Colin Chapman and Ekaterina Kalinenko of Euro Petroleum Consultants on managing risks in the investment process
Risks can come about unexpectedly to companies, especially if they do not have reliable sources of information regarding changing regulations, sanctions, and market price change for equipment, feedstock and products, in advance. Projects still have to be completed, sometimes at a higher cost, comment Colin Chapman and Ekaterina Kalinenko
We regularly analyse markets and projects, and we have seen that significant investments have been put into downstream facilities in regions around the world. We can see that there has been significant number of projects with large cost overruns. Over 50% of projects come online later than expected (in average 18 months later than initial scheduled date).
Five project stages
Projects can usually be broken down into five major stages – evaluation, selection, definition, implementation, and operation.
During the evaluation stage, the major risks can include incorrect analysis of the potential market demand for certain products, and incorrect economic data such as invest-cost estimations and pricing of feedstocks and products. These risks can be minimised by investigating several scenarios to ensure that there are no surprises down the road.
During the selection stage, major risks could include selection of technology, which does not have extensive industrial experience. This could lead to problems during the early years of operation, or the selection of a technology partner that could limit investment in future developments. Another risk is selection of partners that may not provide adequate support during the future project stages for different reasons, for example, geopolitical, lack of resources, or company takeover, etc.
We are seeing more and more M&A activity, especially in the international engineering and construction sector, and this certainly can affect future progress on some projects – to mention a few in this direction, initially Foster Wheeler with Amec, and now Wood within a few years, and CB&I and Mcdermott combining to become Mcdermott. Such mergers can have an impact on technology ownership and may result in sell-offs, or restricted support in some regions. Such risks are of course very difficult to foresee and therefore to mitigate.
During the definition stage, major risks could include inaccurate invest-cost analysis and poor definition of ISBL and OSBL facilities. Performing in-depth analysis and studies during these three early stages of the project help to minimise future project risks.
The next stage is project implementation. Choosing the most appropriate project implementation strategy is key to future project success to meet the required deadlines and control the quality and, of course, the project costs. Whichever model a client chooses will depend on the actual project, location, resources and their experiences. Such models as EPC LSTK, EPCM, progressive lump sum, or reimbursable are examples, which can be applied in certain cases. Before deciding on which model best fits for a specific project, all the risks must be assessed – notably those that can impact schedule, cost and quality.
Change order management is a key activity to manage the project cost risks. Clients must ensure they can control any proposed changes during implementation, especially for EPC LSTK contracts. Such terms must be included in detail in the EPC contract.
The final stage is operations. It is crucial to ensure early successful operations and manage any risks that could impact this such as lack of training of operators, extent of process integration, process controls, safety features built into the design and work processes, partners for product offtake, etc.
Understanding the different risks and building into the project features and helping mitigate major risks may of course make projects more expensive (risk premium). However, over the project lifecycle, such an approach is usually beneficial.
Uncertainty in taking risk
Can risks be managed, or just mitigated? Since the latest crisis in the oil industry unfolded, business environment has become more unpredictable than ever, and with the
capital projects getting evermore complex (for example, integrated refinery-petrochemical complexes), at times, it makes final project decisions extremely difficult due to the many factors to consider. The uncertainty of taking the risk is almost too much to take, especially with brand projects in new fields such as renewables. Additional investment to manage risks can impact the project economics and in some cases can lead to a project being considered less attractive.
We regularly analyse markets and projects, and we have seen that significant investments have been put into downstream facilities in regions around the world. We can see that there has been significant number of projects with large cost overruns. Over 50% of projects come online later than expected (in average 18 months later than initial scheduled date). So, we can conclude that there is still room for improvement to be done in the area of risk management.
The majority of projects in oil and gas industry play strategic role for the local community and region, and since quite a number of parties are usually involved, the decision to ‘abort’ the project at any stage of the process, if it does not make economic sense, is not an easy one to introduce. The good news is that most of the factors that can contribute to a project’s failure, or success, like resource availability and allocation, labour issues, quality and construction control, contracting, etc., can be controlled and managed well.
The ‘drill’ is quite simple and includes major four steps to be taken for risk management – assess impact, quantify and range risks, mitigate, and manage. Managers should always remember that it is a recurring process, and risks should be reassessed regularly, as with changing external and internal conditions, previous assumptions might become irrelevant.
The key to success is not ‘what’, but rather ‘how’ it should be done in practice to make the theory work its way through the project activities. For this matter, leadership and guidance is of utmost importance, as it helps communicate the vision throughout the organisation and allows project teams to clearly understand the importance of the input of each member to the final result.
Risk screening is a worthy instrument for finding out important factors. Generic risks are similar for typical industry projects and could be drawn from reference lists of past projects, or from consultants’ practice. Nevertheless, risks that are harder to investigate, which might decide on a project’s future, are project specific risks. For instance, for a project we worked on a couple of years ago in Russia, the largest risks were quality and compatibility of equipment supplied by different manufacturers in Asia, and also the lack of adequate inspection and control of the local construction company – a company that might try to save on costs under a fixed price agreement through using more economic equipment and materials, wherever possible.
In another region, the biggest concern was the lack of local specialists and cost of qualified labour (mostly expats), logistics, and cross-currency rate changes with US$, which was the contract currency for all contractors. Every risk assessment shall start with market review and be done by experienced specialists. That way, critical factors would not be overseen.
Role of Risk matrix
A tool that has proven its worth is a risk matrix – it can give a simple yet illustrative outlook on risks that the team should focus on and those that could work for other projects but in this precise case would only be a waste of time and resources. There are many matrixes. The easiest one in our opinion is a probability-impact matrix. Risk evaluation shall start with the analysis of probability, and then, consecutively, impact on cost, schedule, and performance (meeting technical specification). All the proceedings should be formulated in the matrix, eliminating the irrelevant options at each step.
From our project experience, we could say that having a high-quality risk questionnaire ensures input data from responsible and competent company workers and project team. It is always important to look at the project through the eyes of those who face these types of problems in their everyday routine. They could even suggest a costeffective and easy solution, as we learned from integrated risk sessions onsite.
Projects can never be risk-free. However, there are three main strategies to manage risk – retain the risk and implement internal risk control procedures and practices; transfer the risk to project counterparties (EPC contractors, O&M agreements, etc.); and transfer the risk to third parties like insurance companies.
The rule here is that risk should be split between the parties in a way that minimises potential impact for each one. From a glance, it means that client will try to transfer over more responsibility to the contractor and vice versa, but actually it makes sense that each party should take ownership for those stages that they have more control over and are ‘comfortable’ with (for example, procurement by a client, construction by a general contractor, etc.).
We are also seeing a change from the oil and gas companies in their project requirements – due to modern economic parameters and also increased competition in markets, there is a notable move towards increased automation – contractors and suppliers are asked to provide automated process and safety systems in their packages.
With Sohar Refinery Improvement Project (SRIP), the Sohar refinery of Orpic will add 82,000bpd to its existing capacity of 116,000bpd – taking the total capacity to 198,000bpd.