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Chapter 1
The aim of this dissertation is to explain the important role played by risk identification and risk mitigation during the feasibility study and basic engineering development phases, in both instances prior to approval of major capital expenditures for industrial plant projects, particularly for the financial viability assessment of the project. This dissertation also develops a Project Risk Review Model for identifying, evaluating and minimizing project risk during those phases of the project, for the purpose of determining its subsequent impact on the economic and technical viability of the project, and thereby aims to improve decision-making on project capital approvals. This dissertation does not intend to cover the whole range of issues involved in project capitalization or finance, nor does it cover all aspects of risk management associated with project finance from a lenders’ perspective, since these topics have already extensively been covered over the past decade, at least, in numerous technical books and journals. Although the focus of this dissertation is not on the specific mechanisms or commercial nuances of structuring a project finance package, an overview of project finance for industrial plants is nevertheless necessary, to provide the setting for an ultimate focus on an owner organizations’ Board approvals required for project

2 capitalization, with a view towards demonstrating the potential detrimental impact that risks associated with a project’s inherent business case, technical reliability and project management

competency can have on an industrial plant project’s technical and economic viability. Therefore, the focus of the Project Risk Review

Model is necessarily on the end of the feasibility study phase and prior the basic engineering development of the project, as well as at the end of basic development and prior to starting project execution, meaning the detailed engineering and construction of the project Substantial emphasis will therefore be placed on demonstrating how a large industrial plant project’s viability can be improved through the identification and evaluation of project risks associated with the project’s inherent business case, technical reliability and project management competency. To this end, this dissertation develops a practical Model that facilitates the detailed identification of business related and technical risks, particularly during its feasibility study and basic engineering development phases. 1.1 Background of the Problem In order for participants, particularly lenders, owners and other investors to have confidence in the economic and technical viability of a project, it is necessary for them to know with certainty that all significant project risks are appropriately identified, managed and/or mitigated. Otherwise the project could, in the first instance, fail to

3 attract favorable financing, and in the second instance, assuming that favorable project finance was secured, the project could still fail to achieve the targets that were set out and agreed upon in the financing agreement, due to a poorly conceived business case, inaccurate engineering, or incompetent project management. Although globalization has created greater opportunities for engineering and construction companies to expand their market share abroad and to earn higher returns, almost 15% of the top 225 global contractors have sustained losses on their international projects (Han and Diekmann, 2001) despite the fact that international projects are generally more profitable than domestic projects. Such losses can mainly be attributed to the difficulties experienced in assessing and evaluating the impact of non-financial risk factors on their projects, according to Zhi (1995), Dailami et al (1999), Ho and Liu (2002), and more specifically on engineering projects, according to Gupta and Sravat (1998), Ozdoganm and Birgonul (2000), Baloi and Price (2002), and Kumaraswamy and Morris (2002). The first big risk exposure for lenders and owners alike, is at the end of a project’s feasibility study phase. At this point, assuming the feasibility study outcomes demonstrate to the lenders that the project has a sound business case and is technically viable, the lenders grant project finance approval to the project owners, effectively trusting that the rest of the project development will proceed as laid out in the

4 feasibility study. The owners share this first big risk exposure, in so much that they in turn give provisional financial approval for the project team to proceed with the basic engineering development of the project. This is a significant commitment because; although in theory the project development has not yet reached an absolute point of no return, substantial amounts of resources, including manpower and funds, are spent during this phase. In most cases on industrial plant projects, specialised and expensive equipment with long delivery periods will be designed and procured during the basic engineering development phase, to ensure that this equipment will be delivered to the project, to be installed as per the agreed schedule. Therefore, practically speaking, it is very rare indeed that a large industrial project will be abandoned at the end of its basic engineering development phase. In other words, when, at the end of the feasibility study period, the lenders and owners give their respective approvals to proceed with the project, it effectively means that the project will invariably go ahead and be designed, built, and put into operation, in spite of all the uncertainties and risks that lay ahead and still have to be identified and dealt with. However, the greatest risk exposure on industrial plant projects, for lenders and sponsors alike, occurs at the end of the project’s construction period when the project is commissioned into operation. In a study on project securities and risk, Tiong (1990) explained, “risks would peak in the early operational years when the projects are under

5 the greatest pressure due to peak debt servicing when the highest interest burden occurs”. By the time that the project starts its operational phase, almost all of the money, including the financed loans, have already been committed into the plant facilities for the purposes of the feasibility study, basic engineering development, procurement of all equipment and materials, detailed engineering, and actual construction of the plant. Ensuring a viable project, therefore, includes demonstrating that the project has a sound business case, technical accuracy and project management competency, thus providing the basis of confidence, not only for a project finance agreement between lenders and sponsors, but also to proceed the project execution with confidence. 1.2 Statement of the Problem The crux of the problem is to pre-empt the occurrence of economic and technical risk exposures prior to commissioning plant operations, to ensure that the project continues to demonstrate a sound business case throughout its pre-project planning phases, and to ensure that the project is then technically well defined, thoroughly planned, correctly designed and and efficiently on constructed the with a clear





allocation, management and mitigation of all significant risks associated with the project.

6 The determinant factors leading up to the period of greatest risk exposure, which occurs at the end of the project execution phase when the plant is commissioned into operation, is thus entirely dependent upon the experience and knowledge, or the lack there-of, among project financiers, owners and other stakeholders including equipment vendors and engineering contractors, to be able, particularly at the end of the feasibility study and basic engineering development phases of the project, to know for certain that all significant project risks have been satisfactorily addressed and that they are sure of the readiness of the project to proceed to the next phase. Therefore, it stands to reason that the readiness of a project to proceed, be it with basic engineering development or with execution, is largely pre-determined prior to each of those events, through proper verification of the completeness and acceptability of the project’s inherent business case, technical reliability and project management competency. Financial and technical feasibility studies, as well as the basic engineering development phase, fail to account suitably for the risks and uncertainties associated with the business case, technical accuracy and project management competency of the project. The joint effects of uncertainty prior to execution and the irreversibility of decision-making once the project is constructed, requires stakeholders involved during the feasibility and basic development phases not to take a stationary view of important variables such as product demand, feedstock prices,

7 sources of energy, capacity expansion requirements, issues, potentially operational





requirements and numerous project management issues. The variables and assumptions driving a project’s financial and technical viability are full of uncertainties, more so because variables are often adjusted as more information about the project is obtained and assimilated, and therefore cannot be treated as though known with certainty at any point during the pre-project planning stage of the project. The assumptions and interrelationships of all of these variables must be continuously tested and evaluated, particularly at the end of each of the feasibility and basic development phases where significant capital approval decisions are made, to ensure agreement between all stakeholders, right up to the point of final capital approval prior to executing the construction phase. However, as was so very well put by Levine (2003), a principal of The Project Knowledge Group and actively involved in project

management for over 38 years, “we all acknowledge that the management of risk can be the most critical factor in project success. Yet, as I look at the practices that have been put in place in most firms and at the tools that are being used to support these practices, I find that risk analysis and risk management are most often missing”. Any decision to invest in industrial plant projects must be based upon a combined assessment of the financial and non-financial risks

8 surrounding the project, ensuring that identification, evaluation,

management and/or mitigation of the project risks are refined and accounted for during the pre-project planning phases of the project. According to Wang et al. (2002) risks must be identified in a rational systematic manner, otherwise some risks may be overlooked, and it is these unidentified risks that tend to be most disastrous and

catastrophic. 1.2.1 Importance of analyzing Project Risks for Industrial Plant Project Finance Specialists will be utilized to give advice on the related business case and technical aspects of the project. During this pre-project planning stage of the project, that is, the feasibility study and basic engineering phases, the stakeholders will seek confirmation that: • • The final plant will meet the requirements of the lenders and users Any construction works can be designed and built in the agreed timescale, according to the agreed capacity and quality, and for the agreed cost • Specification for the design, construction and operational services to be provided are appropriate to the proposed project infrastructure, site conditions, and also within the specifications of local and national authorities • The stakeholders will also want to know the overall levels of business risk, as well as the specific components of risk associated

9 with the technical development and practical execution of the project • For the design and construction of industrial plant projects, stakeholders will review the payment mechanisms, for example, that the penalties for poor performance are commensurate with the owners’ and contractors’ respective risks • Any assumptions for the major and regular maintenance of the project are reasonable • Stakeholders may also seek advice on specialist operating environments, for example, necessary safe handling procedures and legislation for hazardous raw materials and products of the project. Insurance due diligence will also be conducted as a part of the pre-project evaluation. Insurance generally falls into two categories: statutory and other insurances common to all projects, and those insurances that address project specific risks. The insurances proposed by any of the project stakeholders must be acceptable to all the stakeholders. The level of insurance and any deductibles must also be appropriate to the project. For project specific insurance it is important that the risk is appropriately identified, managed and mitigated, and that the cost of insurance gives an acceptable benefit to the project. The cost of insurance will be included in the financial model and thus be a part of the economic evaluation of the project.

10 In the first place, it will be virtually impossible for any team of experts to ascertain the economic and technical viability of a project, nor to address the potential impact of all project related risk upon the viability of the project, unless such a team has a decision support system with appropriate tools to analyze and evaluate the various risk issues, in order to produce a meaningful project proposal that maintains the economic and technical viability of the project while appropriately addressing all of the significant risks. Much research has been carried out in the area of risk identification, particularly regarding industrial plant projects, resulting in different categorizations of risks (Gupta and Sravat, 1998,

Kumaraswamy and Morris, 2002, Ozdoganm and Birgonul, 2000, Salzmann and Mohamed, 1999, Wang et al., 2000). Typical methods adopted by the private sector to identify risks include experience, risk matrices, checklists, databases, site visits and intuition (Akintoye et al., 2001). As some project stakeholders become more experienced in the development of large industrial projects, they will naturally find this process of identifying risks increasingly easier. Nevertheless, industrial plant projects are inherent high-risk investments in which political and economic instability, social, technological and other non-financial factors can significantly affect the financial viability of the project over the long term of investment.

11 1.3 Purpose of the Study The purpose of this dissertation is to explain the important role played by risk identification and evaluation during the feasibility study and basic development phases of industrial plant projects, in both instances prior to approval of major capital expenditures. The focus of risk identification and evaluation is specifically on the viability assessment of projects, for the purpose of improving decision-making on project finance approvals. The resultant strategy of this dissertation centers on the definition, development and testing of a comprehensive Model that is used to identify and evaluate risks, particularly the management of risk as applied to owners, engineering construction companies and

constructors involved in the total engineering, procurement and construction of industrial plant projects. The definition and

development of these risks are based on supporting published literature, together with materials gained from several companies that actively build similar industrial plant projects, particularly in the oil, gas, petrochemical, mining and minerals

industries, as well as the contribution and experience of engineers and colleagues within the mentioned organizations. Although project finance deals with the structuring and financing of projects, preferably on a non-recoverable base, the principles of financial management must still be applied, especially to the project

12 evaluation process. In order to demonstrate clearly how technical and economic risk are analyzed and evaluated, specific international projects in the process of development and construction are used as case studies. The model is tested on numerous large industrial projects under development and construction, in collaboration with project management teams and groups of engineers who are actively working on those projects. To summarize, the purpose of this study is first to show that project finance is directly influenced by the identification and evaluation of project related risks. Second, it will stress that risk identification and evaluation is of the utmost importance for the financial and economic viability of the project. Thirdly, a Model is developed with which project stakeholders, including lenders, owners, contractors and project teams, can identify and furthermore evaluate the risk implications of their projects. Finally, several actual projects will be reviewed and analyzed as case studies to test and evaluated the usefulness of the Model, by providing team generated reports that compare the basis of the original approved capital against the financial requirements of the project subsequent to the application of the Model. This review process takes place in structured environments, between the project teams and their peers, using the Model as their guide. Where the initial structuring of the Model is not optimal, it is rectified in a team effort, based on the findings from the project review process. the project reviews result in a score for

13 each project, which is used to demonstrate the level of risks still prevalent in the project. Overall, this research gives a practical overview of what project risk implications on capital expenditure approvals exactly entail, as seen from the viewpoint of the stakeholders. 1.4 Theoretical Framework Principally, it is the intention of this dissertation to illustrate that optimal decision-making on capital project approvals requires a twopronged approach as follows: • The organisation must adopt the ‘correct’ approach to capital project approval, from a strategic competitiveness perspective (the concept of strategic fit) and • Once the approach to capital project approvals is adopted, the organisation must be able to develop that project faster and more efficiently that its competitors and at a minimised total economic life-cycle cost if it wishes to be successful in its target market. Consequently, this dissertation will demonstrate the development and implementation of a Project Risk Review Model based on the principles of risk management and incorporating a modification of the concept of strategic project fit as it applies to the corporate industrial plant owner organization. The ultimate aim of this model is the

competitive enhancement of the capital project development and execution process.

14 This dissertation has been structured in such a way as to ensure adherence to the following concepts: • the concepts presented within the dissertation must flow logically from one point to the next in order to maximise reader comprehension of the topics presented, and • Given the diverse nature of the topics to be presented, the order of presentation must be such that the reader has the requisite knowledge of associated underlying fundamental theory at all stages within the dissertation. Therefore, the function of Chapters One and Two is to provide the reader with all of the requisite background information regarding the nature of the research problem as well as the underlying fundamental theory required for an in-depth understanding of the associated issues. Chapter One: This chapter provides a description of both the importance and complexity of corporate risk management in the context of industrial plant project finance and capital approvals, and provides the background for the dissertation hypothesis. The

dissertation hypothesis is also defined and the research methodology explained. Chapter Two: This chapter, through literature research pertaining to the research topic at hand, provides the necessary background and current understanding of the importance of risk management in capital project finance. This sets the tone for the rest of the dissertation since,

15 subsequent to these first two chapters; the reader should appreciate the importance of innovative project risk management in ensuring the strategic competitiveness of the corporate industrial plant owner organization. 1.5 Research hypotheses Hypothesis To discuss the risks associated with the development and execution of industrial plant projects, and to demonstrate that using a Model for the identification and evaluation of those a project risks improves the chances for their identification, management and/or mitigation, which leads to improved certainty regarding the technical and economic viability of industrial plant projects. Dependent Variable The impact of project risk on project finance Independent Variables Developing a Model to improvethe identification, evaluation and management of risks, and therefore obtain better certainty on the financial and technical viability of projects. 1.6 Importance of the study The Model enables lenders, owners and other investors to ascertain the potential detrimental impact of identified risks on the overall viability of the project, at any stage of the project, including

16 during its feasibility study phase, which includes conceptual

development of the project, and the subsequent basic engineering development phase; and also to evaluate the project’s preparedness to proceed with execution of its detailed engineering and construction phase. Application of the Model also results in a score that can be benchmarked, over time, to the evaluation of other similar industrial plant projects in the industry. The Model can be applied to most industrial plant projects during any phase of the project’s development. The application of this practical Model will pro-actively reduce the potentially significant end-of-project risk exposure for lenders and sponsors by ensuring, during the pre-project planning stages, that a clearly defined business case is provided, and give greater insight into whether the project could successfully be designed, constructed and commissioned. 1.7 Scope of the study To place large industrial plant project risk in the context of project finance, an overview of structured project finance for industrial plant projects is therefore provided here, emphasizing the need for improved capital applications to the Board that must be made at the end of a project’s Feasibility Study and its Basic Engineering Development phases. An overview of associated risks and the difficulties of identifying, analyzing and evaluating the impact of risk on those financial applications is also provided.


1.8 Definition of terms

1.8.1 Defining Risk Management Throughout this dissertation the term ‘financial product’ will be used extensively. This is a generic term used by the author to indicate the development of a financial solution, which is required to satisfy a specific need. Given this definition the term ‘financial product’ may, for the purposes of this dissertation, be taken to mean either the creation of an intangible product (such as a derivative instrument) which may be marketed as such or alternatively the creation of a financial solution which has as its purpose the resolution of an identified need. An

example of such a financial solution may be the creation of a risk management strategy for managing a particular financial risk or set of identified risks, or the design and development of an analytical risk analysis algorithm. Such solutions are analogous to the provision of a service. Note that the author makes a clear distinction between the terms ‘financial product’ and ‘financial instrument’. Within this

dissertation a financial product is considered to consist of a collection of one or more financial instruments, which serve to act as underlying to the product concept.

18 It should therefore be apparent even at this early stage that the intangibility associated with a financial product leads to the term being applicable in a wide variety of circumstances. This emphasises the

need for the results of the research to be widely applicable with respect to the subject matter, a concept inherent throughout the structure of this dissertation. 1.8.2 Defining a Model The term ‘model’ is used extensively throughout this dissertation. To this end, the model is considered to be a representation of a system that is constructed to study some aspect of the system or the system as a whole. Models can be used for both applied and highly theoretical purposes. The model developed within this dissertation was developed with a focus on the practical application thereof. Three types of models can be identified, being description, explication, and simulation. The author has chosen to base the model developed within this dissertation on the explicative model format, being the use of models to extend the application of well-developed theories or to improve our understanding of their key concepts. 1.8.3 Abbreviations i. ii. iii. iv. v. vi. DEF IBL IFL OBL OFL OOM Definitive Estimate Inside Battery Limits Inside Factory Limits Outside Battery Limits Outside Factory Limits Order Of Magnitude Estimate

19 vii. viii. ix. ROM Rough Order of Magnitude Estimate SDE Semi-Definitive Estimate VROM Very Rough Order of Magnitude estimate

1.9 Summary and Organization of the Remaining Chapters Chapter 2, through literature research and also by relating actual cases from the personal experience of the author, pertaining to the research topic at hand, a necessary background and current

understanding of the importance of risk management in capital project finance is provided. As a necessary an integral part to project risk management, recent literature on the life cycle management of projects is reviewed and current practices in estimating the expected capital costs of such projects is explained. This Chapter also provides brief overview of the financial modeling function, concentrating on, amongst others, the need for financial engineering, the financial engineering process, and some of the techniques used in financial engineering. The complementary relationship between the need to mange business and technical risks and the financial engineering function is emphasized. This sets the tone for the rest of the dissertation since, subsequent to these first two chapters; the reader should appreciate the importance of these concepts in innovative project risk management, and the role that these concepts play in ensuring the strategic competitiveness of the corporate industrial plant owner. Towards the end of Chapter 2 the discipline of corporate risk management is illustrated. Discussions on strategic financial and

20 technical risk management provide the reader with the knowledge that will be required at a later stage within the dissertation. As will be

apparent upon completion of this Chapter, the need to manage business and technical risk is a primary driver of ensuring the financial viability of a large industrial plant project and typically serves as the ultimate justification for the project. It is therefore important that the reader be familiar with not only the need to manage such risks, but also the various methods with which this can be accomplished.


