MB 203_Project Management

8/8/2019 MB 203_Project Management

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COLLEGE OF MANAGEMENT AND ECONOMICS STUDIES (CMES)

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MBA OIL AND GAS MANAGEMENT

MB-203

PROJECT

MANAGEMENT


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Course Code: MB-203

Course Name: Project Managemen t

UNIVERSITY OF PE TROLEUM & ENE RGY STUDIES


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Contents

Unit 1 Project Fea sibilit y Economet r ic Model .......................................................... 1

Unit 2 Pr oject Cost Cont ingency, Risk an d Sensit ivity Analysis ......................... 17

Unit 3 In it ia t ing a Project ............................................................................................. 33

Unit 4 Pr oject Execut ion Developing a Pr oject Schedu le ..................................... 51

Unit 5 Pr oject Cont rol Checking Pr oject Pr ogress with Bell an d "S" Curves .... 81

Unit 6 Project Cost s Con t rol ........................................................................................ 99

Unit 7 Pr oject P rocur emen t Eva lua tin g Bids for Ma jor E quipm ent .................. 119

Unit 8 Att ribu tes of a Good Pr oject Mana ger .......................................................... 135

Unit 9 Mode rn Tr en ds ................................................................................................. 143

Unit 10 Bib liogr a ph y ..................................................................................................... 153


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1UNIT 1 Project FeasibilityEconometric Modelu

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Unit 1

Project FeasibilityEconometricModel

The f ac to r s a f f ec t ing the f eas ib i l i ty and the po ten t i a lprofitability of a new project are of concern to marketers,

developers and investors (Figure 1.1). Complex econometric

models, which analyze these variables, have been developed

to run on large computers . (Econometr ics i s the use of

mathematical and statistical methods to develop and verify

economic theo r ie s ) . Economet r i c mode l tha t can be

developed on a PC is described here.

In developing a PC econometric model, six factors must be

considered.

Capital Costs

The capital cost of a new project can usually be determined

with reasonable accuracy (say within 15%). Capital cost is

an extremely important number for two reasons: first, it is

required "up-front". The money has to be found and spent

many years before there is a payout. Second, the overall

profitability of a project is usually measured in terms of

Object ives

After reading this unit, you will be able to:

y Understand the concept of

l capital costs

l working capital

l operating costs

y Appreciate the concept of product revenues and the interplay ofeconomic environmental factors impacting project feasibility

y Determine techno-economic feasibility of a project

Activity 1A

Establish capital cost of a project

familiar to you. Select the mostexpensive component of capitalcost and list out ways to minimizeits cost. (In case you have notdealt any project, select/formulate a project which will becalled your project in futureactivities.)

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2 Project Managementu

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Return on Investment (ROI). Many operating concerns and

investors set their goals on ROI (say, a minimum of 20% per

ann um pr e-tax). The average annu al ROI is th e tota l earnings

d iv ided by the spec i f i ed p ro jec t l i f e t imes the to ta l

investment. A 10% increase in capital cost wil l cause a

corresponding 10% decrease in ROI for a project with a

10-year life cycle. A 20% ROI on a project with a 10-year life

means that the project will earn 20% for 10 years, which is200% on the life of the project or 100% over 5 years. This is

equivalent to a payout period of 5 years.

The need to mainta in a h igh ROI to att ra ct investors explains

why there is so much pressure to keep the ini t ial capital

investm ent to a m inimum. Fr equently, desirable options and

expansions are deferred. Features that will improve yields

or increase efficiency are carefully examined if they add to

the cost.

Activity 1B

Establish working capital of your

project. Determine inventorylevels of various components soas to minimize working capital.

Work out operating costs of yourproject. List out action plans forreducing operating costs.

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S. No. Factor Probable Accuracyof Estimate/Prediction

Possible Effecton Project

Profitability

1 Land & Site costs Good Minor

2 Engineering costs Good Minor

3 Equipment & Material costs Good Major

4 Construction Cost Fair Major

5 Initial Start Up Costs Fair Intermediate

6 Construction Duration Good Minor

7 Working Capital Fair Major

8 Operating Costs Fair Major

9 Plant Labour Rates Poor Major

10 Cost of Feedstocks Poor Major

11 Cost of Utilities Fair Major

12 Product Sale Volume Poor Major

13 Product Sale Price Poor Major

14 Residual Plant Value Poor Minor

15 Taxation Rates Poor Major

16 Rates of Inflation Poor Major

17 Interest Rates Fair Major

18 Currency Exchange Rates Poor Major

19 General Economic Climate Poor Intermediate

20 Government Influences Poor Major

Figu re 1.1: Major Fa ctors Affecting Project

Profitability


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Figure 1.2 is the checklist of items that make the capital

cost of a new project. Major items that make up the capital

cost ar e: (1) Land an d sit e developmen t costs , (2) Engineering,

p r o c u r e m e n t a n d c o n s t r u c t i o n c o s t s a n d ( 3 ) S t a r t - u p

(commissioning) costs. The land or the site costs should be

noted separately since they will have residual value after

the end of the project life. For all projects there should be a

substantial sum set aside for start-up (say 15 to 20%). This

sum may need to be higher for new unproven projects and

could be less for established projects. A suitable contingency

or management reserve needs to be included in the capital

cost estimates.

Notes

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Sr. No. Major Classification Detail Items

1 Site Property cost, Fees, Surveys, Clearing & grading, Roads,Railways, Fences, Paved areas, Landscaping

2 Buildings, Foundations &Structures

Process, Auxiliary & administration buildings, Processstructures, Pipe racks, Platforms, Ladders,Maintenance/Handling facilities & foundations

3 Building Services Plumbing, HVAC, Fire protection, Lighting, Alarms &communication

4 Process Equipment An itemized process equipment list from checked processflow sheets.

5 Non-Process Equipment Fire fighting, Maintenance, Storage & other mobileequipment, Furniture, Lockers, Tools, Office, Lab &housekeeping equipment

6 Process Auxiliaries Process piping & supports, Instrumentation, Insulation,Cabling, Switchgear, Earthing & Controls

7 Utilities Steam plant, Power generation & supply, Air Plant,Refrigeration, Water treatment & supply, Effluent treatment &outfall, Sewage & drains, Inert gas supply

8 Offsite Facilities Distribution pipelines for steam, Condensate, Water, Air,Fuel, Electrical cabling, Feedstock & finished producthandling & storage, Tanks, Spheres, Silos, Railway & truckloading facilities, Blow down & flare systems

9 Engineering Costs Administration, Process, Project & design engineering,Procurement expediting & inspection, Reprography,Computers, Communications

10 Construction Costs Construction labour, Supervision, Equipment, Tools,Consumables, Testing

11 Misc. Items Catalysts & chemicals, Spare parts, Construction spares,Surplus equipment, Taxes & insurance, Duties, Start-upexpenses, Management reserves, Errors & omissions

Figu re 1.2 : Gene ral Checklis t of Item s in the

Capital Cost Estimates

Working Capital

Figure 1.3 is a typical checklist of items that are considered

working capital. Working capital is also needed "upfront".


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T h e r e m u s t b e e n o u g h c a p i t a l a v a i l a b l e t o b u i l d u p

inventories, operate the plant and continue to pay debtors

b i l l s b e f o r e p a y m e n t s f r o m c l i e n t s a n d c r e d i t o r s a r e

received.

A majo r componen t o f work ing cap i t a l i s the cos t o f

maintaining inventories of feed stocks, products and other

consumables. Figure 1.3 also shows typical inventory levels

considered necessary. Working capital although required

"up-front", also has a residual value at the end. Inventory

can be sold off and cash value realized on completion of the

plant life.

