase 1 2 3

1.0

Evaluate Alternative Develop Detailed Design Construction StartupConceptual

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MinimumCost

MaximumCost$1.0Million

MostLikelyValueMODE

Frequencyof

Occurrence

$1.4(+40%)

$0.8(-20%) 50/50 Value

MEDIAN

CONTINGENCY

Contingency

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Cost Estimate Confidence

90 % Chance thatcost will not be exceeded

90 % Chance thatcost will be exceeded

Equal Chance of costexceeding or being lower

90/10

50/50

Base10/90

Contingency

Allowances

IdentifiedScope

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Evolution of Estimate Accuracy

PHASE 3

DEVELOP (AFE)

• Adequate FEL (15-30% Engineering)

• Well defined

• +/- 10% accuracy

PHASE 2

SELECT

• More Engineering

• More Definition• Moderate accuracy

PHASE 1

IDENTIFY

• Minimal Engineering

• Low definition detail

• Wide accuracy

COST

50%

COST

50%

COST

50%

10% 90%

10% 90%

10% 90%

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Planning / Scheduling

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Project Time Management - Scheduling

Project Time Management includes the processes required to ensure timely completion of the project:• Activity Definition - identifying the specific activities that

must be performed to produce the various project deliverables

• Activity Sequencing - identifying and documenting interactivity dependencies

• Activity Duration Estimating - estimating the number of work periods which will be needed

• Schedule Development - analyzing activity sequences, activity duration and resource requirements to create the project schedule

• Schedule Control - controlling changes to the project schedule

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Schedule Level Definitions

SCHEDULE LEVELS

PMP PHASE

OUTPUT DOCUMENT

KEY INPUTS TYPE OF SCHEDULE

(Note 1)

LEVEL OF SCHEDULE

(Note 2)

PHASE 1: IDENTIFY

OPPORTUNITY

Preliminary Project Milestone Schedule

Start and completion date Duration based on job size

BAR CHART

1

PHASE 2: SELECT

ALTERNATIVES

Expanded Project Milestone Schedule

Same as Level 1 plus: Constraints (permit period, long lead-time materials, shutdown dates, etc.)

BAR CHART

2

PHASE 3: DEVELOP

ALTERNATIVE

Detailed Integrated Project Schedule

Same as Level 2 plus: Detailed schedules for engineering, procurement, construction and startup (Resource Loaded)

CPM 3

PHASE 4: EXECUTE

Updated Integrated Project Schedule

Expanded detail for design Actual progress, for comparison with planned progress

CPM 4

PHASE 4: EXECUTE

Updated Integrated Project Schedule

Expanded detail for construction & startup Actual progress, for comparison with planned progress

CPM 5

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What Is A Plan?

A Plan Defines Activities Involved in a Project, Their Logical Sequence, and Their Inter-Relationship

METHODS

IDEASLOGIC

MEANS

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Estimates are inaccurate because they are predictions

of future events and the amount of variation that will actually occur is unknown.

Contingency or Float is Added to Estimates to Reduce the Risk of Overrun.

Cost Estimate Probability Analysis

100

105

110

115

120

125

130

135

140

145

150

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Probability

Co

st

($m

illi

on

s)

Appropriated Value

Cost w/o contingency

Schedule Probability Analysis

20

21

22

23

24

25

26

27

28

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Probability

Sch

edu

le (

mo

nth

s)

Appropriated Value

Base Schedule

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Contracting / Procurement

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Current Trends in Contracting & Procurement

Materials & Equipment

• Lead times are increasing

• Prices are increasing

• Inventories are decreasing

• Material shortages

Services

• Contractor capacity is decreasing

• Craft workforce shortage

• Labor rates increasing

Fabrication

• Shop loading is high

• Pricing is volatile

Marketplace

• Marketplace is strong

• Global mega projects

• Suppliers have choices

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What Can Buyers Do?

Demand Planning

• Plan requirements well in advance

• Aggregate demand

• Leverage volume

Market Intelligence

• Use market data to mitigate cost increases

• Monitor supply/demand

• Investigate new market entrants

Supplier Relationships

• Exploit long term relationships

• Qualify additional suppliers

• Don’t let supplier know you are desperate

Commercial Considerations

• Have and stick to Strategy

•Tie cost increases (future decreases) to major underlying cost components

• Leverage volume & spend

• Lengthen term of agreement

• Define work scope & manage contractors

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The Contracting Process

Assess Contracting Opportunities

Evaluation and Agreement

Bidding/Negotiating

Pre-qualification

Develop & Review Alternative Contracting Strategies

Administration

Execution of Contract

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Owner’s Control

Cost Reimbursable

Fixed Price

Owner’sCostRisk

UnitPrice

GuaranteedMaximum

Types of Contracts

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Selection of Contracting Strategy

Item Lump Sum Reimbursable

Scope Definition*

Market Condition

Owner Participation

Owner Control

Owner Risk

Good

Slow

Low

Minimum

Low

Poor

Busy

High

Tight

High

* Do not award lump sum contracts without good scope definition.

