Mitigating Risks To Improve Project Results
I am honored to serve the Society of Petroleum Engineers as president this year. Each president chooses a theme, and for me, my theme was obvious: risk and reward.
Ours is a risky business, and that is what makes it fun and challenging. Risk also drives the big rewards when what we do pays off. Mitigating risk is the very core of what we do on a daily basis: drilling risk, subsurface risk, cost/schedule risk, performance risk, safety risk, geopolitical risk, and price risk. Projects are a constant juggle to find the sweet spot where we produce oil and gas safely, responsibly, and profitably. But as an industry, we make decisions to eliminate risk through analysis rather than manage the risk that will always be there. The petroleum industry is fundamentally a commodity business. Commodity prices change, but combine that with a capital-intensive business with big upfront investments and long payouts, and commodity price swings hit us hard.
Engineers are paid to predict the future, especially production, reserves, cost, and schedule. We cannot control price risk, but we can improve performance. I have always been interested in the intersection of engineering and risk evaluation with oil and gas economics. I wrote my master’s thesis on what we would now call “decision analysis.” I was intrigued by deterministic project and economic evaluation and how data are interpreted within the bands of possibility to get a project over economic hurdles. Even with today’s sophisticated probabilistic economic analysis, results still fall short of expectations and promises to stakeholders.
Too Many Projects Fail
The stakes are incredibly high. Independent analysis of large capital projects has shown that as an industry, we are not very good at delivering on our promises. In its spotlight article on oil and gas megaprojects, Ernst & Young estimates that 64% of major capital projects overrun on cost, and 74% face schedule delays. Cost and schedules are overrun in every region of the world. Independent Project Analysis (IPA) comes to very similar conclusions in its subscription benchmarking service, estimating that 60% of projects overrun costs by more than 20% while only 18% of projects meet both cost and schedule targets. IPA also estimates that projects deliver 35% less of their planned overall net present value from financial investment decision to lookback. Some estimate that more than 75% of projects deliver more than 25% less value than promised.
On the production and reserves side, the story is not any better. Ernst & Young’s 2015 US Oil and Gas Reserves study shows that integrated companies failed to replace US production for 2010–2014, despite more than USD 2 billion in capital investment. Independents fared much better at production and reserve replacement during this time period due to high activity in the US shale plays, but shale production will decline rapidly with diminished development programs.
Those new barrels came dearly. During the period 2005–2013, PricewaterhouseCoopers’ (PwC) analysis showed that global production for the five super majors (BP, Chevron, ExxonMobil, Shell, and Total) has remained flat, while development cost almost tripled (Tideman et al. 2014).
We Overestimate and Under-Deliver
All published studies agree that, as an industry, we consistently overestimate production attainment and underestimate cost and schedule. IPA’s analysis of production attainment shows the too-narrow range of expectations and failure of the results to fall within the P10/P90 range. The average production attainment is only 78%, so production facilities are also oversized. How could we be so wrong?
Fundamentally, our industry usually manages the business to short-term metrics. For publicly held companies, that usually means analysts’ and shareholders’ expectations, annual performance promises, and executive performance goals. For national companies, the stakeholders are different, but the pressure to meet annual metrics, such as cash delivered to the finance ministry, are very similar.
The oil business is a long-term game. We invest billions in projects destined to produce for 30 years or more. Future undiscovered technology advancements will produce marginal barrels over those 30+ years, but we do not know the final estimated ultimate recovery until the last barrel is produced. Short-term metrics in a long-term business is not a formula for sustainable success.
So, What Can We Do Differently?
Ours is a risky business and not for the fainthearted. But we can mitigate some of the unnecessary risks. Many of our gaps are in:
1. Engineering oversight. Most people would agree that engineering oversight has declined in the last 20 years as operators have outsourced almost all design to service and engineering, procurement, and construction contractors. In the last 10 years or so, these contractors have been stretched thin to meet the very high demand for their services. Operators were also people-constrained as their activities ramped up, along with the first wave of retirements from the big crew change. Many misses on cost and schedule have been due to poor interpretation and design mistakes that could have been avoided with more technical review.
2. Executive overconfidence. The PwC article summarized the problem very well: Management sets optimistic goals for a first oil date, and then creates a very tight project to meet that deadline. Once projects are underway, it becomes apparent that the deadline cannot be met within the given budget. Project teams try to speed the schedule by adding resources, and then often blow both cost and schedule.
The real question is: Would we make the same investments if we were honest with ourselves around investment metrics, especially cost and schedule? Analysis of project results consistently reveals the same issues across all projects: outcome ranges that are too narrow, confirmation bias, anchoring, and general overconfidence. With all those negative results, can engineers challenge ourselves to reduce risk and improve reward? Possible solutions include:
1. Technology. Our past performance has shown that advances in technology can help reduce risk. We can increase the predictability of outcomes through better analysis. We can reduce failures and increase safety and operational performance by better monitoring of our operations. And we can create new technologies to increase our opportunities. History has shown that our industry tends to make technology leaps in hard times because we are forced by economics to innovate. I will discuss this issue more in future columns.
2. Better engineering. We need a rebirth of technical oversight for our initial project designs. I believe that at least part of this will come through better institutional memory contained in design systems. We also need to reduce complexity and standardize more designs. Too many projects are completely custom-designed, creating openings for design errors and reducing opportunities for cost savings through standardization.
3. Better business analysis. Are we doing the right development, in the right place, at the right time? Large capital projects have skewed project risks, not normal distributions, with a lot of ‘tail risk’ (low probability but often high consequence). Do we assess those risks well? Do we include learnings from prior projects to improve our economic analysis? Do we monitor changes in risk profiles as projects move forward and act on those changes?
4. Make tough decisions. Finally, management should “just say no” to some projects. Reward systems should reinforce right decisions, not encourage making promises that we cannot keep. We need to find new ways to monitor and reward long-term actual results of projects, not short-term metrics such as final investment decision and first oil promises.
Finally, I think we need a new level of cooperation between operators and the service sector. Service companies are essential to implement projects, yet when times get tough, operators stop the music too quickly. In addition, innovations will be more of a cooperative venture between the asset owner and the service sector. We need a healthy service sector to effectively develop projects, and we need to find a better way to work together.
Risk and reward drive all of our decisions. We balance many, often unmeasurable, risks to develop resources to provide energy for the world. We can do a better job for ourselves, our companies and our stakeholders.
For Further Reading
Tideman, D., Tuinstra, H.T., and Campbell, B.J. 2014. Large Capital Projects in the Oil and Gas Sector: Keys to Successful Project Delivery, http://www.strategyand.pwc.com/media/file/Large-capital-projects-in-the-oil-and-gas-sector.pdf (accessed 7 September 2016).
Mitigating Risks To Improve Project Results
Janeen Judah, 2017 SPE President
01 October 2016
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