Operating Costs

Figure 1.4 lists the typical items that go into the make-up of

operational costs. These are costs which, in general , are

proportional to the plant throughput. They are necessary to

run the plant.

The major operating costs of a process plant are the costs of

feedstock, raw materials, utilities and other consumables.

It is not un usu al for t he a nn ua l cost of feedstock an d ut ilitiesfor a process plant to exceed the capital cost by a significant

factor. This is often recognized by the fact th at a m ajor rea son

for considering a new plant is the availability of feedstock,

raw materials or a key utility at an especially advantageous

price. In many cases, the physical location of the plant

may be dictated by the location of available feedstock or

utility.

SR. NO. ACCOUNT PERIOD MONTHS

1 Feedstock Accounts Payable 0 - 1

2 Feedstock Inventories 0.5 - 1

3 Staff & Labour Payroll 0.5 - 1

4 Utilities 1 to 2

5 Manufacturing Consumables 1 to 2

6 Product Inventories 1 to 3

7 Products Account Receivables 1 to 2

8 Taxes Payable 4 to 69 Freight Payable 0.5 - 1

Figu re 1.3: Working Cap ital Items an d Pe riods

Activity 1C

Establish revenues from the

product sales of your project on

- yearly basis

- over l i fe period of theproject

List out factors that could affectthe product revenues and theprobability of their occurrence.

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SR.NO.

MAJORCLASSIFICATION

DETAIL ITEMS

1 MATERIALSFeedstock materials, Processing chemicals &catalysts, Utilities, Maintenance materials,Operating supplies & consumables

2 LABOURPlant labour & supervision, Maintenancelabour & supervision, Payroll, Additives

3 PLANT OVERHEADS

Administration, Lab, Technical, Purchasing,Inspection, Shipping, Personnel, Safety,Accounting, Clerical, Shops & repair facilities,Cafeteria, Communications, Taxes & duties

4 MARKETINGSalesmen's salaries & commissions, Publicity,Samples, Travel & entertainment, Marketresearch

5 DISTRIBUTIONContainers & packages, Transportation &shipping, Terminals & warehouses

6GENERAL, OVERHEADS

& ADMINISTRATION

General management & central technical,Marketing & other activities, Legal & patent,Research & development, Public relations

7 FINANCIALDepreciation, Debt management, Maintenanceof working capital, Credit functions, Interestpayments.

Figu re 1.4: Check List of Items for Operating Cos t Estimate s

Normally, an investor or developer will want to make sure

that there is a guaranteed source of feedstock and supplies

of key utilities at fixed prices. Long time contracts may be

signed, in advance, for the supply of feedstock and utilities.Such a m ove may go a long way in r educing the m ajor pa rt of

the risk in a new project venture.

Product Revenues

The key objective of the project is to earn revenue from the

sale of the products. For the project to be successful, there

must be a secure mar ket. The main featur es that marketers

will attempt to establish are (1) Is there a demand for the

products and will this continue or preferentially increase

over the life of the project? and (2) Will the price of the

products r ema in st able or in crease over t he life of th e project?

The total profitability of the project is set by the margin

between the cost o f p roduct ion and the se l l ing pr ice of

products. The selling price must be competitive initially and

so far as can be seen remain competitive over the life of the

project. The potential markets should be identified and the

ability of the buyers to pay must also be evaluated. Many a

Notes

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project has failed because although there was a need for the

product, the buyers did not have the capacity to pay. Most

astute developers will attempt to negotiate long-term "baseload" sales contracts at preferential prices. They will find a

financially sound buyer who will take a substantial portion

of the product at a rate that is at tractive and guaranteed

over a period of five or more years. This establishes a base

operating level and a base income for the project.

The operating level is also a key to project success. Large

plants benefit from "economies of scale". A large throughput

achieves higher operating efficiencies and also allows many

fixed or sem i-fixed costs t o be dist ribu ted over h igher volumes

of product result ing in a lower unit cost . The theory of economy of scale is admirable if there is demand for the

volume of product produced. Large plants can be big money

losers if they are not run at full capacity. In any feasibility

study, the level of plant operation is a major contributor to

overall profitability.

Economic Factors

Economic factors, in gener al, cann ot be pr edicted over a long

period. These include the rate of inflation, interest levels,

foreign currency exchange rates, and the general businessclimate. Interest, inflation and foreign currency exchange

rates can be built up in the econometric model to see the

effect on profi tabil i ty . Different high/low rates may be

selected over the life of the project to determine the best

and worst that could happen. From this, the profi tabil i ty

risk can be established. In some cases it may be possible

to hedge against adverse conditions by buying forward or

by inco rpo ra t ing ad jus tmen t s o r e sca la t ion c lauses in

contracts.

Government Influences

City, state a nd centra l governm ents can have a major impa ct

on a project. New taxes may be introduced or existing rates

may be changed. Regulations may be passed, particularly

with regard to environmental concerns, that may require

additional capital expenditure and add to the operat ing cost.

Tax incent ives may be made to compet i to rs in another

location.

Activity 1D

Establish profitability of your

project. What could be reasonsfor lower profitability?

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Nothing can be done about future government influences.

The best that can be done is to pick up an area where the

government seems stable. Look carefully at the history andcheck out al l pending legislat ion. Select backward areas

offering tax concessions over the life of the project.

The Econometric Model

The first step in preparing an econometric model is to set

up t he columns and rows required. In t he example given h ere,

the operating life of the plant will be 10 years, with a three

year construction period. A column of values will be required

for each year. An initial design value and a final value are

also needed. A reference column and a description columncomplete the picture resulting in 17 columns overall. These

are labeled A through Q.

The rows under the columns now deal in sequence with the

fac tors a l ready descr ibed to g ive the f inancia l p ic ture .

Reference should be made to the econometr ic model in

Figure 1.5. This model is an example to illustrate method

and technique. The actual values are not necessarily in line

with commercial practice.

C o l u m n H e a d i n g s : Columns a r e iden t i f i ed wi th the i rheadings and year numbers.

General Factors

u Row 1: Avera ge Inflat ion Ra te, per cent . This row shows

the predicted rate of annual inf lat ion for the entire

project life of 13 years.

u Row 2: Compounded Escalation factor (CEF). Row 2

converts row 1 into a compounded multiplier. CEF for

year

N = (1+I1/100)x(1+I2/100)..x(1+IN/2/100). For year N

average inflation rate is taken at mid year point, hence

N/2.

u Row 3: Plan t Opera ting Rate, per cent (POR). The plant

operat ing rat e is a key variable in the profitability study.

A 60% operating rate is considered for year 1 rising to

100% over the first five years.

Activity 1E

List out economic factors that

could affect profitability of yourproject. Establish their trend ofchanges based on the analysisof data of recent previous years.

