Uncertainties related to capital projects in the process industries have increased dramatically over the past three years. Brent crude prices have fallen precipitously to around $65/bbl, while the costs of capital expenditure (capex) projects in the upstream sector are estimated to have increased approximately 10-13% per year. In construction contracting, uncertainty increases cost because estimators must add contingencies to protect their bids from unknown conditions.

As the process industry seeks to contain capital costs, many of the causes will be difficult to corral, while the volatility of oil and gas prices makes planning difficult. According to a recent study from the global consulting firm EY, two-thirds of the 360 megaprojects surveyed are currently over budget, and more than 70% are behind schedule.

The rising costs of executing projects are having direct effects: Several oil majors have reduced their capital spending plans and engineering, procurement and construction (EPC) contractors are under increased pressure to shave project costs. Are the owner-operators and the contracted project teams working together and doing the right things to contain these costs?

At the same time that owner-operators have been driving EPCs toward lump-sum bids, the competitive environment has forced more aggressive bidding. EPCs more comfortable with lump-sum contracting have been thriving, but they should be asking what the overall risk may be, now and in the future.

Between the pressure of costs and the willingness of some contractors to bid lump-sum, estimators are in a difficult place. The traditional approach in lump-sum bidding has involved a manpower-intensive and not easily scalable enumeration of project components. In addition, new approaches to estimating may be required, and are already being pursued by some key industry players such as Petróleos Mexicanos (PEMEX) and Sadara Chemical Co., which have employed model-based methods that significantly beat industry-average performance.

Many North American EPCs feel owner-operators are talking a good story about value-based contracting, but the shared-value part of the equation is not yet evident. There is a lot of engineering creativity across the EPC industry, and value-based project agreements that offer partnerships with EPCs can improve processes and reduce life-cycle costs.

Continuing innovation in engineering technologies empowers creative engineers to make these advances. The key to unlock their creativity will be the owner-operator’s willingness to share the benefits.  At the same time, however, the industry is pushing for more standardized designs and fewer one-of-a-kind, “best possible” projects.  This has been evident at recent industry conferences.

At the Rice Global E&C Forum in Houston in September 2014, Marathon Oil Corp. CEO Lee Tillman made a compelling case for repeat design for facilities whose engineering principles are proven, such as gas-oil separation plants and gas-to-liquids projects. Tillman explained that while some of the runaway project costs are due to the increased technical risk of difficult and unconventional projects, a number of customers are shifting to using modular designs for a variety of reasons. 

Design technology has advanced to a point where modular, standardized designs can be efficiently executed with high quality and high reliability. Modular design also introduces opportunities for subtle trade-offs between on-site fabrication and shop modular fabrication. When modular construction is being considered, long-lead-time items often become extended further due to the need to deliver to the fabrication site, the time to fabricate and then finally ship. Early and accurate conceptual design becomes even more important, so traditional work flows must be modified to achieve a fast-track design.

At the Engineering and Construction Contracting Association annual conference in Orlando also last fall, the record crowd of 900 industry executives broadly agreed that misalignment between owner-operators and contractors is a key factor contributing to cost uncertainties. The lack of shared understanding of project scope is a critical communication issue between owner-operators and their EPC contractors. The project estimate and the project process-flow diagram (PFD) were specifically named as major concerns.

A number of industry experts also have made these points. One leading independent consultant who advises upstream capex spenders explained, “Owner-operators are rushing the FEED (front-end engineering and design) phase. When FEED gets squeezed, project scope isn’t defined well, and then this uncertainty is multiplied over the life-cycle of the project and the asset.”

Drew Dietrich, engineering tools manager at WorleyParsons, concurs, identifying a well-executed PFD as a key point of leverage. “The pressure on project teams exerted by owners means that the project managers are in a rush to begin detailed design even before the PFD has been done completely and reviewed by both sides,” he says. “A completely and correctly detailed process flow, reviewed with the client, can save a lot of repeat work later.”

While new paradigms in estimating, value-based contracting, modularization and increased focus on communication around the PFD are all in the idea phase now, they are significant factors that will contribute to streamlining the complex capital-projects environment in the coming years.

Ron Beck is engineering & construction industry marketing director, Aspen Technology Inc., a global supplier of software used in the estimating, conceptual design and FEED activities in the process industry.