Economist's Corner

Megaprojects: Managing Risks and Controlling Costs

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With the era of “easy oil” behind us, upstream companies face the challenging task of meeting the increasing global energy demand. Oil companies push the boundaries of technology to squeeze out every barrel of oil from their existing fields, while exploring further and drilling deeper to exploit new reserves. With the complexity involved in the operations going up, the industry is building larger and more complex projects. Such megaprojects require billions of dollars of investment, multidisciplinary teams, meticulous planning, flawless execution, and cutting-edge technology. As is the case with any complex project, delays and cost overruns haunt project managers right from the stage of conceptualization. The reasons for these delays can be broadly classified as technical and nontechnical.

Technical Complexities

  • Frequent changes in specifications and business requirements lead to numerous iterations and delays in front-end engineering and design (FEED). Such projects also deploy complex and cutting-edge technology specifically developed for these projects. Pressure on project managers to deliver “first oil” often leads to these technologies being used untested, leading to commissioning delays and even the need to redesign or carry out expensive modifications.
  • Projects of such scale require thorough project management skills. Being multidisciplinary projects, there are numerous interdependencies between internal departments on one hand and external agencies such as original equipment manufacturer (OEM), vendors, and contractors on the other. With so many moving parts, ensuring tight timelines is challenging. Many companies still follow the process of tendering out to the lowest bidder, which may make the project vulnerable to delays due to inexperience or poor service quality by the vendors.
  • Successful execution of projects requires specialized equipment and manpower. Often equipment such as deepwater rigs have to be scheduled months in advance. Instances of project managers scheduling the project execution around the availability of long lead time equipment is common. Delay in release or movement of the equipment from a previous work location may delay projects. Delays due to shortage of skilled manpower, both on the project management side as well as the construction side, are also prevalent.
  • Difficult terrains and lack of access to proper infrastructure strain the supply chains by delaying material movement to the project site. A good example of this challenge is the Gorgon liquefied natural gas (LNG) project in Australia, which is located hundreds of miles away from the nearest city and approximately 1,000 miles from the nearest port.

Nontechnical Factors

  • Often megaprojects lie in ecologically sensitive areas, leading to strong opposition from environmental groups. For example, the Keystone XL pipeline, which runs through biologically sensitive areas, has encountered strong opposition from environmental groups in the US leading to significant project delays. Similarly, the Gorgon LNG project is located in a Class A nature reserve zone, which requires strict quarantine processes for all materials brought into the project site.
  • Often governments require a stipulated minimum level of local content. Many developing countries lack sufficient skills/technological capabilities for executing such projects. Nevertheless, regulations force project managers to source a certain percentage of material and manpower locally, even at the expense of quality and lead time, potentially leading to project delays due to lower productivity and local supplier lack of experience.
  • Rough weather conditions are one of the most common reasons for project delays, especially offshore. Getting drilling/project equipment to deepwater locations is dependent upon weather conditions such as ocean swell, current, and wind direction. Rough weather may delay construction activities, thereby idling all equipment and manpower. With rig day rates for deep water in the range of USD 300,000/day to USD 500,000/day, even one day of rig idling has significant impact on project costs.
  • A majority of the megaprojects under construction today require an oil price above USD 60/bbl to achieve positive cash flows. With oil price fluctuations, these projects face an uncertain future. Given global sourcing of materials and services, foreign exchange fluctuations can also add another element of risk.
  • The role of geopolitics in project delays has gone up substantially over the past few years as more projects are conceived in volatile regions of the world. Political unrest, international sanctions, war, and acts of terrorism are threats to the workforce and project schedule.

Examples of project delays due to the mentioned reasons are ample across the industry. Upstream projects in the Caspian Sea and Russia have been delayed by multiple years and billions of dollars due to technical complexity. Australian LNG projects are running behind schedule and with cost overruns due to the lack of skilled manpower and complex supply chains. An Indian refiner faced delays due to regulatory hurdles and land acquisition problems.

Project delays are common across both international oil companies (IOCs) and national oil companies (NOCs). In the case of IOCs, pressure from shareholders for maintaining a healthy reserve replacement ratio leads to project managers taking on ambitious targets and untested technologies, causing project delays. While for NOCs, the challenge in executing projects in an integrated manner in the face of procedural constraints, complex contracting procedures, possible government interferences, and less autonomy are major reasons for project delays.

Such delays not only lead to cost overruns, but also result in deferred hydrocarbon production, thereby delaying revenue generation. With the shareholders focused on higher return on investment, such delays and cost overruns are deemed unacceptable.

Project managers have long been using traditional tools and techniques like stage-gates, work breakdown structure, and Critical Path Method/Program Evaluation and Review Technique models to plan and execute projects. However, to tackle the complexities of megaprojects, companies have adopted new techniques and more efficient work practices such as the following.

Increased management oversight. As senior management comes under pressure from shareholders and financial institutions to ensure tight capital control, management oversight on large projects has increased. Frequent status updates and constant tracking of these projects have become a boardroom agenda. This not only ensures that the project managers are adhering to their timelines, but also highlights potential risks well in advance, enabling management to take corrective actions.

Integrated planning and execution. The traditional “silo” approach to project design is being replaced by an integrated planning and execution approach. Critical OEMs and vendors are engaged from the FEED stage. This ensures that all major stakeholders are seamlessly integrated during the design phase, prevents any surprises during the project execution, and eliminates the potential for rework.

Information technology. Project and portfolio management tools have helped provide project managers with better real-time visibility of project risks by analyzing information from multiple sources, thereby helping them make timely and informed decisions. These tools have also enabled collaboration between stakeholders, resource optimization, and real-time cost monitoring.

Modularization and standardization. The construction industry has embraced the concept of modularization wherein the entire project is broken down into various modules, which can be fabricated at a dedicated facility leading to reductions in cost and time. These modules are then transported to the project location for assembly. Modularization cuts down the necessity to transport raw materials and machines for construction to the project site, thus reducing the possibility of delays. Standardization of modules is yet another step wherein specific modules are consistently manufactured to predefined specifications to enable reusability in different projects.

Integrated sourcing and procurement. Integrating the sourcing and procurement function during project conceptualization helps in putting together a procurement strategy early on in the project. This not only reduces delays due to nonavailability of parts or long lead times, but also ensures the sourcing strategy is in line with the project requirements and timelines. Standardization of parts further enables the procurement department to source parts cost-effectively and helps to minimize risks with quality and lead time.

While there are numerous examples of project delays, instances of on-time completion of projects within the stipulated budgets are also worth mentioning. A global exploration and production company completed one of its deepwater Gulf of Mexico projects before the scheduled time, generating significant early cash flows to the business. An integrated oil and gas company commissioned its project offshore Nigeria 5 months ahead of schedule and USD 400 million below the anticipated budget. These instances have been possible largely due to companies demonstrating a disciplined project management approach and following the industry best practices mentioned earlier.

With the cushion of high oil prices dissipating, contracting and sourcing of capital are becoming increasingly difficult. To ensure the success of megaprojects from both the technical and financial perspectives, the energy industry will have to focus more on containing project risks, reducing delays, and ensuring faster “first oil” to improve the viability of such projects and enhance shareholder confidence.

Varun Unnikrishnan is a principal consultant with PricewaterhouseCoopers India’s oil and gas consulting practice and focuses on hydrocarbon operations. He started his career with Oil and Natural Gas Corporation as a production engineer. Unnikrishnan holds a master’s degree in mechanical engineering from the Indian Institute of Technology and an MBA in operations from Indian School of Business.

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