Chapter 2

This chapter investigates current explanations of industrial plant project finance as described in recent literature, briefly reviews the early development of project life cycle management and provides an overview of how it is practiced today, particularly by industrial plant owners and engineering contractors. As a necessary part of understanding project finance and industrial plant project risks, the chapter provides an overview of common estimating techniques that are employed to establish the expected costs associated with the development and execution of industrial plant projects. Finally, a discussion follows on the main focus of this dissertation, namely how current literature and practice addresses the identification of risks pertaining to industrial plant projects. 1.10 Overview of Project Finance for Industrial plant projects Project financing is not a new financing technique. Bodnar (1996) states that project specific financing of finite-life projects have a long history; it was already the rule in commerce by the 13th century. He relates the example when, in 1299, the English Crown negotiated a loan

22 from Frescobaldi, a leading Italian merchant bank of that period, to develop the Devon silver mines. That loan contract provided that the lender would be entitled to control the operations of the mines for one year. The lender could take as much refined ore as it could extract during that year, but it had to pay all costs of operating the mines. There was no provision for interest. The English Crown did not provide any guarantees concerning the quantity or quality of silver that could be extracted during that period. Such a loan arrangement was a forebear of what is known today as production payment financing. However, differences of opinion exist on exactly when project finance originated. Hall (1976) stated that the establishment of the Suez Canal Company in 1856 to build the Suez Canal should be regarded as one of the very first examples of project finance. Thereafter, in the 1930’s, the concept took root with the financing of independent oil owners, or so-called “wildcatters”. Many of the Texas and Oklahoma “wildcatters” usually did not have sufficient capital to develop their oil resources, or their balance sheets were not strong enough to borrow the necessary funds on their own account. During those times the banks were the only source of funds and the concept of production payment financing, or payment from the downstream revenues of the project, was born. The banks required oil and land as security, while the entrepreneur used his income from the oil to pay off

23 his loan. According to Hall these were the first real examples of project finance. Regardless of when or how project finance actually took shape, as pointed out by Bagnani, Milonas and Travlos (1994), project finance continues to be a useful tool for companies with insufficient balance sheet strength to take on the whole debt, and who wish to avoid the issuance of a corporate repayment guarantee, thus preferring to finance the project "off-balance", that is, with limited or no recourse to themselves as the owners of the project. Although project finance can be used for all types and sizes of projects, the costs related to implementing project finance structures invariably prohibit the use of this type of instrument for smaller scale projects. Employing a carefully engineered financing mix, project finance is invariably used to fund large-scale natural resource projects, from pipelines and refineries to electric-generating facilities, hydroelectric projects, and more recently also public-private infrastructure projects. According to the World Bank (2003), project financing is increasingly emerging as the preferred alternative to conventional methods of financing infrastructure and other large-scale projects worldwide. According to Yescombe (2002), “Project finance is a method of raising long-term debt financing for major projects through financial engineering, based on cash flows generated by the project alone; it depends on the detailed evaluation of the project’s construction,

24 operating and revenue risks, and their allocation between investors, lenders and other parties through contractual and other arrangements”. In an article in the Harvard Business Review, Wynant (2002) defined project finance as “financing of a major independent capital investment that the sponsoring company has segregated from its assets and general purpose obligations.” Project finance applies, in this dissertation, when an industrial enterprise or owners decide to undertake a capital expansion program. Capital expansion programs are considered because the existing plant technologically is outdated, or because the existing plant is already fully utilized and thereby restricts the owner’s market share. It might also be that the owners are not currently involved in a desired activity, and that the intended project involves a decision to diversify into new products and markets. Project financing as a discipline necessitates understanding the rationale for project financing, how to prepare the financial plan, assess the risks, design the financing mix, and how to raise the necessary funds. In addition, it is necessary for lenders, as well as for owners and other investors to understand the reasons why some project financing plans have succeeded while others have failed. A knowledge base is required regarding the design of contractual arrangements to support project financing. The knowledge base must support the investigation and evaluation of issues involving the host government’s legislative

25 provisions, various types of partnerships, financing structures, credit requirements of lenders, and how to determine the project's borrowing capacity; how to prepare cash flow projections and how to use them to measure expected rates of return; tax and accounting considerations; and analytical techniques to validate the project's viability. All of these aspects are typically investigated, combined and presented first in a feasibility study that serves to demonstrate the economic and technical viability of the project to the lenders, owners and other investors. Thereafter, providing the lenders successfully approve the outcome of the feasibility study, the project proposal is further defined during the basic engineering development phase, for final capital approval by the owners for the project to proceed with execution. Industrial enterprises or plant owners invariably structure their businesses in such a manner that any one of their industrial plants, or sometimes several related types of plant, is wholly or partially owned by a particular strategic business unit (SBU) with limited liability to the main corporation. This is evidenced by corporate and business unit structures of major industrial owners that operate in the Oil and Gas industries and others that operate in the Mining and Minerals industries, as explained by Rutterford and Montgomerie (1992), and can be seen today on most of these type of organizations’ web pages. In cases where the organization wishes to enter into a new market with different product lines from those already existing within the organization, or into

26 a new mining venture, they will form a new SBU, or, for the purpose of more easily explaining the structuring of industrial plant project finance in this dissertation, a new Project Company will be formed. By structuring the project as an independent Project Company, the structuring provides for a project that is legally and economically selfcontained, thereby protecting the rest of the organization’s business from any potential mishaps that may occur with that particular Project Company, for whatever reason. A generalized project finance structure, showing the Ownership and Contractual Relationships of a typical industrial plant project, is shown in Figure 2.1. Similar generalized graphic portrayals of project finance structures are also used, in various different forms depending on the nature and types of projects, and can be found in many books and journal articles on project finance, for example Tiong (1990), Sapte (1997), Pollio (1999), Tinsley (2000), Yescombe (2002), Davis (2003), to name a few. Nevertheless, the basic structure of industrial project ownership and contractual relationships can be said to remain the same. Due to the sophistication and specialized nature of project finance, most lenders, owners, other investors, and also the major contractors involved with the project, sometimes also referred to collectively as stakeholders of the project, these days recognize the necessity of each having their own specialized project finance departments with acute

27 understanding of the many different types of risk, including its analyses and evaluation, that is required to ultimately ensure the effective structuring of project finance proposals and subsequent contracts. This is evident in major organizations such as the World Bank, the Bank of Scotland, and the International Bank of Japan, the Bank of England, Stanley Morgan Bank, other similar major financial institutions, and any of the major corporations in the Oil & Gas, Petrochemical, as well as the Mining & Minerals industries. The nature of large industrial plant project finance involves risk in disclosures regarding legal and market requirements; reliable design engineering and construction that ensures the plant can operate at it designed capacity for the minimum specified operating periods; structuring of contractual agreements and concessions; insurance supports and financial guarantees; assumptions by issuers, investors, or by third parties; public policy and social concerns; international market risk regarding projected returns on investment; currency risks; political, geopolitical and economic risks. Industrial plant project financing face technology risks involving the whole range of project development issues from market potential to reliability of feedstock, proven versus new and unproven technology, availability of energy

28 Figure 2.1 _________________________________________________________________________ Ownership and Contractual Relationships
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29 sources, transportation and telecommunication, through to realistically projected production ratios. Project finance for self-liquidating projects, particularly industrial plant projects such as a refinery, petrochemical or chemical plant, a mine, or power generation plant, is invariably finance that is repaid from the cash flow of the project. Harries (1990) asserts, “The lender expects to be repaid only from the cash flow to be generated by such a selfliquidating project. The sole collateral for the loan are the assets and the revenues of such a project, except for very limited recourse to, or support by, the equity owners or other finance sponsoring parties interested in the project”. The above definition describes those characteristics that distinguish project finance for self-liquidating projects from other types of project financing options, such as, for example, in the real estate industry where the assets of the project are usually sufficient collateral for the loan. In a definition that stresses the motivational factors of project finance, namely that project finance is an element in overall corporate risk management, de Nahlik (1992) writes, “Project finance is a way of developing a large project through a riskmanagement and risk-sharing approach while limiting the downside impact on the balance sheets of the developers and sponsors”. From the above definitions , it is clear that the stakeholders, all of whom have a vested interest in the success of the project, must ensure, through thorough investigation and evaluation, the likelihood of the

30 projected cash flow to be generated by the project. However, as stated by Songer, Dickmann and Pecksok (1997), this likelihood of project risks and the associated projected cash flows of an industrial plant project must obviously be determined prior to commencement of execution of the project, during the pre-project planning stage; that is, during the feasibility study phase and again re-confirmed during the subsequent basic engineering development phase. 1.11 The Early Development of Project Life Cycle Management According to the US Department of Commerce, Patent and Trademark Office (2003): Project Life-Cycle Management (PLCM) emphasizes decision processes that influence project cost and usefulness. These decisions must be based on full consideration of business functional requirements and economic and technical feasibility in order to produce an effective project. The primary objectives of the PLCM approach are to deliver quality project that: 1) meet or exceed customer expectations when promised and within cost estimates, 2) work effectively and efficiently within the current and planned infrastructure, and 3) are inexpensive to maintain and cost-effective to enhance. In a paper, An overview of the Project Cycle, commissioned by the NASA Alumni League, authors Kevin Forsberg and Hal Mooz provide the following definition of a project life cycle:

31 The project cycle is an illustration of the typical and necessary project events sequenced from beginning to end. There are three aspects or layers to the project cycle, each containing their own set of events. These layers are the Budget, Business, and Technical aspects. Today’s life cycle management of projects is a discipline that started in the 1930s with the US Air Corps' and Exxon's project engineering co-ordinating function. In Gulick's 1967 paper on the matrix organization, he gives an explanation of the early development of project life cycle management. The life cycle management of projects is first put into full modern practice around 1953-1954 with the US Air Force Joint Project Offices and Weapons System Project Offices, followed in 1955 by the US Navy's Special Projects Office. These were first and foremost mechanisms for achieving organizational integration. And from that integrating base developed a practice of systems management: specified performance requirements for the final project; carefully preplanning to prevent unexpected future changes during the development of the project; appointing of a prime contractor to be responsible for the project’s staged development and delivery. Scheduling/risk analysis tools were developed by 1957-1958 to assist planning. CPM provided cost control and resource management capabilities; PERT was used extensively as a public relations tool to help manage the Polaris project's external environment. NASA was formed in

32 1958. In 1959 the Anderson Committee formalized the systems management approach: projects and programmes to be managed according to life-cycle stages, and more attention to be paid to frontend feasibility analysis. By the end of 1959 the Harvard Business Review published its first article on project management. Organizational integration was encouraged further in the 1960s when the matrix form was introduced in 1960. 1.12 Characteristic Life Cycle of an Industrial Plant Project with respect to Project Finance Project Life-Cycle Management (PLCM) emphasizes decision processes that influence the cost and technical viability of the project. These decisions, for large industrial projects, are typically taken by a Project Steering Committee (PSC), under the direction of the corporate owner’s Board of Directors, and must be based on full consideration of business functional requirements and economic and technical feasibility, in order to produce a financially viable project. Most industrial organizations that plan to execute capital projects use this PLCM approach, the primary objectives of which are to deliver a quality project that: 1) meets or exceeds owners’ and other investors’ expectations, 2) works effectively and efficiently within the current and planned infrastructure, and 3) are inexpensive to maintain and costeffective to enhance.

33 The PLCM philosophy of the organization will include the establishment of policies, procedures, roles, and responsibilities that govern the initiation, definition, design, development, deployment, operation, maintenance, and management of their projects. The Board of Directors will normally insist on compliance with the provisions of the organization’s PLMC philosophy and associated procedures, for the sake of avoiding unnecessary risk and maintaining consistency in the execution and monitoring of their projects. The primary participants responsible for implementing the PLCM philosophy are the functional and technical managers responsible for defining and delivering projects, their staff, and their support contractors and suppliers. Project Life Cycle Management is typically comprised of six phases; during which defined work deliverables are created and/or modified. All phases of the PLCM may not necessarily apply to all types of industrial plant capital projects, but that is usually decided on a case-by-case basis, with necessary Board approval for deviation from the PLMC philosophy. The project phases may be tailored to accommodate the unique aspects of a particular project as long as the resulting approach remains consistent with the primary objective to deliver a quality project. Project phases may overlap or phases may be skipped entirely, providing the project follows a development strategy that provides for delivery of desired quality products in a cost effective and timely manner. The tailored development process will be described in a

34 particular project’s feasibility study, and / or ultimately in its plan of execution, which must be submitted by the project team to be approved either by the PSC, or, depending on their levels of approval authority, by the Board. The life cycle phases with their associated objectives and deliverables, as described in Figure 2.2, are those that are considered essential for the proper evaluation and control of industrial plant projects. The end of each phase is designated by a number starting from one, indicating the decision hold points, also called decision check points or decision gates, where the project team must approach the respective decision makers for approval before proceeding with the next phase of the project. The owners will typically approach the project lenders for financing approval at Gate 3, that is, at completion of the project’s feasibility study phase. Upon financing approval, the owners and other investors will thereafter assume the responsibility for successful completion and operation of the project.

35 Figure 2.2 _______________________________________________________________________ Project Lifecycle of an Industrial Plant Project
P r o j e c t P h a s e G s O I d e a P r e B a s i c 1 t o 2 F e a s i b3 Ei l in t y i n e4 e E r xi n e g c u 5 t i Oo e n e r a F i e an s i b i l i t y g e n t e s s in e u s p p e t if y s s s s in e o r t I na vn e d s t i gD a e t ve e a t nh de S e P e r c e t f l T s e s c h n o T l oe gc yh A nl t ie t yr n a A i v l t e e s r u t e l o p E t xh e e c r Pr e r do j e c n o l oF g i x y e n a tB i v a e s e u t


e r a 6t i o

n n d

I d b j e c t i vF e o s r m u l a A a n d N e w B u s B A c t i v i t i e sI d e a O e c i s i o n G a t e s ( H o l d P o i n t s )

t e O p e r a t e a w it h a E v a l u a t e d P r o j e c t lin e


I s t h e I d e a I s t h e I d e a a S t r a t e g ic t h e R ig h t B u s i n e s s F iB ? u s i n e s s ? t

I s B u S o C o A r e D e

t h e I s s in e s s B u lu t io n S o r r e c t ? C o A l l R i s kA s r e f in e d ? A d d

t h e W e r e A ll s in e s s O b je c t iv e s lu t io n M e t ? r r e c t ? C o m m is s io n A ll R is k s in t o O p e r a t io n . r e s s e d ?


a j o r t o b e A d d r e

 A lig n w it h V is io n s O s u u l i ne e s B t I C o s t s  S t a r t S t a k g s As l ie ndm e n B u s in e s s

 C F o i nr pa ol i sr a e t e B  u C a s e & B e e  n C e of i s t s t E& s t i m  +2 0 ~ 4 0 % A  S ot a l d r te S s t a k  e h r e t oA n l i g n m e n t I dS e c a o p e 

 Cs i on se t s Es s t i m n+ 1 e 5 f i ~t s 3 0 % A  F ti n :a l i s e P r a e Tc ce uc rh a n c o y l o g  F oi n l da en rc s i a' l M h o C n o Pm r po l j ee t c e t  G e t B o a r d

F r e e z e P r o jT e r c a t c k B a s e l i n e C o s t   E n s u r e S t a b le a t e : S c o p e a g a in s t A c t u a l C o s t O p e r a t io n s c c u r a c y C o s t E +s 1 t 0i m % F to e l l: o w  a t h e A g r e e d  U p d a t e P r o je c t o c e s s A c c u r a c y P r o je c t S c h e d u le a n d D r a w in g s y A g r e e C o n  t Cr a o c n t ti nr a g c t  U p d a t e O p e r a t i o d e l S t r a t e g y & S A c d h m e d n u i sl e t rs a t i o n i M a in t e n a n c e M E n s u r e P r  o Cj e o c mt m u n i c a t i o n &  E v a lu a t e P e r f o r B u y - in R e a d in e s s R e p o r t in g


a t a

o n s & a n u a ls m a n c e

36 1.12.1 New Business Idea Generation Phase The purpose of the Business Idea Generation Phase is to: • Identify and validate an opportunity to improve the business accomplishments of the organization or a deficiency related to an existing business need • Identify significant assumptions and constraints on solutions to that need, and • Recommend the exploration of alternative concepts and methods to satisfy the need. This phase is completed upon agreement between the Program Sponsor and the Board to initiate a project. The Program Sponsor referred to here is a person within the organization with overall authority over the project, typically appointed by the Board to report to it all relevant matters pertaining to the project. 1.12.2 Pre-Feasibility Phase This phase will determine whether an acceptable and costeffective approach can be found to address the business need, with high confidence that technology can support it. The purposes of this phase are to: • Identify project development interfaces • Identify basic functional requirements to satisfy the business need

37 • Establish project boundaries, identify goals, objectives, critical success factors, and performance measures • Evaluate the costs and benefits of alternative approaches to satisfy the basic functional requirements of the proposed business venture • Assess identifiable project risks • Identify and initiate risk mitigation actions, and • Develop high-level design, process models, data models, and a concept of the proposed operations. This phase may include several trade-off decisions such as the comparison of the advantages and disadvantages of apparently appropriate technologies, or a decision to use an incremental delivery versus a complete, one-time deployment. The Program Sponsor approves requirements and the Board verifies that the requirements are clearly defined. This phase is completed upon approval by the PSC and when the Program Sponsor and the Board agree to the project boundaries. 1.12.3 Feasibility Study Phase The purpose of this phase is to: • Further define and refine the functional requirements of the project

38 • Complete business process reengineering of the objectives to be supported • Develop detailed data and process models of a particular selected technology • Define functional requirements that are not expressed in the process models • Develop the high level and logical design to support the functional and technical requirements, and • Continue to identify and mitigate risks, to ensure that the selected technology can be phased in and coordinated with the business. At the end of this phase, a completed high-level engineering and logical design describes the system. This phase is completed at Gate 3, only if the Board grants provisional capital approval to proceed with the basic engineering development phase. 1.12.4 Basic Engineering Development Phase The purpose of the Basic Engineering Phase is to: • Design, develop, integrate, and test the business idea and the selected technology upon which it is based • Update and finalize plans to deploy the project, and • Complete business transition planning and initiate business transition activities.

39 All components of the logical design are allocated to components of the basic design and based upon these the basic design is then completed. Risk identification and mitigation activities are performed to significant detail, in order to address any remaining risks. This phase is completed at Gate 4, when the Board verifies that acceptance testing has been successfully conducted, that all operational support requirements are addressed, and only if the Board grants final capital approval to proceed with the execution phase. 1.12.5 Execution Phase In this phase, the project is executed by way of detailed engineering, procurement and construction (EPC) to bring to reality the intended business plan. Performance objectives have been identified, agreed to, and recorded in major Contractual Agreements between the owners, engineering contractors, suppliers and constructors, prior to going into execution. These agreements are also documented in the project’s Plan of Execution (POE). 1.12.6 Operations Phase The purpose of this phase is to: • Achieve beneficial operation, to maintain, and to enhance the project

40 • Certify that the project can process the contracted requirements • Conduct periodic assessments of the project to ensure the functional requirements are being satisfied, and • Determine when the project needs to be upgraded, or replaced. 1.13 Project Finance for an Industrial Plant Project based on the Feasibility Study The commercial viability of the project is first demonstrated when a feasibility study is compiled where in the business case and technical reliability of the project is addressed. Based on the feasibility study, approval for finance is then sought, particularly from the lenders to the project, and provisional finance is committed by the organizations’ Board of Directors, for the Project management Team (PMT) to complete the next phase, namely basic engineering development phase of the project. The PMT typically includes, but is not limited to, members from the owners’ organization, the technology supplier(s) or Licensor(s), an Engineering contractor, and other specialists that may be invited as and when required during the feasibility and basic engineering development phases. The objective of the feasibility study is to allow the parties, namely the lenders, owners and other investors alike, to make an informed decision as to whether the project is technically, commercially and financially viable. The feasibility study will establish

41 the financial return of the business proposition with all business assumptions agreed in principle, to the extent that a decision can be made to invest necessary funds, normally in US dollar currency due to the international character of large industrial plant project finance, to be spent during the upcoming basic engineering development phase. The table of contents of major components of a typical feasibility study document for a large industrial plant project is shown in Table 2.3.

42 Table 2.3 ________________________________________________________________________ Table of Contents for an Industrial Plant Feasibility Study 1. Introduction 1.1. Overview of Project Company 1.2. Opportunities in the Marketplace 2. Project Overview 2.1. Introduction 2.2. Project Definition 2.3. Site Location 2.4. Environmental Assessment 2.5. Future Project Opportunities 3. Project Implementation 3.1. Introduction 3.2. Research and Development 3.3. Reasons and basis for selected Technology Licensor 3.4. Pre-Feasibility Study Concerns 3.5. Feasibility Study Deliverables and Requirements 3.6. Basic Engineering Design Execution Proposal 3.7. Reasons for proposed Contracting Strategy 3.8. Proposed Contractor Selection Process 3.9. Proposed Engineering, Procurement and Construction (EPC) Execution

43 Table continues _______________________________________________________________________ 3.10. Outline of the proposed Project Schedule, that is, a Master Schedule consisting of Major Milestones to be agreed between the project stakeholders 4. Basis for Project Economics 4.1. Introduction 4.2. Feedstock 4.3. Product(s) 4.4. Operating Costs 4.5. Capital Costs 5. Business Plan 5.1. Introduction 5.2. Project Company Structure 5.3. Shareholding Structure 5.4. Proposed Contractual Framework with the selected Technology Licensor 5.5. Business Case and Marketing 6. Financing Plan 6.1. Financing Structure 6.2. Risk Analysis and Security Structure 6.3. Sources of Finance 6.4. Export Credits

44 6.5. Export Credit in Project Financing Schemes 6.6. Financial Advisor Table continues _______________________________________________________________________ 6.7. Selection of Arranging Bank 6.8. Financial Model 6.9. Financial Analysis 7. Summary and Proposed Strategy 8. Key Conclusions of the Pre-Feasibility Study 8.1. Feasibility Cost Estimate compared to Pre-Feasibility Cost Estimate 8.2. Feasibility Financial Analysis compared to Pre-Feasibility Financial Analysis 9. Appendixes 10. Project Implementation Strategy and Agreed Ground Rules ________________________________________________________________________

45 The business plan portion of the feasibility study is normally done by the owners, sometimes in collaboration with financing consultants working for a selected major financial institution. If a financial institution is utilized, they may be requested to assist on the basis that they will be remunerated for their efforts by way of fees earned, if the owners and other investors accept their financing proposal. In such an instance, the financial consultants often compares the risk of investing their time and expertise against the probability of the project not going ahead, and considers the potential loss as a cost of doing business. The business plan for a typical feasibility study of an industrial plant project will have the following major deliverables, as shown in Table 2.4.