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Capital Cost

u R o w 4 : Land Cost , $M. The land cost o f $20M is

e x p e n d e d i n y e a r 1 a n d a l s o a v a i l a b l e a s f i n a l

recoverable sum. The initial and final values are both

multiplied by the Compounded Escalation Factor (CEF).

u Row 5: Plant Cost $M. The plant cost is estima ted at $

250M, which will be sp ent @ 20% in year 1, 30% in year

Notes

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NO. YEAR NO. DESIGN 1 2 3 4 5 6 7 8 9 10 11 12 13 FINAL

YEAR VALUE 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1013 VALUE

GENERAL FACTORS

1 Avg. Inflation Rate % 6 6 7.5 8 8.5 9 9.5 10 10.5 11 10.5 10 9.5 9.5

2 Compounded EscalationFactor

1 1.03 1 .061 1.101 1.145 1.193 1.247 1.306 1.372 1.444 1.523 1.603 1.683 1.763 1.847

3 Plant Operating Rate % 100 0 0 0 60 70 80 90 100 100 100 100 100 100

CAPITAL COST

4 Land Cost $M 20 20.6 35.24

5 Plant Cost $M 250 51.5 79.57 110.07 28.62 44

6 Working Capital $M 186.15 0 0 0 125.42 23.25 25.31 27.5 30.1 14.6 12.75 13.1 13.61 14.04 299.93

7 Total Capital Cost $M 456.15 72.1 79.57 110.07 154.04 23.25 25.31 27.5 30.1 14.6 12.75 13.1 13.61 14.04 379.17

OPERATING COSTS

8 Feed Unit Cost $/BBL 26 0 0 0 26 27.3 28.67 30.1 31. 6 33.1 34.04 36.5 38.41 40.33 46.13

9 Cost of Feed $M 455 0 0 0 455 477.75 501.44 526.72 553.06 580.71 609.74 640.23 672.24 705.05 706.86

10 Utilities Power $M 2.52 0 0 0 2.12 2.43 2.75 3.09 3.46 3.64 3.84 4.04 4.24 4.44 4.44

11 Utilities Water $M 0.53 0 0 0 0.44 0.51 0.57 0.64 0.72 0.76 0.8 0 .84 0.88 0.93 0.93

12 Maintenance $M 10 0 0 0 8.43 9.63 10.91 12.26 13.72 14.44 15.23 16.03 16.83 17.63 17.63

13 Misc. Materials $M 15 0 0 0 12.64 14.45 1`6.36 18.39 20.57 21.65 22.85 24.04 25.25 26.45 26.45

14 Plant Labour $M 3 0 0 0 2.28 2.69 3.13 3.6 4.11 4.33 4.57 4.81 5.05 5.29 5.29

15 Administration $M 8 0 0 0 9.16 9.55 9.98 10.45 10.97 11.55 12.16 12.82 13.47 14.1 14.1

16 Total Operating Cost $M 520.05 0 0 0 516.07 544.31 574 605.26 638.21 670.26 704.05 739.4 776.37 815.03 815.03

REVENUES

17 Product A Base Price $/BBL 33.5 0 0 0 33.5 35.18 36.93 38.78 40.72 42.76 44.8 9 47.14 49.49 51.97 51.97

18 Product A Extra Price $/BBL 30.15 0 0 0 30.15 31. 43 32.85 34.41 36. 13 38.02 40.11 42.2 2 44.33 46.44 46.44

19 Product A Revenue $M 345.89 0 0 0 207.53 250.67 297.37 348.1 403.44 440.65 463.02 486.34 510.4 6 536 536

20 Product B Price $/BBL 32 0 0 0 36.63 38.19 39.91 41.8 43.89 46.2 48.74 51.3 53.86 56.42 56.42

21 Product B Revenue $M 196 0 0 0 134.62 163.73 195.54 230.43 268.84 292.95 298.51 314.18 329.89 345.56 345.56

22 Excess Feed Revenue $M 0 0 0 0 1 63.8 129.99 90.29 47.4 0 0 0 0 0 0 0

23 Total Revenue $M 637.54 0 0 0 606.23 648.19 692.89 740.93 793.01 850.57 895.27 941.18 988.24 1036.39 1036.39

FINANCIAL PICTURE

24 Cumulative Cash Flow $M -72.1 -151.67 -261.74 -325.61 -244.98 -151.4 -43.31 81.39 247.1 4 25.57 614.17 812.42 1019.74 1398.91

25 Discounted Cash Flow $M -70 -142.96 -237.79 -284.45 -205.29 -121.41 -33.16 59.3 4 171. 17 279.43 383.14 482.69 578.39 757.47

26 Annual Depreciation $M 22.5 0 0 0 22.5 22.5 22.5 22.5 22.5 22.5 22.5 22.5 22.5 22.5 0

27 Depreciated Book Value $M 250 250 250 250 2 27.5 205 182. 5 160 137.5 115 92.5 70 47.5 25 25

28 Actual Annual Profit $M 94.99 0 0 0 67.66 81.3 96.39 113.16 132.3 157.82 168.72 179.28 168.36 198.86 1384.93

29 Discounted Annual Profit $M 94.99 0 0 0 59.11 68.2 77.29 86.6 3 96.46 109.32 110.78 111.84 112.51 112.79 944.92

30 Discounted Annual ROI % 20.02 0 0 0 12.96 14.95 16.94 18.99 21.15 23.97 24.29 24.52 24.66 24.73 20.72

LOAN ALTERNATIVES $M125 CAPITAL + 250 LOAN

31 Loan Interest/Repayment $M 45 45 45 45 45 45 45 45 45 45 45 45 45 45 250

32 Cumulative Cash Flow $M -257.9 -193.81 -79.89 -10.38 85.85 181.15 292.09 420.89 592.1 777.62 971.67 1172.87 1381.74 1760.91

33 Cash Retained $M 375 257.9 193.81 79.89 10.38 30 60 100 150 210 250 290 320 342.47 375

34 Interest on Cash in Hand $M 15.47 11.63 5.99 0.03 2.55 5.4 9.5 15 22.05 27.5 30.43 32 32.53 210.91

35 Declared Annual Profit $M 0 0 0 0 55.85 65.3 70.94 78.8 111.21 143.32 154.05 171.2 184.4 1039.27

36 Discounted Annual Profit $M 0 0 0 0 46.8 52.36 54.3 57.45 77.94 95.55 96.1 101.72 105.73 687.05

37 Discounted Annual ROI % 0 0 0 0 37.44 41.97 43.44 45.91 61.63 76.64 76.88 81.37 84.5 54.96

Figu re 1.5: The Econ ome tric Model

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2, 40% in year 3 and last 10% in year 4. Expenditure in

each year is multiplied by CEF. The equation for the

expenditur e in year 3 (for exa mple) is 250x0.4xCEF. The

final cost is the residual scrap value assumed as 10%.

The final value is also multiplied by CEF.

u Row 6: Working Capital, $M. The working capital is

es t imated a t $20M plus 2 months of feedstock and

product inventories. The working capital is generated

by an equat ion which escala tes the $20M and adds

2/12 t hs of the designed feedstock/product quanti t ies

t imes the operating rate t imes the feedstock/product

prices for the year in question. Addit ional workingcapital is needed each year to allow for escalation and

increased operating rates. The final residual value is

the cumulative value of all the working capital spent.

u Row 7: Total Capital Cost, $M. This is the sum of rows

4 thr ough 6.

Operating Costs

u Row 8: Feed Unit Cost, $BBL. This is the contractual

feed for the 10 year period. The initial cost is $26/bblsubject t o a 5% increase ea ch year . The cost in year N is

$26x1.05^N.

u Row 9 : Cost of Feed , $M. This va lue i s the bar re l

per day (50,000) times the number of operating days

in the year (350) times the feedstock unit cost. Since

the contract requires that the whole 50,000 barrels be

taken, this number is not multiplied by the operating

ra te .

u Row 10: Utilities Power, $M. Power requirements haveb e e n e s t i m a t e d a t 1 . 8 k W h / b b l o f f e e d a t d e s i g n

throughput. At lower plant operating rates, the power

u s a g e p e r b a r r e l w i l l i n c r e a s e b y t h e 0 . 6 p o w e r .

Electr ici ty rates are ini t ial ly $0.08 per kwh and are

subject to escalation. The equation for power costs thus

becomes 50,000 x350x1.8x0.08xCEFx(POR/100)^0.6.

u Row 11: Utilities Water , $M. Water requirements have

been estimated at 15 gallons per barrel. Water costs at

Activity 1F

Prepare an econometric model

of your project.

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$2.0 per 1000 gallons initially are subject to escalation.

