the capital projects world in 2009 let’s use the lull wisely business presented to the houston...
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The Capital Projects World in 2009
Let’s Use the Lull WiselyBusiness Presented to the Houston Roundtable January, 2010
Ed Merrow
CONFIDENTIAL - IBC 2009 2
Questions to Ponder
• Where have we been?
• What have we learned?
• Where do we go from here?
CONFIDENTIAL - IBC 2009 3
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
CONFIDENTIAL - IBC 2009 4
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
CONFIDENTIAL - IBC 2009 5
• 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
Practices Have Suffered
CONFIDENTIAL - IBC 2009 7
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
CONFIDENTIAL - IBC 2009 8
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
CONFIDENTIAL - IBC 2009 9
Questions to Ponder
• Where have we been?
• What have we learned?
• Where do we go from here?
CONFIDENTIAL - IBC 2009 10
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 not the 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
CONFIDENTIAL - IBC 2009 11
Questions to Ponder
• Where have we been?
• What have we learned?
• Where do we go from here?
CONFIDENTIAL - IBC 2009 12
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
CONFIDENTIAL - IBC 2009 13
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
INDEPENDENT PROJECT ANALYSISCONFIDENTIAL 14
Major Equipment Escalation Mechanical Equipment
Equipment data primarily include mechanical equipment (Examples: compressors, fans, blowers, and pumps). Cost escalation trends are displayed in US dollars.
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Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Time
INDEPENDENT PROJECT ANALYSISCONFIDENTIAL 15
Major Equipment EscalationTypical Project Mix of Equipment
Cost escalation trends are displayed in US dollars.
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Equipment data include a diverse mix of fabricated and mechanical equipment with some E&I.
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0.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.52.6
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Time
CONFIDENTIAL - IBC 2009 16
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
INDEPENDENT PROJECT ANALYSISCONFIDENTIAL 17
Bulk Materials EscalationMix of Trades
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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ary
2003
(Jan
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= 1
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0.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.52.6
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Time
INDEPENDENT PROJECT ANALYSISCONFIDENTIAL 18
IPA Process Plant Escalation IndexEscalation Comparison
Cost escalation trends are displayed in US dollars.Data are a composite escalation index for various types of projects.
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2003
(Jan
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= 1
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0.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.52.6
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Time
Refinery
Onshore Gas Plant
Electrical Distribution
CONFIDENTIAL - IBC 2009 19
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
INDEPENDENT PROJECT ANALYSISCONFIDENTIAL 2020
Labor Escalation ComparisonG
lob
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rom
Jan
uar
y 20
03
(Jan
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= 1
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Cost escalation trends are displayed in local currency.
0.9
1.0
1.11.2
1.3
1.4
1.5
1.6
1.71.8
1.9
2.0
2.1
2.2
2.32.4
2.5
2.6
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Time
Brazil Western Europe
Singapore USGC
Australia Canada
China Middle East
South Africa
CONFIDENTIAL - IBC 2009 21
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
CONFIDENTIAL - IBC 2009 22
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
INDEPENDENT PROJECT ANALYSISCONFIDENTIAL 2323
Cost escalation trends are displayed in US dollars.
Engineering Price IndexG
lob
al T
ren
d f
rom
Jan
uar
y 20
03
(Jan
. 2
003
= 1
.00
)
0.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.52.6
Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Time
CONFIDENTIAL - IBC 2009 24
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
CONFIDENTIAL - IBC 2009 25
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
CONFIDENTIAL - IBC 2009 26
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?
CONFIDENTIAL - IBC 2009 27
Enjoy IBC 2009
And build for the Future