46 Table 2.4 ________________________________________________________________________ Business Plan Deliverables for a Feasibility Study

11. Business deliverables: 1.1. Define the business opportunity definition 1.1.1. Present the business opportunity according to the business scope definition that was agreed by the Board of Directors, clearly describing the business opportunity objectives, given issues, and boundary conditions 1.2. Address stakeholder issues pertaining to the business opportunity, including those of the lenders, owners, other investors, and the selected technology supplier 1.3. Project objectives 1.3.1. Agree on the business objectives that the project has to reach and compile an objective matrix 1.3.2. Decisions to be made to reach those business objectives, and information required to make those decisions

47 Table continues ________________________________________________________________________ 1.4. Decision hold points (or Decision Gates) 1.4.1. Confirm at which hold points the project business case must be presented to the stakeholders for approval, and confirm whom those decision makers will be. These decision makers could be a Project Steering Committee, in addition to the Board members of the organization. By default, a project proposal will be presented for approval after the feasibility study is complete, and again after the basic engineering development together with its specific deliverables, is complete 1.5. Assumptions 1.5.1. All assumptions at every hold point of the project must be highlighted and any relevant actions must be agreed upon 1.6. Stakeholders’ involvement 1.6.1. Communicate who are the project stakeholders and what are their expectations 1.7. Project success planning 1.7.1. Communicate the business vision of project success to all stakeholders 1.7.2. The objectives of project success planning are: To focus the team on a common vision of success

48 Define critical success factors Identify key metrics for measuring success

49 Table continues ________________________________________________________________________ 1.8. Strategic environmental issues 1.8.1. Discuss the impact of environmental issues on the project 1.8.2. Outline the environmental impacts and assess statutory requirements 1.9. Discuss project business issues that are given facts, threats, and opportunities: 1.9.1. What are the given facts that cannot be changed 1.9.2. What issues and threats must be considered and how will they be mitigated 1.9.3. What business opportunities exist and are not yet part of the current scope 1.10. Licensing philosophy 1.10.1. Which licensing agreements are applicable 1.10.2. Who supplies what 1.10.3. Who manages the interfaces between various suppliers 1.10.4. Who has what licensing responsibilities ________________________________________________________________________

50 An engineering contractor will be responsible for the execution of the technical part of the feasibility study. This technical feasibility study will provide the parties with the necessary technical and engineering input in order to facilitate finalization of the commercial and financial aspects of the feasibility study. A pre-qualified engineering contractor with proven competence in the required field of engineering will be selected to perform the technical feasibility study, and the procedures that take place prior to signing the contract for the feasibility study will include a discussion and agreement on the technical scope of work of the feasibility study. The major technical study deliverables that are typically expected from an engineering contractor are shown in Table 2.5.

51 Table 2.5 ________________________________________________________________________ Technical part of a Feasibility Study: Engineering and Project Management Deliverables 1. Engineering Deliverables: 1.1. Provide indicative scope of plant facilities 1.1.1. Communicate and clarify the physical deliverables of the project 1.1.2.Major activities, Work Breakdown Structure (WBS) and the potential for significant changes to the technical scope of work 1.1.3.Agree on deliverables for each phase, including the feasibility study phase, the basic engineering phase, and the execution phase 1.2. Technology development philosophy 1.2.1. Determine what new technology and / or Research and Development (R&D) is involved and what uncertainties are associated with the proposed technology 1.3. Integration aspects 1.3.1. Determine what technology integration is required, for example, between project and any existing plant units or associated plant, including Inside Battery Limits

52 (IBL), Outside Battery Limits (OBL), Utilities, Feedstock and Products 1.4. Value Improvement Plan (VIP)

1.4.1. Assess at this stage which VIP's are applicable and the timing thereof 1.4.2. Understand how VIP 's can improve the results of current work and create a plan to conduct the appropriate VIP's Table continues ________________________________________________________________________ 1.5. Philosophy for evaluating technology alternatives 1.5.1. Agree on how any alternatives will be evaluate, for example, designing for Fit for Purpose or for Lowest Life-Cycle Cost 1.6. Exclusions from scope 1.6.1. Agree on what is not within the scope of the project in order to establish firm boundaries 2. Project Management Deliverables: 2.1. Major milestone schedule and framework plan 2.1.1. Agree on major milestones of each phase and discuss the probability that the set dates will be met 2.1.2. Assess impact of other related projects on this project schedule

53 2.2. Prepare a project road map, discussing and showing with graphics how the project will be developed 2.2.1. Present a road map and action plan as agreed in the project scope discussion meeting with the Board. A project road map is a long-term decision based plan for development of an asset. Its purpose is to: Define major decision points, decision makers, deliverables and focus items Identify resources needed Measure success with appropriate metrics Anticipated changes

54 Table continues ________________________________________________________________________ Contingency planning in the event of changes occurring Maximize asset profitability Prepare action plans and schedules for the execution of the project 2.3. Develop a macro organization chart 2.3.1. Present the macro organization chart showing a structure that includes stakeholders, project steering committee, the program sponsor, functions in the project team, lines of communication and delegation of authorities 2.3.2. The macro organization chart must allow for decision making and communication to be quick and efficient 2.4. Develop an organization chart specifically for the project management team 2.5. List the project management team’s agreed ground rules for project success 2.5.1. Communicate ground rules to stakeholders 2.6. RACI (Responsible, Authority, Copy, and Inform) Matrix 2.6.1. Together with the organization chart, a RACI matrix must be drawn up, showing the various agreed

55 responsibilities within the business, technical and project management scopes of work 2.7. Develop a Fixed-Capital Cost Estimate, of +15% to +30% accuracy, based on a list of equipment, services, and auxiliary facilities for the project. ________________________________________________________________________

56 In the case of an industrial petrochemical plant or mine, for example, the proposed project scope together with a conceptual process package will form the basis of the technical study. The petrochemical process package will previously have been worked up by a team of the owners’ and technology (Licensor) supplier’s engineers, and will include any proprietary equipment necessary for the technological “heart” of the plant. It is the responsibility of the engineering contractor to further develop the given process package into its various plant components, with an optimal plant layout together with ancillary equipment design, and to provide an Order Of Magnitude (OOM) cost estimate of +15% to +30% accuracy of the expected costs for the still to be completed physical plant, but excluding other economic and financial considerations involved with project financing. The engineering contractor is not normally responsible to point out any discrepancies in the proprietary conceptual process design package, particularly where the process involves licensed technology provided by others. However, the engineering contractor doing the technical portion of the feasibility study will be expected to address at least the following: 1. Develop the Core process technologies to the level of process descriptions and PFD’s (Process Flow Diagrams) without proprietary information. Core technologies are those specialized technologies that

57 comprise of the “heart” of the plant, such as, for example, a Reactor that serves a specific purpose to convert certain raw materials, with the help of specified catalysts, into other desired products. The core process technology areas of the plant will be listed, in order to avoid confusion about whose scope of work contains which deliverables. 2. Non-core technologies will only be developed to a process duty specification level, such as, for example: 2.1. Air separation units, boilers, power generation, plant air, nitrogen, and effluent treatment. 2.2. 2.3. 2.4. Optimization of power, steam, and cooling water Instrumentation control and operating philosophy Preparation of operating and commissioning guidelines with

framework plans 2.5. 2.6. 2.7. Environmental impact information Manpower recommendations Process unit layouts

3. Sized equipment list for non-proprietary equipment 4. Raw materials, utilities and chemicals requirements 5. Project execution requirements for development of a preliminary Project Execution Plan

58 6. Up-front input data that is required to commence the technical study, including scope and basis for the conceptual design, conceptual design deliverables and plant nominal size 7. Required scope of work to be done by the Technology Licensor, including the Licensor’s targeted cost estimate of proprietary equipment that will be supplied by them 8. Commissioning and start-up requirements 9. Plant management requirements 10. Sensitivities surrounding all aspects of the technical viability and significant risks of the project 11. A list of technical study deliverables 12. Important assumptions made by the engineering contractor 13. Targeted OOM (Order Of Magnitude) fixed-capital cost estimate of +15% to +30% accuracy 14. Technical study report The next step for the engineering contractor will then be to present the technical portion of the feasibility study in order to obtain approval from the owners and other investors, because the technical study will ultimately form the basis for the remainder of the feasibility study, which will focus on combining the technical study with the business plan in order to demonstrate that the economic and financial viability of the proposed venture conforms to the owners’ goals and objectives.

59 During this final stage of the project’s feasibility study, the parties wishing to structure project finance will draw up a financial model for the project. The financial model is a tool that simulates the Project Company accounts. This model is used for analyzing the economic viability of a project in order to set up a financial structure to meet the requirements of lenders, owners, and other investors in the form of a "bankable” project, and to ensure that the best solution is being developed as part of the negotiations. The financial structure of a project has to be consistent with its risk profile, and the testing of financial structures is being made on the basis of risk occurrence scenarios. Varying several input assumptions and adopting different financial structures, the financial model is used to assess the impacts on the Project Company's cash flow throughout the whole project life. Although there are many different ways of creating a "bankable" project, depending on the nature and circumstances of any particular project, a possible approach related to financing and cost recovery is set out in the financial model. It must show the financial and accounting assumptions used for the project including repayment schedules, cash flows, balance sheet and a profit and loss account. The financial model is very important, not only because it will be used as an ongoing monitoring tool during the rest of the project’s lifespan, at least until all the loans have been repaid, but also because the stakeholders, particularly the lenders, owners and other investors, will

60 place reliance on this model when devising the project finance package for the project. They will have it audited to check that it is arithmetically correct, logically built, that the inputs reflect the agreed financing terms and that the funding, repayment and accounting assumptions are correct and acceptable. The major stakeholders will want to see what effect changing the inputs and assumptions will have on the viability of the project. They will interpret these results and attempt to structure the terms of the project finance accordingly. The lenders will also carry out an internal assessment of the financial strength of the owners and other investors, including analysis of their annual accounts. According to Bakshi, Gurdip, Cao and Chen (1997) at least three aspects of financial modeling need to be addressed: 1) Financial model components; showing the main components of a financial model 2) Financial analysis indicators; which are used as the main criteria for project analysis 3) Financial impacts; a discussion of impacts on the financing structure if certain assumptions and parameters are changed 1) Components of a Financial Model Structure The first aspect of financial modeling to be addressed is the components of a financial model structure, as required for a feasibility study, and these are shown in Table 2.6. The section following there-

61 after sets out those indicators that can be analyzed with a financial model, and then indicators are discussed to show how to interpret the results. The purpose, however, is not to provide detailed instructions on how to create a model for use as a tool during the negotiations between lenders and owners, as the preparation of such complex models should be left to the specialists. The financial model is generally built using a standard spreadsheet program, such as Lotus or Excel, whereby the following work sheets are incorporated: a) Input and assumption sheets gather all the input data necessary for the model, classified as follows: i) ii) iii) etc.) iv) v) b) c) Financial data (characteristics of the credits, bonds, etc.) Operation data (operation cost, traffic forecast, toll rate, etc.) Results and summary sheets Sheets with cash flow statement, profit & loss account and Economic data (inflation, tax rate, etc.) Construction data (construction costs and planning, etc.) Source of funds and amount (equity, credits, bonds, subsidies,

balance sheet d) Various calculation and work sheets dealing with taxation, loan

structure and other relevant aspects required generating the cash flow, profit & loss account and balance sheet for the project.


63 Table 2.6 ________________________________________________________________________ Components of a Financial Model for an Industrial Plant 1. Table of Contents 2. Summary Sheet 2.1. Summary Financial Results 2.2. Financial Graphs 2.3. Area Graph 2.4. Pie Graph 3. Inputs and Assumptions 3.1. Operating Cost Inputs and Assumptions 3.2. Financing Inputs and Assumptions 4. Raw Material Forecasts 3.1. Pace Raw Material Price Forecast 3.2. Sponsors Raw Material Price Forecast 3.3. Fixed Raw Material Price 3.4. Raw Material Price Forecast Utilized 5. Fixed-Capital Cost 3.1. Fixed-Capital Costs Breakdown 3.2. Fixed-Capital Expenditure Profile 4. Escalation Factors 4.1. Manual Input Variable Escalators 4.2. Fixed Quarterly Escalators

64 Table continues ________________________________________________________________________ 5. Capital Drawdown 5.1. Capital Expenditure and Start-up Cost 5.2. Finance Drawdown 6. Start-up Schedule 6.1. Start-up Schedule 7. Capital Allowances and Depreciation 7.1. Capital Allowances and Depreciation 8. Product Revenues 8.1. Product Revenues 8.2. Marketing Fee 9. Project Costs 9.1. Feedstock Costs 9.2. Operating Costs 9.3. Working Capital Requirements 10. Taxation 10.1. Taxation 11. Sources and Uses 11.1. Sources and Uses

65 Table continues ________________________________________________________________________ 12. Financing 12.1. Commercial Bank and Tranche 12.2. Working Capital Tranche 12.3. Bond Financing 12.4. Reserve Accounts 13. Leveraged Economics 13.1. Cash Waterfall 13.2. Cover Ratios 14. Un-Leveraged Economics 14.1. Cash Waterfall 14.2. Cover Ratios 15. Balance Sheet 15.1. Balance Sheet 16. Income Statement 16.1. Income Statement 17. Cash flow Statement 17.1. Cash flow Statement 18. Sponsors’ Returns 18.1. Other Sponsors’ Equity Returns 18.2. Owners’ Equity Returns ________________________________________________________________________

66 2) Financial Analysis Indicators

The second aspect of financial modeling to be addressed is the financial analysis indicators that are used as the main criteria for project analysis. Although each party may have its own specific tools to analyze the robustness of a project and the best way of structuring the financing, according to Teall (1999) the following indicators are generally used in the project finance world: a) Project Internal Rate of Return (or Project IRR) This represents the yield of the project regardless of the financing structure. the project Internal Rate of Return (γ ) is calculated on the basis of the following equation: Σ {(Ri-Ii-Ci)/(1+γ )2}=0; where Ri is the operating revenue at year i; Ii is the amount invested in year i; and Ci is the operating cost at year i. the project is advantageous when γ is high. Generally the project Internal Rate of Return (γ ) should be above 7% - 8% in real terms, depending upon country conditions and financial markets. b) Project Return on Equity (or Equity IRR) This represents the yield of the project for the shareholders whose investments are remunerated with dividends. The Internal Rate of Return (γ ) on equity is calculated by the following equation: Σ {(DiIi)/(1+γ )2}=0; where Di is the dividend at year i; and Ii is the amount invested by shareholders at year i. The project is profitable for the shareholders when γ is high.

67 c) Annual Debt Service Cover Ratio (ADSCR) This represents, for any operating year, the ability for the project company to repay the debt despite discrepancies in the assumptions taken into account in the model. This ratio is determined as follows: ADSCRi = CBDSi / Dsi; whereby the project is estimated viable for the lenders when the ADSCR is greater than 1 for every year of the project life. This means that if, for whatever reason, the project revenue is below what has been forecast in the financial model at year i, the Project Company should nevertheless be able to repay the debt. Generally, the minimum ADSCR should be greater than 1.1 or 1.2. d) Loan Life Debt Service Cover Ratio (LLCR) This represents, for any one operating year, the ability for the Project Company to bear an occasional shortfall of cash due to discrepancies in the assumptions taken into account in the model and leading to its incapacity to repay the debt during the last few years. This ratio is calculated as follows: LLCRi = {NVP(CBDSi →end)}/ (DSi→end); whereby NVP(CBDSi →end) is the net present value of the cash flow before debt service from year i to the end of the debt repayment period (net present value is used to neutralize the effects of inflation). DSi→end is the total of debt service remaining at year i, including principal and interests. the project is estimated viable for the lenders when the LLCR is high

68 for every year of the project life. This means that the project company should be able to repay the debt despite a period of cash shortfall. The lenders use ADSCR and LLCR to check project capacity to repay debt in adverse risk scenarios, including if income falls short of that forecasts. e) Net Present Value (NPV) of Subsidies In case the lenders have to subsidize the project over several years, the net present value of these payments gives the real amount of loans as if they were paid in a lump sum at present year. The net present value neutralizes the effects of inflation and gives a precise idea of values taken into account in the future. However, calculating an NPV requires a parameter called an "actualization rate" or discount rate, which has a considerable effect on the result. The actualization rate must be chosen with due diligence. 3) Financial impacts (sensitivity analysis) The third aspect of financial modeling to be addressed is the financial impacts on the model, that is, the sensitivity analysis of the model. This involves a discussion of impacts on the financing structure if certain assumptions and parameters are changed. Using the simulation model as a basis, it is possible to analyze the impacts of the following financial analysis indictors: a) concession life (currently set at 25 years),

69 b) length of the construction period (currently set at 3 years), c) amount of capital subsidies (currently set at 0), d) amount of fixed annual operational subsidies (currently set at 0), e) Equity - debt structure (currently assumed 20/80 after deducting capital subsidies), f) Loan maturity period (currently set at 15 years), g) Loan grace period (currently set at 4 years), h) Loan repayment profile (currently set at annuity repayment), i) Discount rate for subsidies (currently set at real annual rate of 5%). Moreover, in each of the above cases, it is possible to test the robustness of the financial structure as regards sensitivity to the following: a) Project parameters comprising i) Changes in investment costs due to higher construction costs or cost savings (+ x%), ii) Changes in operating costs (+ x%) and iii) Changes in traffic either due to changes in initial traffic (+ x%) or due to changes in annual growth rates (+ x% per year), b) Economic parameters comprising i) Changes in inflation (+ x% per year) and ii) Changes in interest rates (+ x% per year).

70 Assuming the lenders, owners and other investors, favorably accept the feasibility study outcomes, provisional capital approval is given by them for the project team to proceed with the basic engineering development of the project. Essentially the lenders must be convinced that the project deserves financing, and the owners and other investors must be satisfied with financing deal negotiated with the lenders. Financial approval also means that the owners and its project team must from here on after manage and/or mitigate the project’s risks associated with its business case, with its technical accuracy as well as project management competency, in a manner that assures the continued viability of the project, as agreed with the lenders upon acceptance of the feasibility study outcomes. 1.14 Project Finance for an Industrial Plant Project based on the Basic Engineering Development Phase The technical and commercial viability of the project must again be demonstrated upon completion of the basic engineering development phase, when the project team puts a request forward to the PSC (Project Steering Committee) and then to the Board of Directors for final capital approval, prior to beginning the execution phase. Final capital approval is sought at the end of the basic development phase, particularly from the owners, who are in close consultation with the lenders and other project investors, in order to proceed with detailed engineering and construction. At this point, when final capital approval is sought prior to

71 beginning of project detailed engineering and construction execution, it is imperative that the project’s risks must be clearly understood and appropriately addressed, because commitment of money to construction is final and cannot easily be stopped or reversed except at great cost to the owners and other investors. Essentially, the stakeholders of the project, to assure themselves of the viability of the project prior to final capital approval, must again conduct a due diligence of the project after the basic development phase. Due diligence at this stage is the activity of making a thorough assessment of the components of the proposed venture, so that all significant risks can be reflected in the terms of the application for final capital approval. This assessment includes: • Again ensuring that the project’s bankable base case, as established during the feasibility phase, continues to be acceptable, because it may very well have been affected by any number of issues during the basic engineering stage, such as adverse changes in anticipated exchange rates, increased equipment and materials and/or their expected costs, increased execution costs, and so forth • Technical details of the project are understood and within specifications • Project execution management is verifiably well prepared and competent to proceed

72 • Insurance provisions for the project are acceptable to all the relevant project stakeholders and placed correctly in the various contracts • The many project contracts reflect properly the commercial agreement between parties, interface correctly while appropriately apportioning the numerous risks, and also subscribe to the viability of the project. The major technical deliverables that are typically expected from an engineering contractor during this phase are shown in Table 2.7. The engineering contractor may sometimes be required, as a part of the Basic Engineering Package (BEP), to extend the basic design with additional detail that, in some cases, are only required to be done during the following detailed design stage by the project EPC (Engineering, Procurement and Construction) contractor. This extended basic design is referred to as the EBEP (Extended Basic Engineering Package) and is done during the BEP stage if the owners want further design detail that is necessary to begin ordering specialized plant equipment in advance of the EPC execution phase. Engineering terminology abbreviations listed in Table 2.7 are PDP (Process Design Package); BEP (Basic Engineering Package); and EBEP (Extended Basic Engineering Package). Also, the designation P stands for Perform task assuming full responsibility and liability in

73 accordance with the Contract, while (P) means Items be considered as optional extensions of the Basic Engineering Package.