As with power, water consumption per barrel increases

to the 0.6 power at lower operating rates. The equation

for wa ter costs is similar to th e equa tion for power costs

50,000x350x15x2.0/1,000xCEFx(POR/100)^0.6.

u Row 12: Maintenance, $M. Annual maintenance has

b e e n e s t i m a t e d a t $ 1 0 M . T h i s v a l u e i s s u b j e c t t o

escalation. Maintenance costs are reduced at lower plant

operating rates and again the 0.6 power rule applies.

The equation is 10xCEFx(POR/100)^0.6.

u Row 13: Miscellaneous Materials, $M. Miscellaneous

mater ials are est imated at $15M.The same equation

applies as for maintenance.

u Row 14: Plan t Labour , $M. P lan t l abou r has been

estimated at 100 persons, over all, at an average cost of

$30,000 per year. Plant labour is subject to escalation.

At lower p lan t opera t ing ra tes , p lan t labour can be

reduced s l igh t ly by the 0 .8 power . The equat ion is

100x30,000xCEFx(POR/100)^0.8.

u Row 15: Administration, $M. General administrativeand overhead costs have been estimated at $15M per

year . This value is subject to escalat ion and is not

changed by plant operating rates.

u Row 16: Total Operating Cost, $M. This is the sum of

rows 8 through 15.

Revenues

u Row 17: Product A Base Pr ice , $ /BBL. This i s the

contractual price to be agreed with ABC Co. (client). Avalue of $33.5/bbl is selected for the base case. This price

will be su bject to an increase of 5% per year by cont ra ct.

The price in year N is 33.5x1.05^N.

u Row 18: Product A Extra Price, $/BBL. Any product

produced over and above that required to meet the ABC

contract level will be sold on the open market. It is

assu med th at initially this extra product ma y be sold at

90% of ABC's price but that this price will strengthen

Activity 1G

List out factor that could affect

econometric model of yourproject. Check out those factorsthat have greatest effect onprofitability of your project.

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over the years in line with the escalation rate. The price

equation will therefore be 33.5x0.9xCEF.

u Row 19: Product A Revenue, $M. This value is the total

product A multiplied with the above prices. For years 1

to 5 = 15000xABC price + (30,000xPOR-15000)x Extra

p r i ce . Fo r yea r s 6 to 10 = 25 ,000xABC p r ice +

(30,000xPOR-25,000)x extra price.

u Row 20: Product B Price, $/BBL. It is assumed that

product B can be sold on the open market. The initial

market price is $30/bbl. This value will be increased

a n n u a l l y i n l i n e w i t h t h e c o m p o u n d e d e s c a l a t i o n

factor.

u Row 21: Product B Revenue, $M. Product B revenue

will be production (17,500) times the POR times the

price in Row 20.

u R o w 2 2 : Excess Feed Revenue , $M. S ince XYZ

(producer) is contractually required to buy 50,000 bbl of

feed regardless of the plant operating rate, the excess

feed must be sold on the open market. It is assumed

that the excess feed can be sold at 90% of the purchase

p r ice . The r evenue wi l l be 50 ,000x(100-POR) /

100x0.9xfeed pr ice.

u Row 23: Total Revenue, $M. This is the sum of rows 17

through 22.

Financial Picture

u Row 24: Cumulative Cash Flow, $M. This value is the

cumulative sum of the total revenues (row 23) minus

the total expenditures i.e. total capital costs (row 7) and

total operating costs (row 16). Initially the cash flow is

negative due to initial capital outlays.

u Row 25: Discounted Cash Flow, $M. The discounted

cash flow is the actual cash flow in row 24 converted to

present day values. The annual values in row 24 are

divided by the compounded escalation factor (CEF).

u Row 26: Ann ua l Depreciat ion, $M. This value is th e total

capit al cost m inus t he res idual value divided by th e plant

Notes

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l i f e . S ince bo th l and cos t and work ing cap i t a l a r e

residual, this value equates to plant cost minus scrap

value divided by plant life. There are different methods

of calculat ing depreciat ion. This is the straight l ine

method.

u R o w 2 7 : Deprecia ted Book Value , $M. This i s an

accounting Figure and is equal to the capital cost minus

th e residual value minus the a nnu al depreciation to date.

u Row 28: Actual Annual Profit, $M. This value is the

total annual revenues (Row 23) minus the total annual

o p e r a t i n g c o s t s ( R o w 1 6 ) a n d m i n u s t h e a n n u a l

depreciation (Row 26).

u Row 29: Discounted Annual Profit, $M. This converts

the annual profit in row 28 to the present day value by

dividing the actual annual profit by the compounded

escalation factor (Row 2).

u Row 30: Discoun ted Annua l ROI, %. This r ow gives t he

v a l u e t h a t i s o f p r i m e i n t e r e s t t o i n v e s t o r s . T h e

discoun ted an nu al pr ofit (Row 29) is divided by the t otal

initial design capita l cost to give the ROI. The fina l value

gives the average over the plant life.

Loan Alternative

The econometric model up until now has assumed that all

the capital needed will be provided by the XYZ company.

An alternative to this is to raise a loan with fixed interest

rate over the project life including the construction period.

The loan repayment will be fixed and can be considered as

operating cost. The balance of any profit and the residual

cost a re t hen a vailable to the compan y and can be r elated to

a lower investment cost.

To check out the economics of this alternative, a case is

assumed such that $250M is taken as loan over a 13 year

period. An additional $125M is raised as capital by the XYZ

shareholders.

u Row 31: Loan/Interest Repayment, $M. This shows the

annua l in te r es t due on $250M loan a t 18% s imp le

in teres t .

Activity 1H

Modify econometric model of

your project by assuming debtequity ratio of 1:1, i.e. projectfinancing through 50% loan and50% equity.

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u Row 32: Cumulative Cash Flow, $M. This is the same

as row 24 except t he project sta rts with $375M in h and

and $45M in interest is paid out each year.

u Row 33: Cash Retained, $M. Available cash initially

exceeds requirements. Later excess cash is retained to

build up capita l to pay off the loan. To compa re t he loan

alternative with the base case, the final cash retained

equals the loan plus investment capital , leaving the

residual value the same as the base case.

u Row 34: Interest on Cash in Hand, $M. The excess cash

in hand will earn interest. It is assumed that interest

will be earned at the annual inflation rate in Row 1.

u Row 35: Declared Annual Profit, $M. In this case profit

can be declared at any level supported by the cash flow

less the cash retained.

u Row 36: Discounted Annual Profi t , $M. This is the

present or the discounted value of the annual profit.

Row 35 is divided by CEF.

u R o w 3 7 : D i s c o u n t e d A n n u a l R O I , % . I n t h e l o a n

alternative, the profit is divided by the shareholders'

capital of $125M only since this is t he sh ar eholders' t ota l

investment. As can be seen, although the total profit

earned is lower, the ROI is considerably higher due to

the reduced investment.

Analyzing the Financial Picture

Now that the econometric model is complete, it is possible

to examine the profitability of the venture. The base case

yields an average annual ROI of 20.72% over the 10 yearswhich is at t he desired t ar get level. Actu ally, th e profita bility

ma y be higher t ha n sh own, since not all th e working capita l

is expended initially and some interest could be earned on

excess cash in hand . Also the r e s idua l va lue p lu s the

depreciated value exceeds the initial investment. If desired,

the econometr ic model could be adjusted to show these

details, however, the base case results shown are probably

close enough for analysis and decision making.

Activity 1I

Calculate ROI for the following

two alternatives of your projectfinancing :

- 100% equity

- 50% equity and 50% debt(loan).