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Preferred Contracting Strategy

Work Facilities Process Units Utilities Offsites

No. 1 No. 2 No. 3

Project Management Owner

Management Support Consultants or Contractors

Proprietary Technology Owner / Licensor

Basic Engineering Package

Detailed Engineering

Procurement Reimbursable Cost

Construction Management

Construction Construction Contractors--Lump Sum

Commissioning/Start-up Owner

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Performance Measurement

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Project Objectives

Definition

Estimate

WBS

Project Control Cycle - Establish Plan

PhysicalProgress

Actual Hours

Actual Costs

Cost Summary

Forecasts

Performance Curves

Schedule Status

Trends

Scope

Work to Plan

Evaluate vs.Plan

Establish Plan

MeasurePerformance

CorrectDeviations

AFE

Contracting Plan

Control Budgets

Schedules

Cost Variance

ScheduleVariance

Productivity

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Performance Measurement

PERFORMANCE =EARNED HOURSACTUAL HOURS

POOR

PERFORMANCE

GOODTIME1.0

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Cost and Schedule Performance Curves

SV}CV}

Budgeted

Earned

Actual

T

$ or

Wor

k H

ours

Time

SV = Scheduled Variance

CV = Cost Variance

T = Time Variance

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Cost Control / Forecasting

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Costing System to Support Cost Control

Summarize Actual Costs Vs. Progress and Compare to Budget

Identify Accounts With Major Variance

Accumulate Cost at Project Completion

Include in Historical Estimating Data Base If Appropriate

Breakdown of Estimated Costs Using the Standard Code of Accounts

Do Some Work

Account for Costs

Account for Workhours

Measure Progress

Take Corrective Action

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Cost Control System

Spreadsheetor

Database

COMMITMENTS• Purchase Orders and Supplements• Contracts and Change Orders• Owner Costs

BUDGETS

COST REPORTS• Summary • Detail

EXPENDITURES

Purchase Order Log CONTRACTS

TREND LOG

TRENDS

• Status Summary• Change Log

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Progress Reporting

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T h e c a l c u l a t i o n s y o u j u s t p e r f o r m e d f o r P r o j e c t A B C a r e r e f l e c t e d i n t h e g r a p h b e l o w . T h i s s e t o fc u r v e s s h o w s h o w w e l l t h e p r o j e c t i s p e r f o r m i n g a g a i n s t s c h e d u l e ( E a r n e d v e r s u s P l a n n e d ) a n da l s o h o w w e l l i t ’ s p e r f o r m i n g a g a i n s t b u d g e t ( S p e n t v e r s u s E a r n e d ) .

0

5 0 0

1 0 0 0

1 5 0 0

2 0 0 0

2 5 0 0

3 0 0 0

3 5 0 0

0 1 2 3 4 5 6 7 8

M o n t h s f r o m S t a r t o f P r o j e c t

Cum

ulat

ive

Wor

khou

rs

P l a n n e dE a r n e dS p e n t

9 0 0 W o r k h o u r s A c t u a l l y S p e n t

1 2 0 0 W o r k h o u r s E a r n e d V a l u e

1 6 0 0 W o r k h o u r s P l a n n e d

Progress Report No. 1

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Sierra Tank Expansion Project

0

5000

10000

6000

8000

0

2000

4000

6000

8000

10000

12000

14000

0 1 2 3 4 5 6 7

Months from Start

Cu

mu

lati

ve W

orkh

ou

rs

Planned Earned Spent

Total Planned Earned ActualBudget Workhrs Workhrs Workhrs

Activity Workhrs To Date % To Date % To Date % To Complete @Completion

Site Survey 500 500 100% 500 100% 600 120% 0 600Prepare P&ID's 1,500 1,100 73% 1,200 80% 1,500 100% 200 1,700Civil Design 1,000 800 80% 900 90% 1,000 100% 50 1,050Piping Design 3,000 1,700 57% 2,200 73% 2,600 87% 750 3,350Electrical Design 2,500 900 36% 1,100 44% 1,900 76% 300 2,200Inst & Controls 1,000 0 0% 100 10% 350 35% 450 800Const Bid Package 500 0 0% 0 0% 50 10% 250 300

TOTALS 10,000 5,000 50% 6,000 60% 8,000 80% 2,000 10,000

ForecastedWorkhrs

Monthly Workhour Report for End of Month 3Project: Sierra Tank Expansion Project for Chevron

Progress Report No. 2

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Progress Report No. 3

0

500

1000

1500

2000

2500

3000

3500

1 2 3 4 5 6 7 8

Months from Start of Project

Cum

alat

ive

Wor

khou

rs

Actual Cost (AC)

Earned Value (EV)

Planned Value (PV)

3000 – Budget at Completion (BAC)

2000 – Actual Cost (AC)

1600 – Planned Value (PV)

1200 – Earned Value (EV)

Date Now

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Progress Report No. 3

1. Cost Variance (CV) = Earned Value (EV) – Actual Cost (AC)

CV = 1200 - 2000 = - 800

2. Schedule Variance (SV) = Earned Value (EV) – Planned Value (PV)

SV = 1200 - 1600= - 400

3. Cost Performance Index (CPI) = Earned Value (EV) / Actual Cost (AC)

CPI = 1200 / 2000 = 0.6

4. Schedule Performance Index (SPI) = Earned Value (EV) / Planned Value (PV)

SPI = 1200 / 1600 = 0.75

5. Estimate To Complete (ETC) = [Budget At Completion (BAC) – Earned Value (EV)] / Cost Performance Index (CPI)

ETC = (3000 - 1200) / 0.6 = 3000

6. Estimate At Completion (EAC) = Actual Cost (AC) + Estimate To Complete (ETC)

EAC = 2000 + 3000 = 5000

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Summary

Structured Project Development & Execution Process and Total Cost Management can help achieve World-Class Project Performance:

• Better• Cheaper• Faster• Safer

PROJECTS