74 Table 2.7 ________________________________________________________________________ Basic Engineering Development Deliverables for an Industrial Plant Project

Package Class PDP BEP Docume nt Number Title EBEP


Project Engineering Final Package Documentation for PDP for BEP for EBEP Document and drawing list Process Engineering Process guarantee document Basic process engineering design data P P P P P P Use Forms FA 0173-0199 etc. Include relevant data on overload for individual units or groups of equipment, turndown etc. P P P P P P Basic Engineering Manual only

Package Class PDP BEP Docume nt Number Title EBEP Remarks

Process description




Overall coordination and relation of units to one another to be in general volume for multi-unit plants. Ensure Control Philosophy is adequately handled. Not as deliverable.

Process block flow diagram Process calculations Process flow diagram




Table continues ________________________________________________________________________

Package Class Docume nt Number PDP EBEP Title BEP


Materials of construction diagram with materials memorandum



See Working Instruction AG 0339.

Package Class PDP BEP Docume nt Number Title EBEP Remarks

Material balance




For all contractually listed operating cases, preferably separate from PFD to avoid repetition in PDS. Note that standard estimating procedures only cater for one operating case.

Utility balance




… and/or summary. Ensure peak rates are included for design basis of offsite units. Be careful to understand, what the Client expects of this. There are many different possibilities of presentation, with more or less work involved. To extent covered by Scope of Plant.

Energy balance




Utility flow diagram (UFD) Offsite flow diagram (OFD)



77 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Process equipment list




Incl. main dimensions, weights (worst case) Process duty specifications are much less detailed in their information content than a full Process Data Sheet. This is particularly noticeable for Heat Exchangers, where no HTRI calculation of numbers of tubes etc. is made.

Process duty spec for –equipment –Package units


Process data sheets for –equipment –Package units



More detailed than process duty spec. See above. Clarify any necessity for supply in electronic form. Hydraulic assumptions

Pump calculation sheets




Package Class PDP BEP Docume nt Number Title EBEP Remarks

Process data sheets for Instruments

(P) P


Using data sheets FA 0224-0229, LOF 1116811172. Clarify any necessity for supply in electronic form.

Process data sheets for relief valves

(P) P


79 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Health Safety and Environmental (HSE) data

(P) P

… Basis for hazardous area dwg. Review duplication with 050190. [… Review duplication with Safety Manual ...].

Specification of - raw materials - products - utilities Specification of catalyst and chemicals







If applicable inert fill, e.g. packing shall be included. Participation only. Documentatio n is part of Detail Engineering.

Hazard and operability studies (HAZOP)


Package Class PDP BEP Docume nt Number Title EBEP Remarks

Emissions and effluent summary




Separate for gas, liquid and solid streams. Separate for continuous, noncontinuous (deliberate, e.g. at startup or not deliberate e.g. relief emissions) and seldom occurring effluents (e.g. spent catalyst).

Process philosophy for paving and drainage Process requirements for safety systems Relief load summaries Cause and effect diagrams P P



(P) (P) P

81 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Control narratives Set point list Process engineering redundancy concept Description of analyzing methods





Normally only non-standard methods. If client wants a copy of e.g. ASTM methods, then this must be allowed for in the estimates.

Analysis plan List of laboratory equipment Technical specification for laboratory equipment Study of inherent/environmental hazards Operation sequence chart Operation manual for process plant Rotating Equipment Engineering Mechanical engineering and design specification Engineering/equipment data sheet Vessel Engineering Vessel engineering and design specification



P (P) (P) (P)

(P) (P) (P) P P P

For batch processes First issue

(P) P (P) P e.g. for longlead items.

(P) P

82 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Engineering/equipment data sheet / Guide drawings for vessel

(P) P (P) P

Are estimated weights required for early start to civil/structural design? If yes, be careful about commitment for vendordesigned equipment. Note: LURGI does not recommend the supply of workshop drawings since the requirements are to closely tied to vendor's individual requirements, e.g. welding procedures, plate layout, final material selection, organizational methods, etc.

Package Unit Engineering Duty specification for package units P P P In case of PDP for process relevant PU’s only

Duty specification for fire fighting system


Package Class PDP BEP Docume nt Number Title EBEP Remarks

HVAC - Duty specification


To extent required by process

Piping Engineering & Design Plant Layout

84 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Plot plan Area plot plan



P P In case of several units only. In case of PDP typical only

Equipment arrangement drawing




5.6.2 P&I Diagrams Process P&I diagram Utilities P&I diagram Interconnecting P&I diagram Offsite P&I diagram P P P P P P process related offsite

5.6.3 Engineering Deliverables General engineering and design specifications - Piping engineering - Pipe class index – Piping supports - Heat tracing - Piping cleaning Pipe class sheet List - Safety relief valves Data sheets - Safety relief valves Line list Piping study drawing P (P) P (P) P P (P) (P) (P) (P) P P (P) (P) P (P) Requires more definition, e.g. for main process lines over 6” or column studies etc.

Processspecific only

Package Class PDP BEP Docume nt Number Title EBEP Remarks

Battery limit list




In case of PDP Process issue only

86 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Tie-in point list



Pipe Coating and Insulation Coating & Insulation
Coating specification Insulation specification (P) (P) P P

Electrical Systems
Electrical engineering and design specification List of electrical consumers (L.O.E.C.) L.O.E.C. with basic information for control purposes One line diagram Safety characteristic of hazardous areas Hazardous area drawing (P) P P (P) (P) (P) P P P P P P

Instrumentation & Control Systems
Instrumentation engineering and design specification General specification for DCS Instrument list Engineering data sheet for instrumentation Functional diagram for process sequences and plant control systems for DCS Functional diagram for ESD with description P (P) (P) P P P P (P) P To extent required by process. To extent required by process.



Package Class PDP BEP Docume nt Number Title EBEP Remarks

Calculation sheets for flow instrument and control valves


88 Table continues ________________________________________________________________________

Package Class PDP BEP Docume nt Number Title EBEP


Civil, Structural and Architectural
General engineering, design, construction specification for civil work General engineering, design, fabrication, construction specification for structural steel (P) (P) P P

Architecture - Layout drawing (P) To extent required by process To extent required by process

Building Elevation - Layout drawing


Noise Control Engineering
Specification - Basis of noise control concepts (P)

List of suppliers P P P For process critical or proprietary equipment


89 The owners’ commitment to final capital approval is to a large extent based upon the project’s Semi-Definitive Cost Estimate (SDE), of a +10% accuracy, that is prepared at the end of the basic engineering development phase. This estimate is similar to but more accurate than the fixed-capital cost estimate in the feasibility phase, because it is based on significantly more detailed information that was developed during the basic engineering phase, including the equipment, services, and auxiliary facilities for the project. On a typical medium sized industrial plant project of about US$100 million, a variance of +10% effectively means that the costs could vary by as much as US$10 million over or under the projected costs. This is already a very significant variation, not counting estimating errors or omissions of scope. The importance of accurately identifying and evaluating project risks must therefore be appreciated, because every risk on the project has a cost implication associated with it, as confirmed by Conrow (1996). Likewise, if unforeseen risks occur during the execution of the project, it could potentially cause a cost overrun that the owners had not anticipated, and be detrimental to the overall commercial and technical viability of the project. The importance of accurately estimating the fixed-capital costs of the project must also be stressed, both for the feasibility phase as well as for the basic engineering development phase. The risk of errors in estimating can mislead the lenders, owners, other investors and also

90 the contractors, with potentially disastrous repercussions for the continued viability of the project. The following section gives an overview of fixed-capital cost estimating, as it is seen as a vitally important part of project finance decision making for industrial plant projects. 1.15 Estimating Fixed-Capital Cost for an Industrial Plant Project A well-prepared cost estimate, firstly the early estimate during the feasibility phase, greatly facilitates an accurate business case, so that the owners and lenders can make sound economic decisions. To prepare reliable estimates, the estimate methodology must be commensurate with the desired level of accuracy and the level of scope definition at the time the estimate is prepared. As will be shown here in below, the levels of accuracy progressively increase as more detailed project information is developed from the feasibility phase through the basic engineering phase. The first step in the estimating work process is stakeholder alignment. Alignment between the owners and the project estimating team must be established before starting an estimate. Alignment facilitates early communication to ensure a clear understanding of the owners’ expectations and the estimating team’s ability to meet those expectations. Close alignment helps mitigate estimate inaccuracies that can result from misunderstandings and miscommunications. It

91 also enables establishment of the estimate work plan and staffing requirements. The estimate kick-off meeting provides a forum for establishing this alignment and mutual understanding. The accuracy of any estimate depends on the quantity and quality of information known about the project at the time the estimate is being prepared. In simple terms, better scope definition yields better estimate accuracy. When the plant and project execution scope is not clearly defined, the experience and skills of the estimating team in general and the estimators in particular have a significant impact on estimate accuracy. Therefore, for early estimates it is important to use the most experienced team members. CII (Construction Industry Institute, 2003) research shows that team skills and estimating procedures have a significant impact on the accuracy of the estimate. Estimates are prepared for each phase over the life cycle of a project. To produce consistency in estimates, a company-standardized estimating work process should be established. A typical standard estimating work process is described later in this section. An estimate work plan should be prepared before starting any estimate. Effective use of estimate checklists will minimize omissions and duplications. A standard estimating work process should include using key cost indicators to perform reality checks. An estimate of the capital investment for a process may vary from a feasibility phase pre-design estimate based on little information

92 except the size of the proposed project, to an execution phase detailed estimate prepared by a contractor from complete detailed drawings and approved specifications. Between these two extremes of capitalinvestment estimates, there can be numerous other estimates that vary in accuracy depending upon the stage of development of the project. Where information is incomplete or in time of rising-cost trends, there is a large probability that the actual cost will be more than the estimated cost. For such estimates, the positive spread is likely to be wider than the negative, for example, +40 and -15 percent for an OOM estimate. Pre-design cost estimates such as the VROM, ROM and OOM estimates, are all preliminary estimates that require much less detail than firm estimates such as the SDE or Definitive estimates. However, the pre-design estimates are extremely important for determining if a proposed project should be given further consideration, and also to compare alternative designs. The pre-design estimates are used to provide a basis for requesting and obtaining provisional capital approval for a project from company management. Later estimates, made during the progress of the project life cycle, are used to indicate whether, and by how much, the project will cost more or less than the amounts originally approved. Management is then asked to approve a variance, which may be positive or negative.

93 When an estimate is completed, a support document should be prepared to provide a narrative for the basis of the estimate including assumptions, inclusions, exclusions, and other factors that affect estimate accuracy. Estimate reviews should be conducted at strategic times during estimate preparation to improve communications. No estimate should be released without internal reviews. The level and number of reviews depends on the magnitude and purpose of the estimate. Effective communications are enhanced with estimate feedback. No estimating process is complete without continuous feedback loops. Feedback from lessons learned allows adjustments in estimating standards and practices to improve estimates. Therefore, a process must be established to capture and retrieve project data. Risk assessment and assigning contingency are important tasks in preparing estimates, particularly early estimates. Key members of the project management team must provide input to assess risk properly and to assign appropriate monetary contingency value against the magnitude of each perceived risk, based on the expected level of estimate accuracy. Utilizing structured techniques of identifying and evaluating risks to determine realistic contingency values reduces subjectivity, which improves estimate accuracy. This dissertation will develop such a structured model, for the purpose of identifying and evaluating risks during the feasibility and basic engineering phases. The estimators can then select any of a

94 number of estimating software to determine appropriate contingency values for specific risks, thereby providing an alternative approach that can be checked against other methods of assigning contingency. Of the many factors that contribute to poor estimates of capital investments, the most significant one is usually traceable to sizable omissions of equipment, services, or auxiliary facilities rather than to gross errors in costing. A checklist of items covering a new facility is an invaluable aid in making a complete estimation of the fixed-capital cost. Below is a typical list of required information, including equipment, services, and auxiliary facilities, for estimating. This list does not provide a definitive and detailed breakdown of all direct and indirect items required for the various types of estimates, but nevertheless covers all major headings and components. The point of the list is to demonstrate the number of issues that must be considered when identifying and evaluating project risks, for the purposes of accurate estimates to ensure a basis for meaningful decision-making by company management. Typical estimating work process for industrial plant projects: (II) Definitions and Abbreviations a. Definitions i. Cost Estimate - A cost estimate is defined as a calculation of quantity, size and expected costs of the elements of a

95 project of which the scope has been agreed upon with its proposer. ii. Estimate Basis - The basis of an estimate summarizes the philosophy and parameters used to prepare the estimate. iii. Elements Of An Estimate - The elements of an estimate include everything that is required for the engineering, procurement and construction of a defined scope of work. b. Abbreviations i. ii. iii. iv. v. vi. vii. viii. ix. (III) DEF IBL IFL OBL OFL Definitive Estimate Inside Battery Limits Inside Factory Limits Outside Battery Limits Outside Factory Limits

OOM Order Of Magnitude estimate ROM Rough Order of Magnitude estimate SDE Semi-Definitive Estimate

VROMVery Rough Order of Magnitude estimate Responsibilities and Authorities

The following responsibilities and authorities will apply in the request for, execution and authorization of cost estimates: a. Responsibilities of the Project Manager i. When requesting an estimate, it is the responsibility of the person who submits the request to ensure that the

96 information accompanying it adheres to the requirements set out in Table 2.8. ii. It is this person’s responsibility to conduct a Review Meeting on completion of each estimate to ensure that the scope and man-hours provided for in the estimate is agreed to by all parties involved and then to ensure that all involved parties sign an “Acceptance of Cost Estimate” form. Once the estimate is accepted at the review meeting, then this person must sign the estimate to signify acceptance of it. iii. When applying for capital, this person should document the request to the requirements set by the Approving Authority, if requested. b. Responsibilities of the Design Engineer i. The design engineers supply information to the project manager. It is their responsibility to ensure that the information is sufficient to define the scope covered by their designs. This includes all relevant information such as drawings and material take-offs, equipment lists, data sheets for tagged items, and information pertinent to on-site and off-site facilities. It is also the responsibility of all the involved engineering disciplines to, when applicable; supply to the project manager their own estimated man-hours for the activities they have to perform. When applicable, upon

97 acceptance of an estimate after a Review Meeting, the responsible design engineer signs the "Acceptance of Cost Estimate" form. c. Responsibilities of the Cost Estimator The cost estimator is responsible for: i. Doing the required estimate inclusive of a cash flow forecast, according to the norms and standards set by the Manager, Cost Estimating ii. Classification of the estimate based on the information provided iii. Ensuring that the estimate is arithmetically correct, with regard to pricing, unit rate extensions and other calculations in the estimate iv. Assigning a contingency derived from a risk evaluation (informal or formal as applicable) and which depends on the applicable stage of project development and the purpose of the estimate v. Alerting the project manager of probable deficiencies or uncertainties in any of the project elements vi. vii. Completing the estimate as per the agreed schedule Signing the estimate, as well as the "Acceptance of Cost Estimate" form as completed, only after the estimate review has been conducted, when applicable.

98 viii. Authority For Approval Of Estimates All estimates need to be approved before being issued, no matter the reason that they were requested for. This applies to the estimator and his superiors approving the estimate as technically correct, as well as the person requesting the estimate, or his superiors, accepting the estimate as being representative of the scope of work they have to execute. Signature procedures for all estimates are as designated by company management; however, the Estimator signs every estimate.

99 Table 2.8 ________________________________________________________________________ Minimum Information Required For Estimates




1 2 3


5 6

7 8 9




Product of proposed plant Design capacity of proposed plant Geographical location and site information (e.g. Ground formation & climatic conditions) at proposed plant If a similar, historical plant exists, provide the capacity, complexity, erected cost, location and construction midpoint of such a plant Differences between proposed and historical plant e.g. number of trains Plot plan of proposed plant - Preliminary - Final Rough sketches of proposed plant Process description Process flow diagram (PFD) and/or Plant modification diagram (PMD) - Preliminary - Final Mechanical flow diagram (MFD) or Process & Instrumentation (P&I) diagrams - Preliminary - Final Equipment list and process data sheets of the required equipment items - Preliminary - Final (Priced) Quotations for complex, major mechanical equipment






























13 14

(e.g. compressors, fired heaters, large reactors & columns) Purchase orders for all major mechanical equipment tagged items Information on extraordinary items not listed as equipment (e.g. large manifolds)





101 Table continues ________________________________________________________________________









18 19 20

21 22 23 24 25 26 27

Piping: - Piping sketches - Piping planning studies - Isometric drawings Take-offs for bulks - Preliminary - Final Information regarding special requirements, e.g. for health, safety, maintenance or environmental protection. Lump sum or unit rates negotiated and contractually finalized Contract prices (finalized) Sastech and outside engineering services manhours and/or costs - Preliminary - Final License fees/ Paid-up Royalties Insurance First load catalysts and chemicals. Pre-production budget Custom duties Spares Details of proposed off-site requirements, when applicable e.g. in the case of complete grass roots plants and new units within existing plants. (e.g. infrastructure, utilities and interconnecting services between utilities, offsite units and new plant) - Preliminary - Final














Plan of execution (who, when, what, how) - Preliminary - Final





Preferably - XX _____________________________________________________________________

103 Table 2.9 ___________________________________________________________________ Equipment List Design Data


Duty (MW) Pressure Type (e.g. A Frame) Furnace Duty (MW) Fuel feed rate Material(s) of manufacture Type Flares/stacks Physical dimensions: height, Capacity (t/h) diameter Material(s) of manufacture Flare tip specifications Heat exchangers Total surface area (finned for air Duty (MW) (required for cooled heat exchangers) plate heat exchangers) Material(s) of manufacture Type (e.g. fixed tube, floating head, double pipe, U tube, plate, air cooled) Reactors T-T length Type (e.g. fixed bed, liquid Inside Diameter phase, vapor phase fixed Pressure fluidized bed, slurry bed), Material(s) of manufacture wall thickness & internals. Temperature Columns and Towers T-T length Inside Diameter Pressure Material(s) of manufacture Internals: type (e.g. valve trays) and No. Temperature Tanks Height Internals (e.g. heating coils Diameter or vapor conservation Material(s) of manufacture internal floating roof.) Type (e.g. fixed roof, floating roof, sphere, etc.) Pressure Drums and T-T length Internals (e.g. heating Separators Diameter coils) Pressure Type (e.g. Material(s) of manufacture horizontal/vertical, with or Temperature without boots, dished/semi-elliptical heads). Filters Capacity (m3/h) Filter area Material(s) of manufacture Pressure Type Particle retention size

Capacity (steam t/h)



Capacity (m3/h) at suction Medium compressed conditions. Temperature kW No of stages Inlet and discharge pressures Material(s) of manufacture Type (e.g. reciprocating) Steam or electric driven

105 Table 2.9 ___________________________________________________________________


Dryers Centrifuges Crushers

Crystallizers Ejectors Evaporators Mills Mixers Refrigeration units Cooling towers

Capacity (m3/h) kW Type (e.g. centrifugal) Steam or electric driven Inlet pressure Outlet pressure Capacity (t/h) kW Material(s) of manufacture Capacity (t/h) kW Material(s) of manufacture Capacity (t/h) kW Material(s) of manufacture Type (e.g. jaw) Capacity (t/h) Material(s) of manufacture Capacity (t/h) Medium pumped, suction discharge pressures Capacity (t/h) mW Material(s) of manufacture Capacity (t/h) kW Type kW Material(s) of manufacture Type Duty (MW) Duty (MW) Capacity (water m3/h) Material(s) of manufacture Type (e.g. forced draught) Capacity (t/h) Material(s) of manufacture Length Width Type (e.g. inclined, bucket) Capacity (t/h) kW Capacity (t) Span Type

Medium pumped NPSH

Pumping medium and and pressure Number of stages Total heating surface area Type Inside diameter Inside length Speed Speed Capacity Evaporator temperature Type Cooling range Wet bulb temperature Quality of product e.g. parts per million total dissolved solids.