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Modifying the Variables

Now that the econometric model has been set up, unlimited"What if" simu lat ions ma y be car ried out to see t he effect on

the bottom line. The inter-meshing equations on the spread

sheet instantly adjust all related values in the columns and

rows to show the new picture. To illustrate this, following

five "what ifs" are simulated.

u Case A. Project capital cost overruns by 50%.

u Case B . Annual inf lat ion rate runs 15% higher than

predicted rate.

u Case C. Operating rate runs 10% lower than hoped forin first five years.

u Case D. Due to competitive market, proposed price of

product A to ABC company must be reduced by 10%.

u Case E . Market for product B is less buoyant than

anticipated, cut by 20%.

All of these changes can be entered singly or in combination

and the spread sheet will instantly adjust. Figure 1.6 shows

the effect on the annual discounted ROI per cent of each of

the above "What ifs" and compares the changes against the

base case.

Activity 1J

Determine the effect of various

factors on the profitability of yourproject as illustrated in this Unit.

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Fig ure 1.6: Comp aris on of "Wha t if"Case s


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Simplicity and Flexibility

The personal computer with a spread sheet can be used tocrea te a ta i lo r made econometr ic model tha t can be as

complex as you want it to be.

Summary

This unit provides a simplified method of evaluating

economic f eas ib i l i ty o f a p ro jec t by p repa r ing i t s

econometric model on a PC. It also offers insight into

various factors that could affect project feasibility. This

provides good initial evaluation of a project.

Review Questions

1. Define most commonly used finance term involved in

developing a project.

2. Lis t factors used in s t ructur ing a project .

3. Describe economic factors affecting development of new

project.

4. An a l y ze e ffe ct o f v a r i ou s e c on o m ic fa c t or s i neconometrics model for a project.

5 . Explain th e significance of various cost components of

a project.

6. What are the main constituents of Econometric Model

and their significance?

7. Wh a t i n you r v ie w i s t h e n e xt s t e p in e s t a blis h in g

pro jec t feas ib i l i ty? Give deta i l s o f any such s tudy

required.

Notes

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17UNIT 2 Project Cost Contingency, Risk and Sensitivity Analysisu

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The analysis of contingency, risk and sensitivity analysis isan essential part of capital cost estimation. An estimate, by

definition, is an approximate computation of the probable

cost. It is unusual that the project final cost matches the

initial estimate. Those who are unfamiliar with estimating

methods may expect more details and more accuracy in an

estimat e tha n is achievable. There ar e so ma ny variables an d

unknowns at the time an estimate is prepared that arriving

at a reasonably close overall cost estimate is more art than

science. Skill and judgment is needed to identify and predict

the unknown.

Those unfamiliar with estimating methods are more likely

to accept a contingency figure which can be supported by

analysis than a number which appears to be someone's best

guess. Simple systems, which can be readily applied to a

variety of estimates for the analysis of contingency and risk,

are described hereunder.

Object ives


y Establish risk components in project cost estimates

y Establish the sensitivity of cost estimates to various riskcomponents

y Provide appropriate contingency in the cost estimates to coverthe risk factors

Activity 2A

Write down the risk factors in cost

estimates of your project.

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Unit 2

Project Cost Contingency,Risk and Sensitivity Analysis


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Definitions

The following are generally accepted definitions:

u Contingency: A provision for an occurrence dependent

upon chance, accident or uncertain event.

u Risk: Exposure to mischance, danger, hazard, injury,

damage, bad consequence or loss.

u Sensit ivi ty: The quality of being keenly susceptible and

responsive to external forces.

u Analysis: A separating or breaking up of any whole into

i ts par ts so as to f ind out the i r na ture , p ropor t ion ,

function and relationship.

Types of Project Estimates

Contingency, risk and sensitivity analysis can be applied to

any part of a project cost estimate such as:

u Fixed capital

u Working capital

u Operat ing cost

Here we will discuss the application of contingency, risk and

sensitivity analysis to the fixed capital cost estimates. The

concept can equally apply to working capital and operating

cost estimates.

Fixed Capital Cost Estimation

The f i r s t s t ep in the p repa ra t ion o f f ixed cap i t a l cos t

estimates is to sub-divide the project into its units or areas.A typical refining or a petrochemical complex may be sub-

divided as shown in Figure 2.1. This is not intended to be a

complete list. It merely illustrates the first step in breaking

down an ove ra l l complex in to spec i f i c un i t s , a r eas o r

categories to facilitate cost estimation.

The next step is to take each of these major subdivisions and

apply a common code of accounts which will apply to all

project subdivisions as shown in Figure 2.2.

Notes

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Activity 2B

Subdivide your project into its

units or areas. Apply thecommon code of accounts to

each subdivision.

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00 Process Plants

01 Crude Unit

02 Reforming Unit

03 Desulfurising Unit

10 Utilities & Services

11 Water Facilities

12 Steam Facilities

13 Electrical Facilities

14 Fuel Facilities

15 Flare & Blowdown Facilities

16 Waste Disposal Facilities

20 Storage & Transportation

21 Tankage

22 Distribution Systems

23 Loading & Unloading Facilities

24 Material Handling Facilities

25 Dock & Wharf Facilities

30 Civil Works

31 Fences, Roads, Railroads, Dykes

32 General Administration Buildings

40 Miscellaneous Accounts

41 Spare Parts

42 Catalyst, Chemicals & Consumables

43 Maintenance Equipment

44 Mobile & Transportation Equipment

45 Laboratory & Machine Shop Equipment

46 Office Furniture & Equipment

Figure 2.1: Subdivision of a Typical Re fining Complex

Project Subdivisions


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Acct Description Material Labour Sub-Contract Total

A Equipment

A1 HeatersA2 Tanks & Vessels

A3 Heat Transfer Equipment

A4 Rotating Equipment

Sub-Total

B Bulk Materials

B1 Civil Works

B2 Buildings

B3 Piping

B4 Electricals

B5 Instrumentation

B6 Protective Coatings

Sub-Total

C Services

C1 Home Office

C2 Construction

C3 Miscellaneous

Sub-Total

Total

Figu re 2.3: Project Code o f Accou nts for Each Un it or

Area of the P roject

Figu re 2.4: The Overall P roject Estima tes Matrix

Activity 2C

Prepare cost estimate of each

unit of your project in line withFi.2.2. Prepare your project total

cost estimates.

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ACCT DESCRIPTION

PROCESS

PLANT

UTILITIES

&

SERVICES

STORAGE

& TRANSPO

CIVIL

WORKS

MISC

.

TOTAL

01 02 03 04 11 12 13 14 21 22 23 24 31 32 33 41 42 43

ACCT DESCRIPTION

A EQUIPMENT

A1 HEATERS

A2 TANKS & VESSELS

A3 HEAT TRANSFER EQUIPMENT

A4 ROTATING EQUIPMENT

SUB-TOTAL

B BULK MATERIALS

B1 CIVIL WORKS

B2 BUILDINGS

B3 PIPING

B4 ELECTRICALS

B5 INSTRUMENTATION

B6 PROTECTIVE COATINGS

SUB-TOTAL

C SERVICES

C1 HOME OFFICE

C2 CONSTRUCTION

C3 MISCELLANEOUS

SUB-TOTAL

TOTAL


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techniques and the use of common codes of accounts assist

with the build up of cost statistics and the transfer of cost

data and ratios from one project to another.

Estimate Accuracy

Having prepared the unit and overall project estimates, the

next question is "What is the accuracy?" A higher level of

accuracy may be expected than is realistic. However, if the

accuracy probabi l i ty i s assessed by a formal analy t ica l

p rocedu re , then i t w i l l be more l ike ly tha t a r ea l i s t i c

contingency will be set.

The accuracy of an es t imate depends upon the pro jec t

def in i t ion and a lso on the t ime and ef for ts spent on i t s

preparation. Figure 2.5 indicates typically the probable

accur acy of estima tes at each pr oject definition st age. Moving

f rom le f t to r igh t the accu racy inc reases wi th p ro jec t

definition.

