In his latest blog Andy Mant, Senior Account Manager at Fircroft’s Perth, Australia office, examines the impact that cost blow outs are having on the future of mega-LNG projects in Australia and beyond.
On the 30th and 31st October two articles were released by the press which drew our attention to the cost overruns on mega-LNG projects in Australia. The first was an article released regarding Chevron’s Wheatstone project stating they have suffered an additional $5bn cost blow out, coupled with a further $17bn overrun on their prestigious Gorgon LNG project at Barrow Island.
This article was followed up by one in the Financial Times which claimed that the cost overruns across Australian/PNG LNG mega-projects have been close to $50bn.
We all hear on the grape vine of cost overruns on many mega-projects and of course they come as no surprise to many. But this raises the obvious question; why does it seem like the majority of LNG projects blow out on their original budgets? It also brings to the front of my mind the question as to whether cost blow outs, which have been the norm for decades, have damaged the confidence of stakeholders and will ultimately be accepted in the new low oil price environment we find ourselves in today and for the foreseeable future.
During favourable economic periods cost blow outs seem to be absorbed and accepted more readily than cost overruns in an environment characterised by volatile, stumbling oil prices and labour surpluses. In my opinion and from my last article “The Geopolitics of Oil Price and the Changing Landscape of Australian Oil and Gas
” it is clear that the geopolitics around oil and gas production will continue to have an impact for many years to come, therefore the emergent issue that poses a more immediate threat is the lack of efficiencies which are leading to major cost overruns on mega-projects. Cost overruns need to be addressed and root causes identified to reinstill confidence in stakeholders and pave the way for successful future developments. Looking solely at oil prices and ignoring other fiscal plays in such an unpredictable economic climate would, in my opinion, be insufficient as a long term strategy for improving the economics of future oil and gas production.
Why are Mega-Projects overrunning on Cost?
In a very informative report by Ernst and Young back in 2014 many factors were identified as to why LNG projects are overrunning on their capital expenditure. Some of these factors are completely under the control of project management teams whereas others are not as easy to predict and manage. These are illustrated below:
Via: Ernst & Young, Spotlight on oil and gas megaprojects, 2014.
Those listed in grey should be in the control of project management teams at the front end of project phases, way before FID is taken. However, those in yellow are much harder to control and are typically volatile in nature. The issues that are highlighted are often accentuated by a multitude of factors. For example too much emphasis is often placed on price over quality despite the understanding that this approach often results in problems and more expense down the line to correct the issues caused by the very cost saving attempted at the front end and contract package award. This shareholder/stakeholder driven activity is severely damaging budgets on projects. Those individuals that are seeking the best return on their investments are very often hurting their own investment by prioritising cost over quality and not fully understanding the factors highlighted in the illustration above before signing off on decisions.
So we must ask, are these blow outs necessary? By this I mean are they improving health and safety and optimisation at the facility? Typically it seems that these overspends are not doing a lot for improving these factors. There might be more compassion for overspends if the oil and gas sector did not record oil spills, LNG leaks/faults, health and safety issues and declining efficiencies in production.
In a tighter market we need must focus on the consequences of choosing cost over quality. As suppliers are getting more and more desperate to win work they are undercutting on price, over promising and under delivering time and time again. This has been clearly evident across many projects in Australia.
Cost overruns are also brought about by having multiple suppliers working on the project and their (lack of) interaction with both the client and each other. We have seen a resurgence in JV partners across the industry which should offset some of the cost overruns on the supplier side. The Technip/FMC and GE/Baker Hughes collaborations and partnerships are excellent examples of joint ventures that are likely to result in cost savings to their clients without any detriment to quality.
Providing a Sustainable Environment through Effective Cost Management
The low oil price environment we find ourselves in will be here for a while so we need to minimise cost blow outs in order to sustain the future of oil and gas developments in Australia and the rest of the world. However low oil prices are not the only concern. As we have seen with Shell’s Prelude development and the Ichthys project from Inpex, oil and gas discoveries are becoming more and more complex, in environments that are very unpredictable, and harder in terms of actual extraction of the hydrocarbons. Cost blow outs in these types of environment need to be addressed at the front end and contingencies put in place to manage the inevitability of environmental and political issues. Adequate front end loading needs to be applied to the early phases of projects so that their positive effects ripple through the entire project lifecycle both pre- and post-FID.
More JVs need to form like those we have discussed above which will allow for a more collaborative approach to EPCM services provided to mega projects.
We need to increase our performance on projects through perpetual innovation and new ways of thinking. We should not follow through with packages of work and ideas that we know will cause problems as the project moves forward into execution. We need to challenge existing methodologies and bring to the field a new way of thinking about costs on mega-projects.
Shareholders and stakeholders need to take a more holistic view of projects and not be solely driven by cost. Ultimately history has proven that their short-sightedness around profit margins has cost them where it hurts them the most, in their pockets.
If we are to see a resurgence in mega-projects across the world in the near future we need to instil confidence back into the planning phases of projects, not just beyond FID or solely at point of execution.
We need assurance that project management structures have identified key risk factors related to potential cost blow outs and that these factors have been addressed and assured against budget deliverables.
Low oil price is here to stay for the foreseeable future therefore cost blow outs need to be addressed if we are to overcome the hurdle of developmental confidence and move into a sustainable future for oil and gas mega-projects globally.