Boiler Water Treatment System Conveyors


106 Table continues ___________________________________________________________________

Lifts Hoists

Capacity (t) Height Type Load (t) Type

Table ends

107 Estimating Procedure a. General Estimating Activity Sequence i. Planning of Estimating Activities The various estimating activities must be pre-planned and in a case where it is intended to be used as basis for capital application, be catered for in the schedule for the execution of the project. This is the responsibility of the Project manager, or his cost control official, in co-ordination with the manpower planning of the Local Supervisory Estimator. Where there are valid reasons for an estimate not being preplanned, the request for such an estimate might have to be referred to a higher level for prioritizing. The duration to be allowed for the respective estimating activities is to be confirmed with the Local Supervisory Estimator. ii. Requesting an Estimate A Request for Cost Estimate shall be completed and signed by the Project Manager. This will apply in all cases where cost estimating services are required, including when a revision to an existing estimate is requested. The request shall be accompanied by all the relevant information, in the format of the company’s iii. Cost Code of Accounts

108 The request shall be handed to the Local Supervisory Estimator, or his representative, in person, who will log the request and agree on a completion date. iv. Preparing an Estimate The Local Supervisory Estimator will forward the request to an Estimator who will compile the estimate in accordance with the pre-established norms and standards. The estimate will be classified as either a VROM, ROM, OOM, SDE, DEF or Control estimate and it will be stated whether it is suitable to be used as basis for capital application or not. v. Reviewing an Estimate For estimates done for projects, it is the responsibility of the person who requested the estimate to ensure that all parties involved review the estimate, together with the Estimator, to see to it that the total scope of work is covered and that the estimated man-hours are realistic. A risk analysis, formal or informal, as may be applicable, must form part of the review for all estimates exceeding US$1 million, to calculate a realistic contingency to be added to the estimated cost of a project. vi. Releasing an Estimate

109 If the requirements are not met, or if there are any outstanding issues pending from the review, the estimator can refuse to forward the estimate for approval. After the valid approval signatures are obtained, the estimate will be issued to the person who requested it. All estimates will be accompanied by a covering letter together with the appropriate signatures, which states the estimate basis, summarizing the philosophy and parameters used to prepare the estimate and which contains the following highlights: (A) Concise description of the project, for example, name and capacity of plant (B) Statement of estimate type and whether estimate is suitable to be used as basis for capital application or not. (C) Statement of the specific time schedule within the plan of execution on which the escalation calculations are based. (D) Construction approach methods and techniques used in developing the estimate. (E) Qualification of any portion of the estimate that may have a high risk factor. (F) Statement of foreign currency amounts included in the estimate and the rates of exchange used. (G) A cash flow forecast and any attachments.

110 (H) The estimate original will be kept on the estimate file and a copy would be made available to the Manager, Cost Estimating. (VI)Other estimating activities: a. Prepare or assist in the preparation of a cost control base (i.e. project costs, man-hours, manpower loading, progress curves, etc.) b. Adjudication of bids on contracts and purchase orders. c. Change order and trend calculations. d. Claims analysis and evaluation. e. Assistance with the compilation of the Final Job Cost Report. f. Residual, replacement and insurance base values.

g. Downtime and reconstruction costs for EML calculation purposes. (VII) Estimating Involvement In Project Life Cycle These activities follow the summarized flow chart of the Business Development and Project Implementation Life Cycle. The numbering of activities will follow the milestones to facilitate easy reference and to enhance easy reading of this document, the core activities and responsibilities will be defined and where there are any deviations or additions, they will be specified in the relevant stage.

111 (VIII) Idea Generation Stage (Gate 1) During this innovative stage, various ideas may be considered and different business opportunities investigated. This will subsequently require rough talking figures to enable decision-making. Obtaining Very Rough Order of Magnitude (VROM) cost estimates from the Owner’s Cost Engineering Department can accommodate such actions. Official cost estimates will, however, require that formal estimate requests be submitted in accordance with this work instruction. (IX)Pre-Feasibility Stage (Gate 2) During this stage, identified business opportunities are being evaluated and alternatives are being assessed. Proper official Rough Order of Magnitude (ROM) estimates are made to facilitate this preliminary assessment and alignment with the business. If such a cost estimate is required, the request should be in accordance with this work instruction. (X) Feasibility Stage (Gate 3) During this stage the selected business opportunity is finally framed. This involves addressing outstanding issues and concerns carried over from the pre-feasibility stage. Order Of Magnitude (OOM) estimates are made to facilitate possible Approval in Principal of the project, as well as to assist with the approval and planning of resources and making decisions as to whether to continue, to stop, or to rework

112 the project. If such a cost estimate is required, the request should be in accordance with this work instruction. (XI)Basic Development Stage (Gate 4) During this stage, after the conceptual development of a project has been completed, the project definition is fully optimized and potential execution contractors are being adjudicated. A Semi-Definitive Estimate (SDE) is then made in accordance with this work instruction. It is however important that the estimator assigned to the project should become acquainted with the contents and complexity of the project, for example, by attending kick-off meetings, etc. (XII) Execution Stage (Gate 5) During this stage engineering and design are fairly advanced and contracts are being negotiated or executed. Definitive (DEF) estimates are now prepared, which incorporate any design changes and cost trends that may have occurred since completion of the basic development stage, in accordance with this work instruction. It is however important that the estimator assigned to the project should become acquainted with the contents and complexity of the project, for example, by attending kick-off meetings, etc. (XIII) Highlights of an Estimate: a. Concise description of the project, for example, name and capacity of plant

113 b. Statement of estimate type and whether the estimate is suitable to be used as basis for capital application or not c. Statement of the specific time schedule within the plan of execution on which the escalation calculations are based d. Construction approach methods and techniques used in developing the estimate e. Qualification of any portion of the estimate that may have a high risk factor f. Statement of foreign currency amounts included in the estimate and the rates of exchange used g. A cash-flow forecast and any attachments (XIV) Elements Of An Estimate

A cost estimate consists of the following elements: a. Direct field cost b. Indirect field cost c. Owner’s engineering services d. Travel, accommodation and business expenses e. Outside services, such as purchased engineering f. Other costs, such as royalties and license fees

(XV) Contingencies. Each subheading i.e. direct field costs, indirect field cost, etc. has been broken down into numerous sub-codes, details of which appear in the company’s Cost Code of Accounts. This facilitates the building up of

114 cost estimates; the keeping of accounts, correct cost allocations for cost control and is also suitable for use in the different cost reports. Estimates for all projects other than grass-roots projects or totally new units within existing plants, normally exclude the following items, unless specifically requested by the Proposer: a. Cost of servitudes and land b. General company overheads, including c. Finance charges and Interest during construction d. Marketing establishment, including pre-marketing e. Extraordinary maintenance facilities f. Research and Development and Laboratory services

g. Start-up and commissioning, including vii. Commissioning support by the Engineering/ Managing contractor and/ or Owner viii. Start-up assistance by, for example, a seller, licensor, vendors, outside specialists and/ or owner/ future operating company - when allowed for in an estimate it forms part of Pre-production costs ix. Working capital and Operating costs - other than initial loads of Catalysts, Chemicals, Inert materials, Spares and Preproduction costs. These should, when applicable, form part of all estimates.

115 x. Training costs, when allowed for in an estimate it forms part of Pre-production costs, including training given to the future operating/maintenance personnel by: 1. The Engineering/ Managing contractor 2. Outside concerns, other than the Engineering/ Managing contractor xi. Royalties based on production (Note, however, that paid-up royalties/ license fees normally form part of all estimates). (XVI) Estimate Categories according to Functional Areas of a plant The estimate categories of the project are grouped into functional areas of the plant. Quite often different functional areas are designed by different companies and constructed by different contractors. Their cost patterns are also different. This division into functional areas of a plant is not only necessary for producing improved cost estimates but also for more accurate cost control and for insurance purposes. For more details, refer to Figure 2.3. The estimate categories as designated by plant functional location are: a. Processing units b. Utility and service plants and facilities c. Handling, blending, storage and dispatch facilities d. Off-site facilities e. Requirements outside a factory complex fence, such as infrastructure


117 Figure 2.3 ________________________________________________________________________ Estimate Category by Functional Location Reference







Processing unit: Inside the Battery Limits (IBL) of the Processing unit – also called IBL, which is the overall factory boundary. • Off-site facilities: Outside the Battery Limits (OBL) of the

Processing unit – also outside the overall factory boundary. • Infrastructure facilities: OBL of the overall factory boundary also Outside Factory Limits (OFL). ________________________________________________________________________

118 (XVII) Time Factor Of Estimates Capital cost estimates should always be valid for the month in which they are completed, unless the proposer, for example, requests a different validity date for economic evaluation purposes. All estimates that are intended as basis for capital application shall include future escalation, i.e. they are presented on an end-of-job (EOJ) cost basis. Any prices supplied to the cost estimator for materials, contracts, etc. should state if escalation and VAT are included or excluded. The estimator will then do the necessary adjustments to suit the type of estimate. Whenever the Business Economics Section of the company carries out an economic evaluation of a project, an estimate of the effect of finance charges, working capital, interest, etc. shall be made by the estimating department. Upon approval of the project, the Economics Section shall furnish details of these costs to Financial Department for use in profit forecasting. (XVIII) Types Of Estimates The owner may typically require cost estimates to be grouped into three types, based on the nature, quality and completeness of information supplied to the cost estimator, and the purpose of the estimate. They are: a. Order of Magnitude (OOM) b. Semi-definitive estimates (SDE) c. Definitive estimates (DEF)

119 These types of estimates compare with international terminology and can be defined as follows: a. Order of Magnitude are further sub-divided into: i. Capacity Factored OOM The cost of a plant can be calculated where the erected cost of a plant of the same nature, even if of different capacity and in another country, is known. ii. Equipment Factored OOM The cost of a plant can be calculated by applying statistical factors to the cost of the Mechanical Equipment (ME). iii. Conceptual Design OOM In some cases, conceptual designs are of a nature where Capacity Factored or Equipment Factored Estimates are not appropriate, either because of project size or requirements. A plant modification entailing electrical work only is such a case. OOM Estimates for these cases can be done on a Conceptual Design Philosophy. The OOM estimate is normally not suitable to be used as basis for capital application. The purpose of an OOM estimate is more to establish whether or not further expenses in examining a proposed project is justified, that is, during the conceptual design stages of projects. It could be used, however, as basis for capital application and cost control, but each separate case shall be treated on its own merits and if suitable, recommended as such by Cost Engineering Services.

120 During the Idea Generation and later on the Pre-feasibility stages of project development, OOM estimates are sometimes either called “VROM” or “ROM” estimates, alternatively the acronyms for Very Rough Order of Magnitude or Rough Order of Magnitude estimates. These types of estimates are usually done with very limited scope definition and include high contingency allowances, to enable a preliminary indication of the viability of a given project to be made. The expected accuracy for OOM type estimates ranges between +50% to -30% and +30% to –15%. See Figure 1.4 below. Minimum requirements are as per Table 1.6.

121 b. Semi-Definitive (SDE) A Semi-definitive estimate is based on partial design from all disciples, employing as much detail as time and money permits, using plant modifications/ mechanical flow diagrams, priced equipment lists, available plot plans, design drawings and other available details. The Semi-Definitive Estimate is primarily intended for economic evaluation studies. It is usually suitable to be used as basis for capital applications and for cost control. The expected accuracy of this type of estimate is within +15% and -5 %. See Figure 1.4 below. Minimum requirements are as per Table 1.6. c. Definitive Estimate (DEF) In the Definitive Estimate the engineering and design are at an advanced stage, and each element, or group of elements, has been quantitatively surveyed and priced using the most accurate unit prices available. A Definitive Estimate is requested normally after capital application, to incorporate any design changes and cost trends that may have occurred since the Semi-Definitive Estimate. It can be used in requesting capital adjustments, if required, and is more suitable for cost control. Note that when projects are well advanced into the execution phase, properly defined/ detailed estimates are sometimes called “CONTROL” estimates. The expected accuracy of this estimate is within +5 % and –3 %. See Figure 1.4 below. Minimum requirements are as per Table 1.6.

122 d. The terms “VROM” and “CONTROL” estimates are used to describe the extreme ends of the OOM - High contingency allowances, and Definitive - Low contingency allowances, estimate ranges.

123 Figure 2.4 ________________________________________________________________________ Expected Accuracy of Cost Estimates


124 (XIX) Equipment List For Estimating The following information is required on an equipment list, for purposes of estimating: a. Function Different process functions/plant sections can be estimated separately. If this is a requirement, then they should be so indicated by giving them numbers, for example, one to nine. b. Type of Equipment For equipment factored estimates the types of equipment should be grouped as follows: i. ii. iii. iv. v. vi. vii. viii. ix. Boilers, furnace, flares, stacks and gasifiers Heat exchangers and condensers Reactors Columns and towers Tanks and drums Filters and separators Compressors, generators and pumps Miscellaneous equipment Conveyors, cranes and lifts

c. Reference/tag/site number d. Description/name, for example, tower overheads condenser, and size/capacity. e. Quantity/numbers of

125 f. Unit price

The equipment list should be backed-up by the necessary equipment design information as indicated in Table 2.9. (XX) Chart Of Estimating Responsibilities The information as indicated in Table 2.10 is required for any estimate that is to be used as basis for capital application. The chart indicates, by way of examples, which party assumes responsibility for a specified portion of work.

126 ________________________________________________________________________ Table 2.10 Chart of Estimating Responsibilities Engineering Services Supplie Labor Overhe Equipm Basic Detail Procur s ads ent eRental ment 1 1 1 5 5 6 5 3 3 3 3 4 5 5 6 5 3 3 3 3 4 5 5 6 5 3 3 3 3 4 1 1 1 1 1 1 1 1 1 5 5 6 5 1 1 1 1 4 Construction


Process Eng

Project Management Excavation & Earthworks Concrete 5 5

Structural Steel 6 Buildings Mechanical Equipment Piping Electrical 5 2 2 2

Control Systems 2 Paint/Insulation 4

0 = Owner 1-10 = Others, not Owner 1 = EPC Contractor: Engineering, Procurement, Project- and Construction Management 2 = Supplies by EPC Contractor: Equipment, Piping, Electrical & Instruments 3 = Mechanical Contractor: Equipment, Piping, Electrical & Instruments (Erection) 4 = Mechanical Contractor: Paint & Insulation (Material & Labor) 5 = Civil Contractor: Excavation, Earthworks, Concrete & Buildings (Material & Labor) 6 = Structural Steel Contractor (Material & Labor)


128 (XXI) Contingencies Contingencies in capital cost estimates are cost allowances to cover uncertainties and unforeseeable or indeterminable elements within the scope, at a certain stage in project development, which previous experience has shown are statistically likely to occur. Contingencies are applied to produce the most probable ultimate total cost of the project and therefore form an integral part of the estimate. Note that, in addition to contingency, there may be other cost allowances in capital cost estimates for known and foreseeable elements that for accounting policy, estimating techniques, management direction, or other valid reasons are not specifically included elsewhere. These allowances for “known” elements are separate from contingency, which is for “unknown” elements. The calculation of contingencies is not directly proportional to the accuracy factor of the estimate, but a combination of the statistical chance that an over or under-expenditure may occur, the quality and quantity of information, and previous experience with similar projects. A risk evaluation, depending on the project stage and purpose of the estimate, should be conducted on all estimates exceeding an amount as defined by internal company policy. For the purposes of this explanation, the amount of US$1 million is used. Any risk evaluation should, however, always be conducted together and in conjunction with the party, or parties, with knowledge of the information on which the

129 estimate was based. For initial conceptual estimates an informal evaluation is sufficient. This evaluation should be based on the risk information provided by the party, or parties, who supplied the information on which the estimate was based. For estimates that are required for capital application, a formal risk evaluation session is necessary. Such a session should be held during the estimate review meeting, i.e. between estimate completion and estimate acceptance, and has to involve all parties who provided technical, cost and schedule information on which the estimate is based. The determination of a project control base after contract award may also be subjected to a risk evaluation to re-assess the contingency applicable at that particular stage of the project. For cost control purposes and reports produced during project execution, an informal risk assessment is necessary in order to determine the remaining contingency required, after consideration of the commitments, expenditures and any outstanding work or unresolved issues. The following aspects should be considered in contingency determination: a. b. The specific stage of process development/ project execution The nature of the project, i.e. whether it is a Revamp/ Debottlenecking/ Brown Field project, or a New Facility/ Green Field project

130 c. The quantity and quality of information required for the different types of estimates: i. In cases where the estimate will serve as basis for capital application, the anticipated level of detail required to facilitate proper cost control in accordance with the anticipated or actual project plan of execution ii. If only for economic evaluation purposes and/ or for comparison with other technologies d. e. f. The factors that affect contingency The maturity level of the technology involved The methodology to be applied in order to determine appropriate levels of contingency taking into consideration to what extend people with proper knowledge of the purpose, scope and nature of the project contributed towards assessing the risks involved. Table 2.11 set the requirements and prerequisites, which are necessary for determining proper levels of contingency in estimates.