Figu re 2.5: Accuracy o f Estima tes Rela ting to

Project Definit ion

Activity 2D

Establish estimate accuracy of

each sub-division of your projectand of the total project.

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Order of magnitude

Preliminary

Definitive

Detailed

Final

0 1 2 3 4 5

10

20

30

40

500 Original concept1 Process design complete2 Basic engineering complete3 Detailed engineering complete4 Mechanical erection complete5 Financial completion

Probableaccuracyofestimate


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At stage 0, when the project is still in the initial conceptual

phase, an order of magnitu de estimat e may ha ve an a ccura cy

of between 30 to 50%.

At s tage 1, when p rocess des ign has been f ina l i zed , a

preliminary or factored estimate from equipment costs may

be prepared with an accuracy of between 15 to 25%.

At stage 2, when basic engineering is complete, i.e. piping

and ins t rumenta t ion d iagrams, p lo t p lans , a r rangement

studies etc. have been completed, a definitive estimate can

be prepared with an accuracy of 10 to 15%.

At stage 3, on completion of engineering wh en final d ra wings

and bills of materials have been completed and all material

has been pur chased, a deta iled estimate can be prepared with

an accuracy of 5 to 10%.

Stage 4, corresponds to mechanical completion of erection,

but even at this time, the final actual cost of project is not

known precisely.

The last stage 5, at financial completion, is when the final

actual cost is known which is when all the bills have been

sett led. This may be af ter several months of mechanical

completion.

If the above ranges of accuracy are typical and has been

proved by experience from many projects, then if one can

define the stage of project definition, the likelihood is that

t h e a c c u r a c y w i l l f a l l s o m e w h e r e i n t h e s h a d e d a r e a

indicated. It follows that an average contingency within the

range shou ld be a l lowed , depend ing upon the spec i f i cproject.

Figure 2.5 also indicates that the accuracy is related to the

proximity to the completion date. An estimate is more likely

to be accurate if the time to completion is reduced. If there

is a long schedule period, the probabil i ty of inaccuracy

increases.

Notes

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The Need for a Contingency

Regardless of the time and effort spent in preparation of anestimate, there is always the possibility of errors due to:

u En gineering err ors an d omissions

u Cost and rate changes

u Construction problems

u Schedule s lippages

u Miscellaneous unforeseen

u Estimating inaccuracies

D u r i n g t h e p r e p a r a t i o n o f t h e e s t i m a t e , e a c h i t e m i s

costed by estimating the man-hours or material content and

applying a cost rate. At the preliminary est imate stage,

t h e m a t e r i a l c o n t e n t i s n o t c o m p l e t e l y d e f i n e d . A n

a l l o w a n c e i s t h u s r e q u i r e d w h i c h r e c o g n i z e s t h a t t h e

f ina l mater ia l quant i ty wi l l exceed the in i t ia l quant i ty .

This is covered by a design margin applied to the equipment

and bulk mater ia l ca tegor ies and is an in tegra l par t o f

t h e e s t i m a t e . D e s i g n m a r g i n s a r e n o t p a r t o f t h econtingency.

The contingency is required to cover those events which

could occur during progress of any normal project. Complete

coverage to cover wor s t poss ib i l i t i e s cou ld r equ i r e a

significant contingency for each code of accounts. The sum

of these con t ingenc ies wi l l g ive a ve ry l a rge ove ra l l

contingency for the total project.

The probability that things will go wrong on all accounts is

unlikely. Therefore, the overall contingency does not need

to be the sum of the maximum individual contingencies. It is

an average cont ingency tha t should be adequate i f i t i s

assumed that not all things will go wrong and some things

may go better than planned. The practice, therefore, is to

determine average contingency for each account. This is

totaled and kept as a separate overall contingency, available

to the project as a whole.

Activity 2E

Prepare a contingency

worksheet of your project in linewith Fig.2.6.

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Method of Determining Contingency

The method of arriving at a reasonable contingency requires judgmen t . So , i t i s des i r ab le tha t a cons i s t en t log ica l

procedure be used in its development. The procedure should

separa te wha t m ay be term ed "average contingency" and the

"ma ximum risk cont ingency," which would be t he contingency

required to cover the worst case.

Average contingency is determined by examining the project

definit ion stage for each code of accounts and applying

average es t imat ing accuracy fac tors appropr ia te for the

specific project. The maximum risk contingency (discussed

later) is determined by examining problem areas in each codeof accounts.

The average accura cy ranges ar e tak en from t he chart shown

in Figure 2.5 for each stage of definit ion. The probable

accuracy selected for a specific project will be within the

ranges shown in Figure 2.5 for each stage. Whether the

Figure selected will be at the top or bottom end of the range

will be determined by the variables and unknowns for the

specific project.

For example, a Gulf Coast project for a conventional process

unit would be at the lower end of the range, while a non-

standard process unit at an overseas site would be at the

upper end o f the r ange . P rocess unknowns , sou rces o f

engineering, procurement and construction, the schedule

period, market and economic factors could all influence the

selection of the probable accuracy for the specific project.

Following this evaluation, a chart as shown in Figure 2.6 is

drawn up for the specific project being evaluated.

STAGENUMBER

PROJECT DEFINITIONTYPICAL

ACCURACYRANGE +OR -

ACCURACY RANGESELECTED FOR

SPECIFIC PROJECT

0Initial concept prior to finalization of processdesign

25 to 50 30

1Process design finalized with equipment but notquoted. Bulk material factored but un-priced

15 to 25 20

2

Completion of basic engineering, mechanicalflow sheets, P&Ids, plot plans approved,equipment quoted and preliminary take-offs forbulk materials quoted

10 to15 13

3Engineering and design complete with finalquantities take off. Orders placed for tools,equipment & materials

5 to 10 8

4 Mechanical erection complete 0 to 5 4

5 Financial completion 0 0

Figu re 2.6: Basis for Avera ge Contin gen cy

Notes

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To evaluate the average contingency, a standard worksheet

form is used as shown in Figure 2.7.

Figure 2.7: Conting enc y Workshe et Form

Columns 1 & 2 on the left hand side of the form list the

equipment and bulk materials by code of accounts. The form

may be subdivided under material, subcontracts and labour

in a similar manner to the way in which the unit estimate is

built up.

Column 3 shows the current estimate value or most recent

forecast value in dollars.

Colum n 4 expresses the value in column 3 as a percentage of

the es t imate to ta l . This i s used for sensi t iv i ty analysis

(discussed later).

Column 5 through 10 indicate the percentage of column 3

that has been defined through to the stage indicated. For

example, if the project is in the initial conceptual stage, then

it will show 100% under stage 0. If the account has passed

through the definit ive est imate stage and 50% has been

purchased, then 50% would be at sta ge 2 and 50% at st age 3.

The object is to identify the degree of definition for the

account by al locating the total 100% in the appropriate

columns from stage 0 to stage 5. This allocation need not be

too precise. It can be perform ed on a n a pproxima te judgmen t

basis. I t is of par t icular value if the project est imate is

reviewed at periodic intervals and contingency reevaluated

as the pro jec t def in i t ion improves . In such a case , the

AccountNo.

Description

ForecastValue,

$

%

ofTotalCost

%

atstage0

%

atstage1

%

atstage2

%

atstage3

%

atstage4

%

atstage5

%

Normal

Contingency

Normal

Contingency,

$

Activity 2F

Establish overall average

contingency for your project byusing the contingency sheet

prepared earlier.

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i s to iden t i fy the major i tems of r i sk and to assess the

maximum cost impa ct of the risk. The next step is to at tempt

to assess the percentage probability that this risk will occur.