131 Table 2.11 _________________________________________________________________________ Contingency Determination Guide
People To Be Involved In Risk Assessment Estimator Proposer (Usually A Process Engineer) “Informal” Estimator Proposer Project Eng / Manager Eng/Design Disciplines Involved “Formal” Estimator Proposer Project Eng / Manager Eng / Design Disciplines Involved Cost Control “Formal / Informal” Projects Cost Control “Informal”

Estimate Type OOM - Conceptual Design - Capacity factored - Equipment Factored OOM - Equipment factored SEMI-DEFINITIVE

Project Stage Business Development - Idea Generation - Pre-Feasibility Business Development / Project Execution - Feasibility - Basic Development

Purpose Of Estimate Economic Evaluation Technology Comparison Capital Application

Anticipated / Actual Plan Of Execution

Contingency Calculation Method Manual/Compu ter - Points Rating / Uncertainty Evaluation (UE) Method Computer - @Risk for Lotus - Crystal Ball for Excel

Anticipated EPCM/Turnkey, or - for-and-onbehalf


Project Execution - Basic Development

Improved Control Base

Actual EPCM/Turnkey, or - for-and-onbehalf

DEFINITIVE CONTROL Execution Cost- And Scope Control

Computer - @Risk for Lotus - Crystal Ball for Excel

Project Execution - Execution

Manual/Compu ter - Forecasted ITC

132 Table 2.12 _________________________________________________________________________ Percent Contingency Range

Estimate Type

Nature Of Project

Maturity Level Of Technol ogy

OOM Concept ual Design Capacity factored - Equipment factored -

OOM - Equipment factored




Revam p / Debottlen eck / Brown Field New Facility / Green Field Revam p / Debottlen eck / Brown Field New Facility / Green Field Revam p / Debottlen eck / Brown Field New Facility / Green Field

See estimate requirem ents as per Table 1.6

Duplicate / Establish ed Relatively / Radically New Duplicate / Establish ed Relatively / Radically New Duplicate / Establish ed Relatively / Radically New

10,9 to 35,0

15,6 to 50,0

See estimate requirem ents as per Table 1.6

8,5 to 14,0

12,2 to 20,0

See estimate requirem ents as per Table 1.6

7,0 to 10,6

10,0 to 15,2

Up to 7,0

Up to 10,0


133 Record Keeping The Request for Cost Estimate, together with all supporting documentation, for example, sketches and vendor/budget quotes etc. is kept in an estimate file identified with the project. The individual estimate has to carry a revision number and all subsequent revised estimates for the same job have to have superseding revision numbers and must be stored sequentially in the same file. Due to the extremely sensitive nature of the information contained in these files, they are kept in locked filing cabinets either in the estimator’s offices, or in a central filing room, which is in turn kept locked. Only cost estimators are allowed to retrieve estimates. When a project is completed and archived the estimate file may be reduced to the final estimate only. Detail supporting documentation and early revisions should however be marked and archived in a paper bank, in which event this action only takes place one to two years after a project has been completed. 1.16 Literature Review and Current Practice in Project Risk Management For the purposes of this dissertation, ‘conventional’ engineering is meant to denote those companies who do not follow the Life Cycle Management process as described above, alternatively called the StageGate process, of developing and executing their projects. In their article, New Problems, New Solutions: Making Portfolio Management More

134 Effective (2000), authors Robert G. Cooper, Scott J. Edgett and Elko J. Kleinschmidt of the Industrial Research Institute wrote that: Early in the life of a project, management must make some important Go/Kill and resource commitment decisions on specific projects. The dilemma is that the up-front homework is rarely done well enough to provide the quality of information that management needs to make sound decisions. For example, a study of over 500 projects in 300 firms revealed major weaknesses in the front end of projects: weak preliminary market assessments, barely adequate technical assessments, dismal market studies and marketing inputs, and deficient business analyses, on average. These are critical homework activities, yet in study after study, they are found wanting--the up-front homework simply does not get done well. Even worse, these activities are strongly linked to ultimate project outcomes. The greatest difference between winning products and losers lies in the quality of execution of the project's homework activities. • Why is quality of execution of these early stage activities so pivotal to success? There are two reasons, we observe: • When the quality of this early stage work is better, an excellent foundation is laid for the project. Thus, subsequent activities are more proficiently executed--better product design, better testing, better launch and production start-up--and success rates rise. As

135 an example, better up-front homework usually results in sharper customer input, which in turn means earlier, more accurate and more stable product definition. Note that unstable product specs is one of the major causes of long cycle times, while sharp, early product definition that is fact-based is strongly connected to product profitability. • When the early work is done better, market and technical information on the project is superior. Thus, management has the information it needs to select the winning projects (and to remove the dogs). The result is a much better portfolio of projects, and again higher success rates. For example, bad market information plagues many new product projects. Lacking good data on market size, expected revenue and pricing makes it difficult to undertake a reliable financial analysis. Indeed, one company's analysis of the accuracy of its financial analyses undertaken just prior to development revealed a 300-percent error in NPV estimates on average! Because so many firms rely on NPV numbers as the dominant decision criteria, such errors render the decision-making process a hit-and-miss exercise. One might be better off tossing a coin! • The overriding message here is that doing projects right will ultimately lead to better project selection decisions, hence higher odds of doing the right projects.


Our benchmarking studies, which by now include more than 300 companies, reveal that businesses that boast such a new product process (referring to their Stage-Gate process) fare much better: higher success rates on launch (by 37.5 percent); meet new product sales objectives more often (88 percent better); and meet profit objectives more often (72.0 percent better). So, Step 1 is to overhaul your new product process: install a StageGate process complete with defined stage activities that emphasize the up-front homework, a menu of deliverables for the key decision points or gates, and defined criteria at each gate against which the project is judged. Experience dictates that it is very difficult to implement portfolio management without an effective new product process, such as Stage-Gate, in place. Without proper marketing and technical assessments and studies, it is virtually impossible for any Board to determine whether they have a viable project, or not. There are an enormous amount of risks omissions and inaccuracies involved during the Feasibility Study stage, when marketing information dictates the Business Case of the project. So too during the Basic Engineering stage when technical completeness and accuracy will not only determine the technical viability of the project, but most importantly will determine the project scope and estimated costs. It is clear that risks associated with marketing and technical

137 omissions and inaccuracies must be identified during the early preplanning, i.e. front end loading phases of projects, to ensure that capital approvals for projects are based on sound information. In a 2003 paper entitled Risk Minimization in Project Finance, designed to explain how risks are approached by financiers in a project finance transaction, Rafal A. Zakrzewski, a solicitor with Mallesons Stephen Jaques in Australia, Writes that: Project finance is different from traditional forms of finance because the financier principally looks to the assets and revenue of the project in order to secure and service the loan. In contrast to an ordinary borrowing situation, in project financing the financier usually has little or no recourse to the non-project assets of the borrower or the sponsors of the project. In this situation, the credit risk associated with the borrower is not as important as in an ordinary loan transaction; what are most important are the identification, analysis, allocation and management of every risk associated with the project. In a no recourse or limited recourse project financing, the risks for a financier are great. Since the loan can only be repaid when the project is operational, if a major part of the project fails, the financiers are likely to lose a substantial amount of money. The assets that remain are usually highly specialized and possibly in a remote location. If saleable, they may have little value outside

138 the project. Therefore, it is not surprising that financiers, and their advisers, go to substantial efforts to ensure that the risks associated with the project are reduced or eliminated as far as possible. It is also not surprising that because of the risks involved, the cost of such finance is generally higher and it is more time consuming for such finance to be provided. Financiers are concerned with minimizing the dangers of any events which could have a negative impact on the financial performance of the project, in particular, events which could result in: (1) the project not being completed on time, on budget, or at all; (2) the project not operating at its full capacity; (3) the project failing to generate sufficient revenue to service the debt; or (4) the project prematurely coming to an end. The minimization of such risks involves a three step process. The first step requires the identification and analysis of all the risks that may bear upon the project. The second step is the allocation of those risks among the parties. The last step involves the creation of mechanisms to manage the risks. The World Bank website (2004) has a section that provides various Tools to explain and to provide advice on the mechanisms of project financing. In their article on Allocation of Risk in Project Finance, they state that:

139 All project risks should be assessed to the finest possible degree prior to initiating the project. Each risk must be assessed under the responsibility of the entity which will incur the risk. Reasons of efficiency and equity require risks to be taken by entities which will obtain the greatest benefit from the operation, or those whose line of business is concerned, namely technical risks by contractors and operators, and economic and financial risks by the Employer. Allocating the commercial risk to the private sector seems to be an incentive. Nevertheless, it is a risk which is, to a large extent, beyond the private sector's control and of huge magnitude. Among the private firms competing for the project, those that will accept this risk might not be the most efficient, but only driven (sometimes blindly) by the hope of obtaining the high profit they can expect for this high risk. A clear example of project risk allocation is provided in a table from an article by Carl R. Beidleman, Donna Fletcher and David Veshosky, entitled The Essence of Project Finance (Spring 1990); their table is reproduced here below:

Typical Allocation of Risk among Project Financiers
Resour ce Owner s Financi al Adviso rs Gover nment Bodie s Insuranc e Compani es Third Party Invest ors

Types of Risk Technolo gy Credit Bid Completi on Cost Overrun Performa nce Political Liability Equity Resale Off-take

Develo p-ers

Contra ct-ors

Lende rs

Suppli ers

Consu m-ers




*IFC = International Finance Corporation *OPIC = Overseas Private Investment Corporation

In the author’s research of current literature, it became apparent that categories of risk are generally recognized for the various phases in the project’s life cycle, including in the development, construction and operation phases. For example, it is generally recognized that in the development phase there is technology risk, credit risk and bid risk. Technology risks means that a new technology may not prove economically or structurally viable, or regulations regarding its use may change. Credit risk has to do with the credit worthiness of an individual sponsor, the project as a whole, or the Project Company. Bid risk means the risk that a project may not be launched successfully. In the construction phase, well recognized categories include completion risk, cost overrun risk, sponsor’s performance risk and political risk. Completion risk is the risk that the project may never reach its operating stage, due to the non-performance of the engineering and

141 construction (E&C) contractors. Cost overrun risks also pertain to the possibility that the E&C contractors may not complete the project within the contracted price. The sponsor’s performance risk is described as the inability of the sponsor to provide goods or services as per the agreed quality or on schedule. Political risk includes regulatory or legislative changes that occur during project construction, as well as the possibility that governments may not allow the repatriation of funds. In the operation phase of a large industrial plant project, risks that are generally recognized are cost overrun risk, sponsor’s performance risk, liability risk, equity resale risk, off-take risk, interest rate risk and currency risk. However, although much recent literature has been published about the need to identify project risks, as well as for the manner and mechanisms for allocating risk, by far the largest volume of literature focuses on the recourse considerations involved in these risks, i.e. the reasons for allocating risk to those parties best able to handle them, and the contractual rights of various parties to claim against those other parties to whom the risks were assigned. Very little published literature can be found on how to go about identifying specific risks, particularly on the systematic and comprehensive identification of business, technical and project management risks pertaining to during the various development phases of industrial plant projects. Hence the identified need for this dissertation to address these aspects, based on the

142 author’s experience and knowledge gained in this regard in the Oil, Gas, Petrochemical and Mining industries over the past 25 years. The Author’s Experience of Current Practice in Project Risk Management The difficulty of identifying and mitigating risk in an informed manner begins to take on serious significance during the feasibility phase of a large industrial plant project because, as explained during the earlier parts of this dissertation, at the end of the feasibility phase the owners and lenders must decide at that point, at Gate 3, whether they are willing to commit significant amounts of money to continue with a project that, once the expensive basic engineering phase begins, it means for all extents and purposes that the project development and execution is either beyond recall, or otherwise it means a very significant loss of capital and reputation to the owners, financiers and other stakeholders. In practice over the past 10 years, capital applications for industrial plant projects subsequent to their Feasibility Study phase and Basic Engineering phase proved more often than not to be understated. In other words, over expenditures too often necessitated further applications for additional capital requirements to complete the Basic Engineering and Execution phases of industrial plant projects. It was found that in most cases this was due to inadequate definition of the project’s business case, technical accuracy and project management competency.

143 Research and experience also shows that there is a convergence of insurance and capital markets and with bankers being increasingly risk aversive, technical difficulties of a project often overshadow the complexities of financing. To address these technical difficulties there is a general move towards contractual transparency and a sharing of project risks and benefits between owners, contractors and insurance companies particularly as, due to an increased competitiveness for investment capital, large industrial plant project financing moves more towards off-balance sheet financing. More and more, in order that projects are completed within budget and schedule, stakeholders and contracting parties are actively working towards an atmosphere of ‘us against the project’ and not ‘against each other' and a genuine attempt is made to ensure that there are no hidden agendas and that project risks are identified and displayed. It has also been noted that the legal profession do not always welcome a solution to project risks as it is often not in their interest. Many insurance companies today recommend the appointment of a Risk Manager/Adviser at the beginning of a project, i.e. before any contracts are signed, as it has been widely noted that in order to win a contract, an increasing number of risks are incorporated in an agreement and left to others to resolve if problems arise. Such one sided allocation of risk, particularly upon parties that struggle or fail to

144 properly or costs effectively mitigate those risks, eventually and very often result in events that are detrimental to the successful outcome of the project. An experienced Risk Manager will be able to facilitate Risk Identification, conduct a Risk Analysis and Risk Allocation. However, it bears pointing out that it is also not advisable to rely entirely on the experience of only one risk manager, but rather to appoint a core team of experienced risk experts, when evaluating industrial plant project risks. Daniel Kahnaman and Amos Tversky (1982), demonstrated that individuals in their decision-making tend to over emphasize recent information and trends and under-emphasize prior information, arguing that experts tend to be more prone to overconfidence than novices while maintaining reputations for their expertise One of the goals is be to make the project more attractive to lenders and equity investors alike. This process invariably also has a positive impact on the attitude of the lender, rather than the remaining option of having the owner dictating insurance cover requirements to the suppliers, engineering contractors and constructors. Particularly for new technology projects, there appears to be a general move away from lump sum towards reimbursable contracts due to the high additional costs imposed by the contractor to cover perceived risks in a lump sum contract. Also, in 2002, as a part of a search by this author and other project team members, for insurance

145 cover for two industrial plant projects projected at a total installed cost (TIC) in excess of US$1 billion each, one located in Africa and the other in the Middle East, it became evident that US$120 million was the maximum Liquidated Damage cover that was available from most insurers in the insurance market. Due to tough competition for favorable project finance and the ever increasing costs associated with initiating, financing and executing projects, a growing concern in many industrial plant owners and contractors has in recent years caused them to focus on developing inhouse systems and procedures to be employed in the more detailed identification and mitigation of risks inherent in the management of their projects. The author was involved in several such initiatives, working on industrial plant projects internationally, in project teams on the owner’s side, on the engineering contractor’s side and also on the constructor’s side. This experience and knowledge has led to the development of a model that can and has been utilized over the past five years on 34 industrial plant projects, ranging in TIC size between US$40 million to US$1.35 billion, for the express purpose of identifying and mitigating the numerous risks inherent in the project’s business case, technical accuracy and project management competency. The research basis of the development of the Project Risk Review Model and relevant materials are illustrated in chapter 3, while the model itself is analyzed and validated in chapter 4.


Chapter 3
The research approach to the hypothesis in this dissertation uses a modified version of the Question Hierarchy as proposed by Cooper and Emory. This approach assumes the research problem to be composed of a hierarchy of questions with a descending level of specificity. The aim of the Question Hierarchy is to achieve a focus on the research problem as a result of increasingly descriptive questions. In accordance with the data presented in chapters one and two, the following management, research and investigative questions were defined in terms of the Question Hierarchy: Management Question: How may the functions of the Feasibility Study and Basic Design Engineering of large capital projects be enhanced in an industrial plant owner organization, from a risk management and mitigation

perspective, in order to improve the financial viability of capital projects and thus improving the competitive position of the organisation within its industry? Research Question: Can audit reviews pertaining to the completeness and quality of Feasibility Studies and Basic Engineering Deliverables for industrial plant projects, in conjunction with risk management principles; reduce

147 the greatest financial risk exposure that occurs at the end of the project’s construction period when the project is commissioned into operation? Investigative Questions: • Are there any differences in applying the concepts of risk

management, before major capital approvals for industrial plant projects, to the functions of Feasibility Studies and Basic Engineering as opposed to ‘conventional’ project engineering prior to capital approval? • How can the functions of Risk Management and Feasibility Studies

be integrated from a project selection, development and execution point of view so as to enhance the financial viability and successful execution of industrial plant capital projects? • How can the functions of Risk Management and Basic Engineering

be integrated from a project selection, development and execution point of view so as to enhance the financial viability and successful execution of industrial plant capital projects? • What additional factors, if any, need to be considered in this

integration (possibly factors particular to the pre-approval project development environment)? • Will it be possible to construct a generalised model during the

Feasibility Study and Basic Engineering phases, which may be used to identify and manage risks related to a project’s business case,

148 technical accuracy and project management competency, thereby to improve the applications for strategic capital approvals at Gate 3 and Gate 4, for industrial plant projects? The answers to the questions posed in the Question Hierarchy will be obtained via a combination of descriptive and investigative research. In line with the principles of risk management, particularly risk identification and mitigation and which form a substantial part of the conceptual emphasis of this dissertation, a structured approach will be used in the attainment of the research objectives. Cooper and Emory, while alluding to the problem-based nature of research describe the importance of descriptive research. They point out that: “…. descriptive research is the stuff out of which the mind of man, the theorist, develops the units that compose his theories. The very essence of description is to name the properties of things: you may do more, but you cannot do less and still have description. The more adequate the description, the greater is

the likelihood that the units derived from the description will be useful in subsequent theory building.” This dissertation employs a combination of descriptive and investigative research in the attainment of the stated objectives of the research. Specifically, initially this dissertation relies primarily, but not exclusively, on descriptive research as the mechanism via which the

149 underlying fundamental concepts inherent within this dissertation are brought to the reader’s attention. Several topics receive such

treatment, being project finance, project life cycle management, the issues involving business management and engineering with respect to Feasibility Studies, Basic Engineering Development and Estimating for industrial plant projects, the principles of risk identification and allocation, and the author’ past experience of risk management processes in the development and execution of industrial plant projects. This descriptive research is followed by the investigative research, which is, in effect, the heart of this dissertation. The basis of the

development of the Project Risk Review Model and relevant materials are illustrated here, followed in chapter 4 by analysis of results obtained through application of the model, and the validation of the model. 1.17 Ethical Assurances The research for this dissertation did not involve the use of human subjects. The focus of the dissertation is on the business related and technical aspects of industrial plant projects. No proprietary or confidential information belonging to any company or organization was reproduced or divulged in this dissertation without the prior knowledge and permission of the company or organization.

150 1.18 Description of Instrumentation The documentary instruments, which served as the basis for this investigation and for the development of the Risk Review Model, comprised of, (i) past examples of risk identification on capital projects, (ii) copies of previous applications for Board approval of these projects, (iii) the final financial outcome of the same projects, with a particular focus on actual over expenditures versus approved budgets that provided the evidence that these projects were in certain respects not successful. These documents pertained to industrial plant projects ranging in size from US$20 million to US$1 billion. The documents listed under item numbers (i) through (iii) above were provided by the document control center of a major international organization that is actively involved in the development and construction of industrial plant projects. For purposes of confidentiality, the documents can not be exactly reproduced here. Nevertheless, the pertinence of the contents of these documents are utilized and described, and form part of the basis for this research. 1.19 Description of Research Design The method of investigation followed in this study, consisted of the following: 1. A literature study on the development of project finance and risk identification on industrial plant projects, as well as those opinions given on the subject from time to time. Not much

151 literature exists on the actual detailed risk identification of industrial plant projects as such, particularly not for evaluating the completeness and accuracy of a project’s business case, technical accuracy and project management completeness. However, because these topics are of a multidisciplinary nature, literature is available on certain aspects thereof, and these aspects were studied and incorporated where possible in the literature study; 2. Attendance of seminars on project risk identification or aspects thereof, both locally and abroad. Interviews were also

conducted with people and institutions involved in project risk identification and mitigation; 3. Practical experience gained over a period of four years, as a senior manager responsible for improving the system and

procedures for risk identification on capital projects, for an international owner organization in the oil and gas industry; 4. Experience gained over more than ten years in related work situations in the Oil & Gas industry, and which was applied in the compilation of this study. 5. As leader of a taskforce that developed a progressive series of Risk Review Checklists, starting at a ‘helicopter view’ level and progressively expanding the details of the checklists to cover the necessary details required for comprehensive business

152 case, technical accuracy and project management competency of industrial plant capital projects. The checklists were devised to review past projects’ documents to establish potential areas for improvement, and ultimately to be included in the Project Readiness Review Model. 6. The various checklists and review process were compiled by a Risk Management Taskforce consisting of senior managers and engineers, each having at least 10 years experience in the business, technical and project management related issues of industrial plant projects. The taskforce meetings were

facilitated by an Alignment Meeting Specialist and were conducted in a structured environment, on a regular scheduled basis, over a period of several weeks. 7. The Project Readiness Review Model was utilized by the taskforce to review and evaluate the development and execution preparedness of more than thirty industrial plant capital projects over a period of 3 years; particularly the Feasibility Study and Basic Design Engineering completeness of these projects, with the purpose of identifying risks associated with these phases of the projects. 8. The approach followed by the author was to create a practical document, i.e. this dissertation, including a Project Readiness Risk Review Model, which could be of use to senior managers

153 and academia who are not intimately familiar with the subject. At the same time care was taken not to neglect aspects of theoretical importance. 1.20 Operational Definition of Variables Judging from the inconsistencies and varied types and numbers of issues that were not clearly or completely addressed in the

development of the projects investigated, including their lack of technical preparedness, inaccurate capital approval applications and incomplete supporting documentation, it became clear that systematic and structured risk identification was not always comprehensively done on all projects, and that the methods of risk identification varied in their scope, from project to project. Further investigation showed that different risk identification methods, with varying attention to detail were employed on different projects, depending on the knowledge and resources of the respective project management teams. Few of the project teams employed a comprehensive risk identification checklist or system, particularly one that detailed the meaning and implications of specific risks. Once the first list of Common Shortcomings in Risk Identification, Capital Approval Applications and Supporting Documents, as shown in Table 3.1, was compiled by the taskforce, it became apparent that, in order to establish legitimate and transparent checklists that would be most effective in the identification of industrial plant project risks, the

154 operational variables and related investigative processes had to be determined, described and agreed to by the stakeholders. To this extent, the taskforce held a series of meetings with their peers in the industry, to discuss, determine, and ultimately to describe those variables and processes that would be required for risk identification. This resulted in a Project Risk Management Program, which is described further below.

155 _________________________________________________________________________ Table 3.1 Common Shortcomings in Risk Identification, Capital Approval Applications and Supporting Documents Pre-Feasibility Study and Basic Engineering Phases 1. Business Deliverables 1.1 Opportunity Definition Business opportunities were not discussed and/or agreed with all stakeholders, particularly objectives, givens and boundary conditions. Necessary business opportunity framing meetings either did not take place, or else did not include all stakeholders. 1.2 Project Objectives (Objective matrix) Project objectives were not clearly defined nor presented in an objective matrix. 1.3 Decision/Information Required Clear decisions were not made nor was there sufficient available information available to make these decisions. 1.4 Decision Gates (Hold Points) Clear hold points for decision making were not defined and ownership of responsibilities was not specified. 1.5 Assumptions All assumptions during the applicable phase of the project were not highlighted and nor were any relevant mitigating actions agreed upon. 1.6 Stake Holders Involvement All project stakeholders and their expectations were not defined nor communicated. _________________________________________________________________________ Table continues… 1.7 Project Success Planning No clear vision of critical project success factors was established and nor were key metrics for measuring success established. 1.8 Strategic Environmental Issues The identification of environmental impacts and statutory requirements

156 were often incomplete. 1.9 Licensing Philosophy Applicable licensing agreements together with their provisions and licensing responsibilities were not thoroughly researched nor communicated to all stakeholders. 2. Engineering Deliverables 2.1 Indicative Scope Of Facility The physical deliverables of the project, major activities and engineering deliverables together with WBS (Work Breakdown Structure) for the Contractor doing the Feasibility Study and/or the Basic Engineering was not clearly identified nor agreed with the stakeholders and/or with the Contractor. 2.2 Technology Development Philosophy New technology and / or R&D (Research and Development) along with the uncertainties associated with its use were not determined. 2.3 Integration Aspects The project integration that may be required was not identified or specified, for example, between the new project and existing units or plant; OBL (Outside Battery Limits) and IBL (Inside Battery Limits), utilities, feedstock and products. _________________________________________________________________________ Table continues… 2.4 VIP (Value Improvement Practices) Plan Applicable VIP's and the timing thereof for the Feasibility Study phase were not identified nor clearly understood by stakeholders. 2.5 Philosophy For Evaluating Alternatives Project design alternatives were not being evaluated, for example, fit for purpose versus lowest life-cycle cost. 2.6 Exclusions From Scope Stakeholder agreements on what is not within the business and/or technical scope of the project were not made. 3. Project Deliverables

157 3.1 Major milestones of each phase of the project and the probability that dates will be met were not discussed or agreed with all stakeholders. 3.2 Project Road Map A Project road map, i.e. a long term decision based plan for execution of the project, was either not developed at all or was presented while missing important parameters such as major decision points, identified resources, appropriate metrics, contingency planning, action plans and schedules. 3.3 Macro Organization and Project Management Organization Charts Organization Charts omitted to show structures that included all stakeholders, steering committees, sponsors, various functions in the project team, lines of communication and delegation of authorities. Clear responsibilities were not assigned for business, technical and project management responsibilities. The Project Management Team chart showed key positions not identified and/or too many unnecessary positions included. _________________________________________________________________________ Table continues…

158 3.4 Project Ground Rules Ground rules for project success were often not established or agreed with all stakeholders.

Table ends

159 1.20.1 Project Risk Management Program A total project risk management program has three stages. The first stage is risk identification and categorization. The second stage is the measurement or evaluation of identified risks in terms of potential cost or loss, should the risk become an event. The third stage is risk mitigation and control. The first stage of Risk Management, namely risk identification and categorization, is the process of identifying and cataloguing all risks that may potentially befall the project. This list of risks is compiled based on technical knowledge and experience combined with a "what can happen” analysis of the future. Many risks will be identified during a Risk Identification Alignment Meeting, since the members of such a meeting involve key members of the stakeholders of the project, including the Owner, Licensors, Engineering Design Contractor, Project Management Team members, and specialists if required. However, it is essential that during such a Risk Identification Alignment Meeting, the detailed aspects of a project’s business plan, technical accuracy and project management competence must be addressed to ensure that all potential risks related to the project are listed. Therefore the Project Risk Review Model is developed for just such a purpose, to be used to review the completeness of the development of projects at the end of Feasibility and Basic Engineering, as well as to review the completeness of their capital approval applications before submission to the Board.

160 Risks must then be rated and categorized and this can be successfully done by using a Detailed Risk Matrix, as shown in Figure 3.1 below, at the end of this section. The second stage in Risk Management is the measurement or evaluation of identified risks in terms of potential cost or loss, should the risk become an event. That loss is expressed as a time, resource or a monetary loss. When dealing with a project’s risks, it is necessary to establish a potential loss figure based on replacement value. An infinite number of loss scenarios may exist for the project, however, and the probability of each is a function of many factors. The following problems make the process difficult: • For each individual risk there is usually a broad range of potential loss • • Some risks defy definition in terms of potential for loss Many risks are involved in the project. The numbers of combinations in which these risks can create losses are infinite. Therefore, it is imperative that all project stakeholders discuss and agree on the potential financial values associated with the respective risks, and that Contingencies are not lumped together but managed separately against each respective risk. Audits that were done on previous projects showed an almost universal tendency for people, particularly at the start of projects, to underestimate uncertainty and to overestimate the precision of their

161 own knowledge and judgment. Thus, "gut feel," such as single-number judgments in estimating potential losses, can be dangerous, particularly when evaluating the combined effect of a number of variable items. However, one can extend the confidence level by using simulations that eliminate the biases of single-figure subjective judgments. 1.20.2 Methods for Measuring Risk A number of methods are available for handling risk and uncertainty and these may be catalogued as follows: 1. Traditional - the use of allowances based on past experience. For example, an allowance of 5 percent may be included for bulk material quantity growth, another percentage for possible wage increases or an across-the-board mark-up given to the entire estimated cost of the project to account for all variables. This is basically an experienced judgment approach based on previous experience with comparable work. 2. Simulation-methods which use the power of the computer to predict the possible range of outcomes for the project. Usually known as Monte Carlo methods, simulation techniques are the most common measurement technique after the traditional method. 3. Analytic - the use of the mathematics of probability to assess and combine the effects of the individual risk events into an overall measured quantity of risk.

162 4. Discrete Event - Typical approaches of risk measurement use decision trees, influence diagrams and utility theory. These techniques are especially appropriate for analysis of knownunknown risks. A complete description of these techniques cannot be

accomplished in this dissertation, particularly since the focus of this investigation is not on methods of measurement, but rather more specifically on methods for risk identification. Every Project

Management Team (PMT) is encouraged to obtain necessary source documents for more information in order to decide upon a strategy for risk measurement and quantification. The Monte Carlo technique is experiencing increasing favor within the industry for risk measurement. Risk mitigation and control, the third stage in Risk Management, is achieved in various ways, either by the purchase of insurance, or by risk avoidance, or by transferring those risks to others without any costs associated to the project, and by allowing for Contingency Funds. Finally, the PMT can contain risks through careful management and by having regular safety inspections. In summary, risk control includes risk avoidance; risk reduction; risk sharing; risk transfer; insurance; risk acceptance by establishment of Contingency Funds, risk acceptance without any contingency; and risk containment. It is important that responsibility for the management of particular risks is clearly assigned to particular key individuals.

163 1.20.3 Risk Mitigation and Control for Project Implementation Once risks have been identified and measured, project and site management moves into the risk control stage. Actions in this stage fall into two broad categories, namely: 1. Advanced planning actions, which are designed to place risk exposure within controllable limit, and 2. Risk mitigation actions, which are designed to keep actual losses below target and approaching zero, or even to generate additional profit. Advance Planning Actions

During the pre-planning phase of a project, stakeholders must work together to identify all potential cost items in the contract so that the contract can be realistically priced. For work items, the contractors must envision all potential methods for accomplishing the work with a view to finding the most cost-effective approach. For risk items, the objective is also one of cost-effectiveness, namely what can be done to minimize or best control the exposure? A number of actions are possible during the pre-planning phase. i. Risk Avoidance

An option sometimes available to the pre-planning team is to avoid a specific risk by dropping that particular risk out of the scope of the project, if at all possible. This is a wise choice when loss potential clearly outweighs the profit potential for the project. Obviously, loss

164 potential exists on every project so it is a matter of degree of loss that must be taken into account. If major risks involved are the type that the integrated teams can truly control through prudent management and if prudent management can increase the profit, the teams will surely decide to proceed. On the other hand, if high probability risks are beyond a team’s control, such as unforeseen subsurface conditions, then it should be discussed and agreed with the Owners that they need to accept responsibility for such conditions that are potentially inherent to their property. Another example of avoiding risk is to use only proven technologies and practices. The flip side of this, however, may be a lost opportunity for greater profit through the application of new technology or a new technique. ii. Risk Sharing

An example is a target cost/work-hour contract, where risk is usually shared through a formula that splits overruns and under runs between owner and contractors. Still another example is the use of worker incentive programs. iii. Risk Reduction

Through analysis of particularly risky elements it may be possible to find an alternate, which carries with it less loss potential. For example, a constructability analysis may determine it is best to replace

165 planned field assembly of some components with shop prefabrication to avoid potential weather delays at site. iv. Risk Transfer

Instead of risk avoidance, another option may be to transfer the risks. Certain risky elements of the contract may be best handled by contractors or subcontractors. Or if the request for proposals allow, the contractors can include rejection of some owner-assigned risk or can request revised contract wording, as an exception in their proposal. v. Insurance

The potential losses associated with applicable project related risks will be insured through Contract Works Insurance, Public Liability Insurance, Compensation for Occupational Injuries and Diseases Acts (as may be applicable locally), Motor Vehicle Liability Insurance, Contractor’s Equipment All Risk, and other insurance policies. When

self-insuring, this becomes a major risk item; when insured through a commercial or government agency it is a straight cost item. For the optional policies, the contractor normally will not purchase full coverage because of the high costs involved. Instead, these policies will contain a deductible amount, which represents an acceptable level of

self-insurance (potential loss) to the contractor. These deductible amounts become an "uninsured losses” risk item in the contract. Insurance provides protection against losses associated with most unknown risks of a catastrophic nature.

166 vi. Risk Acceptance with Contingency

Contingency is a reserve account expressed in money and/or time to cover losses that do occur. The sum of expected profit plus contingency money on the project represents the total ability of the Owner and its Contractors to absorb losses without experiencing a net loss on the project. vii. Risk Acceptance without Contingency

If competitive conditions preclude inclusion of a large enough contingency, then some risks must be accepted without contingency. If the actions discussed above have been taken, the remaining risks should show low potential loss value and/or contain a low probability of occurrence. Risk Mitigation Actions

Recognizing that the losses assumed are not inevitable and could be either greater or smaller, Owner project management wants to mitigate and contain risk. Effective risk containment may convert some or all of the set-aside contingency to additional profit. Here are brief discussions of some risk mitigation and containment actions that may apply to a project. i. Contingency Planning Thorough contingency planning has always been a common characteristic of successful projects. By planning for both normal and

167 contingency events, response to adverse situations can be speeded up and adverse effects minimized. ii. Qualified Personnel Commitment of key experienced personnel for the duration of the project, selective recruiting and use of formal training where required will best assure the presence of personnel qualified to deal with almost any situation. iii. Qualified Contractors and Subcontractors Use of pre-qualified contractors and subcontractors will help assure that work will meet quality and time requirements and will not adversely affect other activities. iv. Safety/Loss Control Program A strong safety loss control program will minimize human and material losses on the project plus contribute to lower Workers' Compensation costs on future projects. v. Responsibility Allocation

Responsibility for control of risk should be assigned to those individuals with the greatest capability to control that risk, regardless of which organization the person belongs to on the project, i.e. best person for the job, along with a requirement for regular status reporting. vi. Strong Project Controls A project controls operation must be implemented by the PMT that can provide timely and accurate reporting and analysis services for

168 the staff, to enable identification of actual and potential problem areas in time for positive corrective action on site. vii. Constructability Analysis In reviewing particular work for constructability, particularly constructability during the Basic Engineering Design phase, ease of access and reduction of accident exposure should be made key elements in selecting particular design and work methods. viii. Pareto's Law Control In the interest of being cost effective, the attention of the Team Managers should be focused on Key Risk Items with lesser surveillance of the remainder ix. Critical Items Reporting A system must be established on the project for special reporting of any situation that has affected or has the potential for significantly affecting cost or schedule so that these items can receive special attention by the PMT. x. Contingency Account Management Contingency should be allocated to the various risk accounts and on a controlled account-by-account basis, i.e. contingency should not be lumped together into one account. These individual contingency accounts are not necessarily the same control accounts used for cost and schedule control purposes, but instead are focused on specific

169 identified risks. A typical risk control account may be "bulk materials quantity growth" or "cost growth'. xi. Substance Abuse Program A well planned and administered substance abuse program can help assure that all personnel are fit for duty, eliminate the distractions and delays associated with substance abuse problems on the project job site and reduce the potential for accidents. xii. Training Programs Special training programs designed for the project and

administered by a recognized Training Centre can develop needed personnel skills quickly, contribute to team building and otherwise contribute to the efficiency and successful interaction of integrated team members. xiii. Rehearsals For critical operations, rehearsals will reduce the potential for errors during the real operation. xiv. Project Labor Union Agreements Such agreements can eliminate unfavorable work practices and contribute to efficiency of labor and the maintenance of a favorable labor-management atmosphere. This needs to be a well coordinated effort involving all stakeholders on the project. xv. Risk Re-evaluation

170 Throughout the life of a project, risk exposures should be re-evaluated on a regular basis, so that timely control action can be taken and project management attention can be refocused as necessary. xvi. Crisis Management Emergency planning has been identified as a control action of risk management on every project. When speaking of emergency plans,

one usually thinks of such examples as Fire Protection Plan, Hazardous Spill Plan or Extreme Weather Protection Plan. One additional plan that requires special mention is the Crisis Management Plan. xvii. The Crisis Management Plan This plan is intended to provide guidance to project personnel in the handling of situations which attract media attention and scrutiny. Typical examples are labor violence, a serious accident or collapse of a structure under construction. Such incidents will bring hordes of media to a site, all wanting photos or video coverage of the scene plus interviews with witnesses or anyone else willing to talk. In the confusion of a disaster, there is great potential for project personnel to compromise themselves and their companies or to alienate the general public through extemporaneous handling of the situation. Overall, a Crisis Management Plan should be available and well-known to key project personnel and include the following features: a. A copy of the Crisis Management Plan of the Owner

171 b. A catalogue of potential crises for which the project is most susceptible and, for each, special considerations in developing a response c. A directory of Owner and the project personnel to be notified d. A directory of emergency or public agencies to be notified, for each category of crisis e. Identification of the Crisis Manager f. Identification of official spokesperson(s) for the project g. Guidelines for handling of the media h. Instructions to be given to the project personnel concerning release of information i. Security measures to be taken to protect disaster areas and the project property j. Client authorized recovery actions k. Post-disaster handling of Owner employees and the project personnel xviii. Contingency Management Plan As described above, contingency accounts are appropriate for both cost and time for a project. If these accounts are to serve their intended purposes, they must be carefully managed. Every day not used in the schedule contingency account is a day during which

172 overhead expenses will not be incurred, further adding to the profitability of the project. xix. Contingency Cost Management Although the contingency will have been established after consideration of all significant risk elements on the project, the amounts arrived can be kept separate or be lumped together as a single bulk figure. The choice becomes one of managing it as a single line item account or somehow distributing it to parallel other accounts. Managing contingency as a single account has these disadvantages: • There will be a natural tendency to draw down the account on a first-come, first-served basis. This carries with it the potential for exhaustion of contingency funds well before the project is over, thus also increasing the potential for a lack of management focus on previously unidentified risks. Also, as this is happening, managers may feel that the project is in better position cost-wise than it really is because early losses are being covered. This may delay initiation of needed corrective actions. • There will be a problem of control. Every control account in the project, whether risk related or otherwise, should be the responsibility of one individual to manage. The only person

foreseeable that could manage a project-wide account is the Owner Project Manager. Such assignment will however add to

173 the heavy responsibilities already associated with that function and may cause contingency account management to be neglected. However, if contingency account control is left

open, there will be no control. Distribution of the contingency funds across the relevant accounts where the respective risk is being managed is the recommended approach. The distribution should reflect the breakdown of risks that were used in initially establishing contingency during the Risk Alignment Meeting. Obviously, the amount will not be large enough to provide coverage for the maximum foreseeable losses in every account, but it can be distributed on such a basis. Then, if losses do occur in accounts, contingency can be applied to the extent available, and contingency savings can be attributed at the point where they occurred. Contingency should not be used to cover losses in accounts outside those risks for which contingency were established; cost performance in them should instead be reported in terms of positive or negative variance. When losses in a contingent account exceed available contingency for that account, a negative variance will be reported for this account. If contingency funds still remain after the cost accounts they protect are completed, the excess is transferred to a general contingency account. Under this procedure, the project managers will have a more realistic picture of risk versus cost performance and will be able to provide more timely response to

174 problems. Control of each contingency sub-account should be assigned to the supervisor responsible for the activities for which the account was established, and its status should be reported on a weekly basis along with the work items within that supervisor's area of control. During the course of the project the risks should be regularly reviewed and contingency accounts adjusted, if necessary, to cover remaining risks. xx. Contingency Schedule Management The management of contingency time on a project is subject to the same considerations as those applicable to cost. The contingency time could be treated as a single block of time at the end of a project, but it is best distributed over a project so that contingency time precedes each key milestone in the project. As with cost, this approach allows a more realistic and timely picture of schedule performance over the life of a project. Use of contingency time is best discussed and distributed during weekly or monthly look-ahead planning meetings of the Project teams. In effect, this places its control in the hands of the Owner Project Manager, but that is realistic since many activities under a number of contractors’ supervisors feed into each milestone date. xxi. Process Risk Management As projects differ in nature, and / or also the competency levels of contractors, the model reviews for the phases mentioned below may require more than one session.

175 xxii. Initial model review objectives This review can be considered as the front-end-loading activity for the implementation phase of a project. To meet project costs and schedule objectives, the finalization of the following items are critical: • Nozzle orientation, platform and ladder requirements on tanks, vessels and columns regarding permanent access for

operability and maintainability • • • The routing of major piping Emergency access and escape routes The location of and access to major process control and operating stations • The location of areas reserved for maintenance and operational activities i.e. tube bundle removal, equipment cleaning, catalyst loading / unloading etc. • • • • • The routing of main electrical and instrumentation cable racks The location of underground systems Opportunities regarding optimization of piping lay-out Typical layouts and arrangements Mechanical data sheets and related manufacturing drawings for major equipment i.e. columns, vessels, tanks, heat exchangers etc. • The process requirements and process intent regarding the above items.

176 xxiii. Intermediate model review objectives This review is conducted to progressively finalize the following: • The lay-out and arrangement of remaining piping, equipment, control systems, electrical systems and other facilities • The lay-out and arrangements of fire - and other protection systems • The modelling of outstanding vendor equipment and related systems • The remaining location of, and access to process control and operating stations • The remaining requirements regarding process intent, plant operability, maintainability and environmental matters • All required corrective actions are generated and listed during this model review stage. Note that any remaining actions to be taken during the final model review must be approved and agreed upon by both the Owner and the Contractors. xxiv. Final model review objectives This review is conducted to finalize the following: • • • Agreed upon action items from the intermediate model review Modelling of remaining vendor equipment and related systems Plant operability, maintainability, emergency access and


177 _________________________________________________________________________

Figure 3.1 Risk Rating Chart
Likelihoo d Consequenc e

Frequent -happens regularly with this type of project


10 + USD Million

Probable -could happen on this type of project



1 to 10 USD Million III

Occasional -heard of in the industry


100 K to 1.0 USD Million IV

Catastrophic complete system loss and potential for fatal injury or major environmental incident. Major - major system damage or Lost Time Accident potential. Localized environmental incident. Significant failure without major damage nor serious injury. Minor environmental incident.