The net risk then becomes the multiple of the maximum cost

of the risk times the probability. The sum of all the net risks

for each of the risk possibilities gives the total maximum

risk contingency required (see Figure 2.8).

Risk - Areas

Labor Disputes & Shortages Equipment FailuresHigh Labor Wage Settlement Subcontractors Poor PerformanceInclement Weather Supplier's ClaimsLow Productivity Damages And Losses

Late Deliveries Schedule Completion FormalitiesMaterial Shortages Operating Performance Penalties

Figu re 2.8: Risk Areas

Two sepa ra te ana ly ses have now been pe r fo rmed an

a v e r a g e c o n t i n g e n c y e v a l u a t i o n a n d a m a x i m u m r i s k contingency evaluation. Again an overall contingency put

into an estimate need not necessarily be the sum of these

two. I t requires judgment to assess which number i s a

reasonable contingency to apply against t he estima tes. It may

be policy to include the two contingencies as separate items

i.e. including the a verage cont ingency as pa rt of th e estima tes

and m ainta in a ma ximum risk contingency as a separ ate fund

to offset any major risk items that have been identified.

SensitivityHaving carried out the contingency and risk analysis, the

last step is to do a sensitivity analysis. The term may be

interpreted in many ways. But in general, the requirement

is to determine cost areas which could change significantly

and which, in turn, would have the greatest impact on the

overall project cost which will be more sensitive to changes

in some accounts than others. For example, if one account

represents 1% of the total cost, then a 100% overrun in this

ITEM OF RISKMAXIMUM EXTRA

COST DUE TO RISK

PROBABILITY OF RISK

OCCURANCE

NET RISK TO

PROJECT

Activity 2H

Using average and maximum

contingency for each account,establish potential areas of highsensitivity and impact of anyspecific cost changes for your

project.

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account will only effect the total by a maximum of 1%. On

th e other han d, if another account represents 20% of the t otal

cost, then a 10% overrun on this account could affect the

total cost by 2%. Thus the total cost has greater sensitivity

to this account than the first.

As the project proceeds, so sensitivities will change as some

of the accounts become firm and committed. Sensitive areas

will be those accounts which still have the largest dollar

va lues ye t uncommi t t ed and wh ich r equ i r e the l a rges t

contingency.

The analysis o f average and maximum r isk cont ingency

provides an effective means of establishing sensitivity. A

qu ick r ev iew o f the r equ i r ed ave rage con t ingency and

maximum risk contingency against each of the account codes

will indicat e ra pidly the potent ial ar eas with high sensitivity

i.e. the cost accounts which may have the maximum effect

on the total cost forecast both in the areas of overruns and

potential cost savings. It is, therefore, a valuable exercise to

identify the highly sensitive areas. Following on from this,

one may introduce some additional surveillance with checks

and balances in these areas to a t tempt to min imize the

potential overrun and maximize the potential for reducing

the overall project cost.

Having performed a review of each account for average and

maximum contingency to identify potential areas of high

sensitivity, the next step is to identify the impact of any

spec i f i c cos t changes . Fo r example , changes in l abo r

productivity, cha nges in wa ge ra tes or exten sion t o the pr oject

schedule. For specific risks of this type, sensitivity covers

can be constructed to show the impact of these cost changes.

Figure 2.9 illustrates two types of such curves. The first

shows the e f f ec t on l abou r cos t o f chang ing l abou r

productivity combined with the changes in the labour cost

rates. As can be seen, the total labour cost is extremely

sensitive to reduction in labour productivity, more so than

increase in labour rate.

The second chart shows the effect of increased schedule time

on project cost. It shows, for example, that the effect on

Activity 2I

Using the analysis so far carried

out and your judgment,establish a suitable contingencyfor your project. Give reasonsfor selecting this contingency

amount.

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project costs may be significantly increased due to changes

in labour ra tes and possib le labour product iv i ty due to

running into winter (rainy) working conditions, etc.

Judgment Factor

The areas of contingency, risk and sensitivity analysis are

i n t e r r e l a t e d . T h e s u b j e c t p r o v i d e s a f e r t i l e a r e a f o r

mat hema ticians, stat isticians a nd other an alytical types with

computers. At the same t ime, i t is also apparent that no

matter how refined a system is applied, both the basic input

d a t a a n d t h e f i n a l a s s e s s m e n t d e p e n d s h e a v i l y u p o n

judgment.

Figu re 2.9: Sen sitivity Curve s

Notes

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33UNIT 3 Initiating a Projectu

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A new project is "initiated" when owner and contractor enter

into a contract or agree to start work with "letter of intent"

while the contract is being finalized. From the contractor's

viewpoint, the owner has now become the "client".

Manpower Build-up

In order to build a plant, an Engineering & Construction

(E&C) contractor must spend money at the proper rate to

meet the required completion schedule. Money translates

to man-hourswhether it is home office engineering hours,manufacturing hours or field construction hours. To achieve

progress, man-hours must be spent. On a project where short

schedule is of prime importance, calendar time can be saved

by selecting designs already completed, standard equipment

already fabricated, or material in stock. Even when these

methods are used, there are still a large number of hours in

engineering, manu facturing a nd const ruction which must be

expended during the project execution.

Object ives


y Understand the basic steps required to be taken at the time ofinitiating a project

y Explain importance of the various initiation steps at project initiationstage

y Explain how an effective communication channel should beestablished with the client and other team members

y Emphasize importance of freezing project technical data at theinitiation stage itself

Activity 3A

Make a list of the major initiation

steps for your project.

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Unit 3

Initiating a Project


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The E&C must achieve a rapid mobil ization and smooth

application of man power, without flat periods, fluctuations,

or excessive peaks, which will match the project budget and

schedule. This is where the skill of E&C plays an important

part. Figure 3.1 shows the relationship between home office,

manufacturing and construction man-hours. The solid curves

show the desired rate of mobilization and build-up with rapid

spread of work through manufactur ing and const ruct ion

giving optimum peak manpower application consistent with

the needs of the project schedule. The dotted curves show

the impact if early engineering is delayed. This results in

s t e e p e r m o b i l i z a t i o n c u r v e s i n m a n u f a c t u r i n g a n d

construction with higher man-power peaks which, in turn,

lead to inefficiency and greater cost.

Figure 3.1 illustrates the importance of a fast engineering

start. Every man hour below the optimum curve during the

early engineering phase may add four to five times these

hours to the peak du ring the m anu facturing an d constr uction

phases if the scheduled end date is to be met. Conversely,

overstaffing in the early phases ahead of date development

will also lead to inefficient man hour utilization.

Figu re 3.1: Man-hou r Curves for Engine ering , Manufacturin g

& Construction

Notes

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Major Initiation Steps

As soon as a project has been awarded, a project manager(PM) begins a ra ce against time a s th e leader of a tea m, when

th e team, th e rules and the course m ay yet have to be defined.

The initiation of a project puts great pressure on him to get

the project moving. Table 3.1 lists the steps in the initiation

of a project. The list is not compr ehens ive but shows th e more

important activities of a project manager.

These steps do not necessarily occur sequentially. Several

may occur in parallel. The list in Table 3.1 can be assembled

into an activity network as shown in Figure 3.2. All of theseactivities should be undertaken within the first few weeks

of project awa rd. E ach of the a bove steps is described in more

details below.

Figu re 3.2: Project Initiatio n Netw ork

Table 3.1: Project Initia tion Ste ps

1. Review Pre-contract Documentation

2. Establish Client Communication Channels

3. Hold Client Kick-off Meeting

4. Establish Project Procedures

5. Prepare Project Plan

6. Establish Project Organization

7. Hold Project Kick-off Meeting

Activity 3B

Establish a procedure for

communication with client.

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Establish clientcommunicationchannels

2

Reviewprecontractdocuments

1 3

Hold clientkick-offmeeting

5

4

Prepareproject plan

Hold projectkick-offmeeting

7 11

8

Issue projectdesign data

Analyzepreliminaryprojectestimate

Issuepreliminaryprojectschedule

12

9

13

Initiate process design

Reviewengineeringplan

6

Determineprojectorganization

10

Prepareprojectcoordinationprocedure

14

15

Reviewconstructionplan

contd...


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8. Issue Project Design Data

9. Initiate Process Design

10. Prepare Project Coordination Procedure

11. Analyze Preliminary Project Estimates

12. Issue Preliminary Project Schedule

13. Review Engineering Plan

14. Review Procurement Plan

15. Review Construction Plan

Review Pre-contract Documents

Prior to the project award, the E&C would probably have

submitted technical and commercial proposals. PM's job of

initiating a project may be easier if the proposal period has

been fairly extensive and the E&C has spent a considerable

t i m e a n d e f f o r t i n p r e p a r i n g d e t a i l e d t e c h n i c a l a n d

commercial proposals.

At the time of award, the scope of the project may have

changed f rom the enquiry document . The proposal may

have been modif ied, added to or adjusted by a ser ies of

let ters or clar if ication meetings held pr ior to the award.

I t i s e ssen t i a l tha t PM ca re fu l ly check th rough a l l o f

the proposal documentation and assemble a complete file

o f p roposa l documen ts , l e t t e r s , t e l exes , t e l ephone and

meeting notes. He thus has a complete record of what was

requested, what was offered and what was accepted in the

award .

F o l l o w i n g t h i s , t h e P M w i l l h o l d a m e e t i n g w i t h t h e

sales/commercial manager to review the proposal documents

and to d i scuss any add i t iona l po in t s d i scussed du r ingthe meetings with the cl ient . PM will par t icular ly want

to be in fo rmed o f any c l i en t conce rns , p r e f e r ences o r

prior i t ies.

To ensure continuity and a smooth job start, the E&C will

want to involve the nominated PM and the key members of

the proposed project team in the proposal activities and pre-

awar d contr act discussions.

Notes

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Establish Client Communication Channels

If a PM is to maintain control over the project , he mustesta blish with t he client t ha t h e is the official comm un icat ion

channel between the E&C and the client for all major aspects

of the project. During the proposal stage, contacts with the

client may have been many and varied from commercial,

project and process engineering, legal, financial and others.

Client ma y have become used t o dealing with mu ltiple people

and expect to continue to do so.

PM has to take over the scene delicately but firmly both with

th e client a nd within his own organizat ion. This ensures t hat

all fut ure commu nicat ions a re chann eled th rough h im so that

he can maintain control. He will recommend to the client

that similar arrangement is followed in client's organization.

A client PM should be appointed through whom all major

commu nicat ions a re channeled. This does not mean tha t t here

i s n o c o m m u n i c a t i o n o r d i r e c t c o n t a c t b e t w e e n o t h e r

members of the client and contractor's organization. It does

mean that any such contacts/communications are either in

th e presence of PM or with his pr ior k nowledge and t hat the

subject matter is properly recorded and approved by the PM.

Client Kick-off Meeting

As soon as possible, after project award, PM should hold a

kick-off meeting with the client and go through a check list

to make sure tha t there i s to ta l agreement be tween the

contr actor and client with r egar d to th e project requirements.

If there ha s been a detailed proposal, then it ma y be a simple

m a t t e r o f c o n f i r m i n g t h a t d a t a i n t h e p r o p o s a l s t a n d

unchanged for the pro jec t . I t i s rare , however , tha t the

proposal i s to ta l ly def in i t ive in a l l a reas . Normal ly themeeting agenda and check list covers:

u Scope of work and services

u Basis for process design

u Project design data

u Engineering

Activity 3C

Prepare an agenda for kick-off

meeting with client.

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u Procurement

u Construction

u A d m i n i s t r a t i o n p r o c e d u r e s ( a p p r o v a l s , c o n t r o l s ,

reports, documentation, distribution, commercial).

Establish Project Procedures

A comprehensive project procedure is necessary for effective

project management. This procedure makes it possible to

organize and contr ol the project in a systemat ic man ner using

the instructions to identify and refer technical, planning,

r e p o r t i n g , a c c o u n t i n g a n d a d m i n i s t r a t i v e d o c u m e n t sp r o d u c e d t h r o u g h o u t e n g i n e e r i n g , p r o c u r e m e n t a n d

construction.

A n E & C c o m p a n y n o r m a l l y h a s s t a n d a r d p r o c e d u r e s

covering equipment, materials and services which must then

be adapted to suit the specific project. The basic areas to

which project numbering system and procedures are applied

are :

u Tagging and identification of equipment and materials;

u Numbering of technical documents, specifications, data

sheets, drawings, requisitions and purchase orders;

u Procurement commodity codes;

u Scheduling activities in engineering, procurement and

construction;

u Estimating equipment, materials and services;

u Recording man hours on timesheets in the home office

and field;

u Recording project scope changes;

u Project accounting and invoicing;

u Project cost and progress reporting;

u Project document management.

In addit ion, a large project must be subdivided into i ts

various units, areas and plant elements to facilitate control

Notes

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and reporting. Too great a degree of subdivision merely adds

to work and confusion. The best solution is to have the

minimum number of sub-project numbers which will give

reasonab le con t ro l . On a ma jo r mu l t i -un i t p ro jec t , t he

following breakdown is recommended:

u Overall project number for summary cost reports and

comm on/bulk r equirement s;

u I n d i v i d u a l s u b - p r o j e c t n u m b e r s f o r e a c h m a j o r

identifiable process unit within the complex;

u One or more sub-project numbers for off-site systems,

depending upon size and scale;

u S e p a r a t e s u b - p r o j e c t n u m b e r s f o r g e o g r a p h i c a l l y

distinct locations such as marine terminal, remote road

or rail loading or dispatching stations etc.

Prepare Project Plan

On completion of the above steps, PM should prepare a

p ro jec t p lan . Th i s p lan de f ines the p ro jec t ob jec t ives ,

priorities and philosophies. Its preparation fulfills a number

of functions:

u It requires that the PM, as leader of the project, takes

the t ime to access the project needs at an ear ly date

and present his intended plan of execution. Individual

communications or meetings are no substitute for the

writ ten plan.

u It provides a basic reference and briefing document for

those who wi l l u l t ima te ly be invo lved in p ro jec t

execution.

u I t a l lows the E&C management to rev iew the p lan ,

p r o v i d e g u i d a n c e a n d a s s i s t a n c e a n d , t h e r e a f t e r ,

support the plan throughout project execution.

The project plan wil l normally include background data;

scope of work and services by E&C and client; split of work

with others (process licensors, other contractors); basis of

con t r ac t ( l i ab i l i t i e s , gua ran tees ) : r egu la to ry and o the r

approvals; project identification and procedures; dimensions,

Activity 3D

Make a list of the project

procedures required for theeffective control of the project.

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units, language; client participation, reviews and approvals;

spec i f i c p ro jec t needs and h igh l igh t s ; p ro jec t des ign

phi losophies ; and pro jec t schedule cr i t ica l i t ies , p ro jec t

control procedures and reports. In addition, the project plan

will contain separate sections dealing with engineering,

p rocu remen t , cons t ruc t ion , ope ra t ion and f inanc ia l a s

appropr ia te .

Figure 3.3 shows the organization matrix which is set up

w h e n t h e p r o j e c t t e a m i s f o r m e d w i t h i n a f u n c t i o n a l

orga