Consequence Score IV III II I
Likelihood Score




16 12 8



16 32 64 8 4 2


4 2 1

16 32 64 8 4 16 32 8 16



Remote -hard to imagine


Less than 100 K USD

Nuisance functional failure of equipment/proc ess nor potential for injury. Slight environmental incident.



178 1.21 Research Procedures The work of a taskforce, under the leadership of the author, was very instrumental in collecting, developing and describing the

progressive details that were used to put together the Project Progress and Risk Review Model, which is the ultimate goal of this dissertation. Due to the nature and extent of problems experienced during the development and execution of the Owner’s industrial plant capital projects, it became evident from the start of this research that the taskforce members had to be comprised of well educated people with substantial experience and collective knowledge of the necessary steps and technical issues involved in the development and execution of industrial plant projects. For this reason, the core taskforce consisted of at least one senior manager with the required expertise, in each of the respective fields of Business Case Development, Technical Design Development and Project Management. This core group of three members was appointed by the Board of the Owner organization. The author’s taskforce was also given a clear mandate by the Board to develop a system and procedures that would in future ensure project risk identification and mitigation on all of the organization’s industrial plant capital projects. The core group was also instructed to include two professional consultants in the meetings and deliberations of the taskforce. These two consultants were experts respectively in the fields of capital project finance and industrial plant operations.

179 The document review process for completed projects provided for the inclusion of project team members who were actually involved on those projects, i.e. the respective project’s Business Development Manager, Engineering Manager and Project Manager. This arrangement was to ensure that the outcome of the review process would be agreed between the taskforce members and the project team members, thus providing for a more balanced outcome with less chance of bias by either party. The author and taskforce members collected past examples of risk identification on completed capital projects, as well as copies of actual previous applications for Board approval of these projects, and the final financial outcome of the same projects, with a particular focus on actual over expenditure versus approved budgets. These documents from actual projects were analyzed and evaluated by the taskforce members together with the respective project teams for each of the projects. 1.22 Data analysis Having developed and described the Project Risk Management Program as well as the Common Shortcomings in Risk Identification,

Capital Approval Applications and Supporting Documents, as shown in Table 3.1, and armed with this knowledge, the taskforce group compared and evaluated the project related documents that were obtained from the archives of the organization, to produce and tabulate

180 a comprehensive List of Risk Areas in industrial plant capital projects, which could be prevalent during the formulation of the project’s Business Case, Technical development and Project Management Plan of Execution. This List of Risk Areas, see Table 3.2, was subsequently used as the framework for continuing meetings and discussions within the Taskforce and other senior managers, and served as the basis for the development of a more comprehensive checklist of specific risks, tabulated as a Comprehensive Risks Checklist, see Table 3.3. This comprehensive list of more specific types of risks became the final basis for the analysis and evaluation of currently ongoing capital projects that were being built and commissioned for the organization. The described author, in using available of this literature and information as well as as the




Comprehensive Risks Checklist shown in Table 3.3, proceeded to develop the Project Risk Review Model, which is described in Chapter 4. The Model is developed so that project stakeholders, including lenders, owners, contractors and project teams can, in a systematic and structured implications manner, of their identify and furthermore evaluate the Model the risk




organizations to benchmark their projects against previously completed projects, in order to ascertain whether current projects are doing better than their peers, or not.

181 Finally, in Chapter 4 several actual projects are also reviewed and analyzed to demonstrate the workings and usefulness of the Model. Team generated reports are provided to compare the basis of the original approved capital against the financial requirements of the project subsequent to the application of the Model. In other words, as a result of the risks identified through the application of the Model and the correspondingly required mitigating actions against those risks, a cost adjust is made to the budgets of those projects. This project review process takes place in structured

environments, facilitated by the author and taskforce members, and involves the project teams and some of their peers who are not directly involved on the particular projects at hand, using the Model as the risk identification tool. The project reviews result in a score for each project, which is used to demonstrate the level of risks still prevalent in the project, and also to benchmark against other projects within the organization. Where the initial structuring of the Model was found not to be optimal, it was rectified in a team effort, based on the findings from the project review process.

1.23 Assumptions For purposes of clarity, certain assumptions that bear on the accuracy of the study’s findings are provided here in the form of a list.

182 The author assumes that, during the development of the various risk checklists, risk program and analysis of project documentation, the researcher and taskforce participants guarded successfully against the adverse situational influences of • • • • • • our own subjectivity stakeholder subjectivity time limitations potential hidden agenda of some stakeholders personal bias of stakeholders and taskforce members local and outside influences. Furthermore, it is assumed that while extensive efforts were made to provide necessary background information and clear descriptions of the concepts involved in this dissertation, interested readers will primarily be senior academia and those senior engineers who are active in the engineering and project management aspects of industrial capital projects. This dissertation could also serve as material for instruction to less experienced engineers.

183 ________________________________________________________________________ Table 3.2 List of Potential Risk Areas 1. Owner Reputation 3. Contract Conditions 5. Project Site Factors 7. Weather 9. Shared Savings Among Stakeholders 11. Time Factors 13. Labor Factors 15. Materials furnished by Contractor Factors 17. Subcontractor/Vendo r Factors 2. Project execution strategy employed versus relevant experience of the stakeholders 4. Local Area Factors 6. Security 8. Monetary 10. Ability to Perform 12. Project Regulatory Factors 14. Owner Management Team Factors 16. Construction Equipment Factors 18. Care and Custody Exposure

Table ends

184 ________________________________________________________________________ Table 3.3 Comprehensive Risks Checklist 1. Reputation - potential for unfavorable exposure for Owner or any other stakeholders 2. Project execution strategy employed versus relevant experience of the stakeholders 3. General and specific contract conditions as they may, or may not, relate to the project execution strategy and site construction management requirements 4. Unfavorable Contract Clauses to avoid would be: a. Differing site conditions b. Hold-harmless c. No damage for delay d. No relief for Force Majeure losses e. Not responsible for quantity variations 5. Local Area Factors a. Geography/geology/altitude b. Area economic conditions c. Local government stability & sophistication d. Police, fire and medical support e. Local population attitude and stability f. Transportation network g. Communications h. Other support infrastructure, such as housing, etc. 6. Project Site Factors a. Topography/drainage ability b. Access/egress c. Congestion d. Adjacent operations e. Hazards-safety and health f. Location and adequacy of construction support facilities/areas g. Availability of utilities 7. Security 8. Weather a. Normal weather patterns b. Potential for extremes 9. Monetary a. Bidding costs vs. potential for award b. Escalation c. Exchange rates d. Area cost indices e. Payment floats f. Retention g. Unbudgeted premium time h. Overhead costs

185 i. Contractual penalties, such as liquidated damages, etc. j. Regulatory penalties, where applicable ________________________________________________________________________ Table continues… 10. Shared savings among stakeholders 11. Ability to Perform a. Familiarity with type work b. Availability and qualifications of key personnel c. Knowledge of area d. Completeness of design e. Quality of design f. Timeliness of design g. Complexity, constructability of design h. Requirements for new technology i. Competing activity on site j. Availability of access to work when required k. Need for work or fire permits 12. Time Factors a. Deadlines and milestones b. Available normal work days c. Potential for stoppages by other parties or situations 13. Project Regulatory Factors a. Permits - potential for delays or rejection b. Environmental - potential for spills, emission, other violations 14. Labor Factors a. Availability b. Skill levels c. Work ethic/area productivity standards d. Wage scales e. Potential for adverse activity f. Substance abuse in labor population 15. Owner Management Team Factors a. Financial certainty on project scope b. Management of Integrated Team concept versus Interferences c. Realistic Quality expectations d. Client Interpretation of contract e. Ability/willingness to meet obligations within a Team environment f. Change management policies 16. Materials furnished by Contractor Factors a. Quantity variations b. Price c. Availability d. Delivery uncertainties e. Contract-imposed procurement limitations

186 f. Potential for waste in use g. Potential for loss, such as theft, vandalism, damage _________________________________________________________________________ Table continues…

187 17. Construction Equipment Factors a. Availability b. Cost c. Loss or damage 18. Subcontractor/Vendor Factors a. Technical qualifications b. Financial stability c. Timeliness/reliability d. Bondability e. Minority, women, disadvantaged business and small business enterprise requirements 19. Care and Custody Exposure a. Constructed facilities b. Storage of materials/equipment furnished by others c. Special Exposures d. Insurance deductibles e. Owner claims f. Third party litigation g. Warranties & guaranties h. Permitting requirements Table ends

188 1.24 Limitations of the Study The development of the Risk Review Model was done within the environment of one major oil and gas owner organization and the subsequent analysis and evaluation of projects were done on its projects in three different countries. Although this organization and its projects could be considered typical of most such owner organizations within the global oil and gas industry, nevertheless it must be recognized that this study was limited by the exclusion of perhaps more experienced experts who have operated in more challenging environments and in other organizations under different circumstances. Their contributions could have served to significantly enhance the value of the Project Risk Review Model. Although the concepts that are developed in the dissertation are widely known, particularly in the Oil & gas and Petrochemical industries and the checklists as well as the risk program are very generic, nevertheless the specific questionnaires upon which the Project Risk Review Model is based were developed within a particular organization and cannot be considered representative of all organizations because of differences in their operating procedures. Furthermore, the data

obtained from past completed capital projects were not inclusive of differing conditions as may be experienced in many other countries and locations. For example, the different risks involved in executing projects

189 under conditions in China as opposed to those in the Middle East or Africa, were not specifically compared or considered.


Chapter 4

4.1 Research Findings This chapter focuses on presenting the final components and structure of the Project Risk Review Model, based on the findings during the course of the research. All findings that are relevant to the

hypotheses of the study are presented and analyzed in a logical manner. To this end, the purpose and application of the Model is first discussed in this chapter, where-after the questionnaires that make up the body of the Model are listed. These questionnaires were developed based on the various tables and relevant information that were set out and explained in Chapters 2 and 3. Finally, the project risk review process is explained, followed by examples of project reviews are given to demonstrate how the Model was applied in order to identify and evaluate the risks that were involved in those projects. All of these findings provide the foundation for justifying the conclusions that are drawn from this study.

191 4.2 Purpose and Structure of the Model for Project Readiness Review It became clear from discussions held with Board members, senior management and project team members that not all projects could be expected to be fully defined and to have all relevant issues addressed at the end of the Feasibility Study phase. Oftentimes, market demand or other pressures to reduce project cycle times warrant the authorization of projects with underdeveloped definition at this Feasibility stage. In these instances, the amount of time available for defining the scope of the project during the Feasibility Phase decreases. Thus, at Gate 3, the Model has to focus on those critical elements that, if poorly defined, could have the greatest potential negative impact on project

performance. It provides the owners and stakeholders of the Project Company, i.e. the new company that is formed by the owner organization for the purpose of building the new project, with the ability to quickly and accurately predict factors that may impact project risk. At the same time, the Model has to have the capability of enabling the review team to investigate and identify risks associated with the considerable detail that is required from a project team at the end of the Basic Engineering phase. The proposed Model was developed by a team that included the author and other senior management representatives from the Owner organization. The Model was improved through discussions with various

192 Project Management teams as well as with managers and engineers from several Engineering Contractors located in the region. The approach in this Model is based on the premise that maintaining sound cooperation within the Project Company and in the organization at large will ensure that projects are executed effectively. It is believed that projects have on numerous occasions been submitted to the relevant Board for Principal Approval, without adequately describing the project risks or mitigation strategies associated with inadequate scope definition. It is also understood that management would like to have assurances regarding essential deliverables that have not been completed at the time of application, together with their associated risks and mitigation strategies. Therefore, this Model was proposed to be used as a project specific review tool and to be incorporated as an element of the Application for Capital Approval, so that individual projects can be audited in order to provide to the Board a clear description of project status, as well as incomplete deliverables, together with their identified risks, associated costs and proposed mitigation strategies. The Model for Project Readiness Review offers a method to measure project scope definition for completeness, thereby identifying risks associated with Omissions, Assumptions, Verifications, Evaluations, Contractual and Regulatory arrangements, and Consistency of

Presentation to the applicable Board at the stage of Capital Approval in

193 Principal. The Model looks in considerable detail at the quality and completeness of three main project sections, namely business, technical and project management, each of which have sub-categories that, in turn, are further broken down into elements. It has three checklists of scope definition elements in an easy-to-use score sheet format, covering an industrial plant project’s business case, technical

development and project management issues. The three checklists are shown respectively in Table 4.1, Table 4.2 Table 4.3 below. The Model evaluates against international process industry norms the FEL (Front End Loading) levels of efficiency in work planning, communication, cooperation, and application of VIPs, value engineering, and project execution planning. It was agreed that the score sheet resulting from the review process, together with a project specific Executive Summary, should be submitted as an attachment in the Application for Principal Board Approval. This affords the Board members the opportunity to make informed decisions around the risks and associated costs of the project. The project specific tool, i.e. the Model for Project Readiness Review proposed here differs from the more holistic approach that is applied by IPA (Independent Project Analysis), in that IPA provides a grouped comparison of a particular organization’s projects as a whole against a grouping of similar industry projects, where-as this proposed tool analyses one specific project at a time, to determine its efficiencies,

194 completeness and associated risks at any particular point in time after completion of the Feasibility phase. This evaluation can then be compared to other similar projects that are executed within the Owner organization, if needs be, in order to ascertain whether one particular project team fares better than another. 4.3 Model Questionnaires

195 ________________________________________________________________________ Table 4.1 Business Case Review Questionnaire
Element Business Strategy and Strategic Fit Evaluation Description This question is about HOW this proposal would affect your ability to deliver on your mission, vision or corporate goals. If it is not a New Business Venture proposal (i.e. a revamp/ expansion) the question addresses the key business or SBU objectives. What are the key strategic issues that need to be considered - and what were the responses to those? Were changes in strategic goals considered? Were alternative strategies considered? Has the Strategic Fit of the Proposal been tested with the corporate strategy? This question is about the assessment of different ownership and partnership strategies, structures, comparable visions & goals, synergies, alignment of interests, markets shares, other beneficial relationships. Other organisations to involve? Options considered? Risks considered? Assessments made? Negotiations made? Agreements prepared? Cost Sharing mechanisms? Decision making mechanisms? Resource commitments made? Roles and Responsibilities of parties? Work Processes? Evaluation of Completeness No Consideration given. Proposal fits with Business Unit Strategy. Proposal Fits with both Business Unit and Owner Corporate strategy confirmed - and preliminary business strategy designed - not written up. Detail Business strategy written up, not yet approved by stakeholders. Detail Business strategy written up, and approved by all stakeholders.

5 = 4 = 3 =

2 =

1 =

Business and Ownership Structure

5 = 4 =

No consideration given yet Assessed and Recommended a preliminary ownership/ partnership/ JV strategies and forms of legal entity, based on compatibilities, synergies, risks, and potential conflicts of interest. Recommended a preliminary ownership/ partnership/ JV strategy and form of legal entity based on compatibilities, synergies, risks and conflicts Detail and joint partner assessment where applicable, and development of ownership options and strategy – ownership agreements in preparation Final ownership structure recommendation and

3 =

2 =

1 =

Infor Sharing? Exclusivities? Boundaries of relationship or business proposal? Partnership/JV agreement? agreement in principle by stakeholders ownership agreements are ready to be signed - and agreed by all stakeholders

Table continues…

Cross Business Impact Analyses This question is about the assessment of the impacts this proposal might have on other SBU's - beneficial or otherwise in terms of, e.g.Existing and/or future - Markets - Operations - Feedstocks - Utilities - Infrastructure ......... ........and the risks / opportunities associated with those impacts. 1 = 5 = 4 = No consideration given yet Potential cross business unit impacts identified - impacts not assessed. Cross Business impacts analyzed in detail and agreed with different stakeholders - preliminary plans to manage impacts designed Cross Business impacts analyzed in detail and agreed with different stakeholders - final plans to manage impacts designed Cross Business impacts analyzed in detail and agreed with different stakeholders - final plans to manage impacts designed and agreed by stakeholders No consideration given yet. Costs estimates for staff and personnel based on factored estimates. Preliminary structure and staffing levels defined - and included in fixed costs Detail management structure, organization design, and staffing levels designed and incorporated in the fixed cost analysis Detail management structure, organization design, and staffing levels designed and incorporated in the fixed cost analysis, agreed by stakeholders

3 =

2 =

Management Structure and Organization design

This question is about the whether a management structure and organisation staffing plan is available and whether all the costs associated with the organisation structure has been estimated and included in the business economics

5 = 4 =

3 =

2 =

1 =

Table continues…

Industry Analysis and Competitive Advantages This question is about whether all the trends, forces, opportunities and barriers relevant to this industry have been analyzed and incorporated into the business strategy and market strategy. It considers the typical 5industry forces which is used to investigate Product Substitutes, potential New Entrants, Customer forces, Supplier forces, Internal Industry Competition, New technologies, etc. and an understanding of the Key Performance Areas to be competitive in this industry. It also aims to identify whether competitive advantages have been identified and adequately exploited in this proposal. 5 = 4 = No industry analysis done yet Understanding of basic industry competitive advantages and Key Performance Areas Industry analysis included barriers to entry, new product and business trends, substitute products, new and potential entrants, suppliers of raw materials, customers, competitive advantages and disadvantages of the proposal, but not well documented. Well documented Industry analysis which included barriers to entry, new product and technology trends, substitute products, existing, new and potential entrants, suppliers of raw materials, customers, competitive advantages and disadvantages of the proposal, and recommendations detailed. 1 = Industry analysis recommendations, competitive advantages and disadvantages identified, were incorporated (addressed) in the final marketing plan, business strategy and (where applicable) in the ownership strategy.

3 =

2 =

Table continues…

Competitor Analysis and Value Chain Comparisons This question is more specific than the previous one in that it considers key competitors' cash costs or value chain costs and compares them with this proposal. The idea is to establish how this venture would be able to compete with its rivals on a purely value chain cost basis. It is therefore sometimes necessary to compare potential alternative value chains, e.g. different technologies or locations need to be assessed to identify the most competitive option/s. 5 = 4 = Not Considered yet All Competitors Identified and an understanding of their Value Chains exists. Preliminary assessments made of competitors' value chains and cash costs, and compared to this proposal, but not well documented Well documented and Detailed assessments made of relevant competitors value chains, and cash costs, compared to this proposal, and improvements made to this proposal's value chain to improve its cost competitiveness. Final documented and Detailed assessments made of relevant competitors value chains, and cash costs, compared to this proposal, and improvements made to this proposal's value chain to improve its cost competitiveness. The design rate, on-stream factors, product yields (Saleable products per year) are not known The design rate, on-stream factors, product yields (Saleable products per year) are based on assumptions The design rate and product yields are well known, but onsteam factors are based on assumptions 2 = The design rate, on-stream factors, product yields (Saleable products per year) are well known, but not agreed with owner and licensor The design rate, on-stream factors, product yields (Saleable products per year) are well

3 =

2 =

1 =

Plant Capacities

5 =

4 =

3 =

1 =

known, agreed with owner, licensor and included in the business case

Table continues…

Market Strategy This question determines the alignment between the marketing strategy and the rest of the proposal, particularly the scope of the design, the operational costs and the impact of marketing decisions on capital investment decisions. 5 = Impact of market strategy on capital and operating cost was not considered Impact of market strategy on capital and operating cost was only considered on a conceptual level Impact of market strategy on capital and operating cost was considered, opportunities not yet included in project Capital and operating cost are in line with proposed marketing strategy and optimization opportunities are mostly included in project Capital and operating cost are in line with proposed marketing strategy and all optimization opportunities are included in project Preliminary sales volumes considered Market volumes, growth rates, supply & demand balances on a regional basis, target markets and potential customers identified Market volumes, growth rates, supply & demand balances on a regional basis, target markets, potential customers and plant ramp-up rates verified with historical data and reliable source forecasts and documented. Preliminary sales agreements, LOI's and take-or-pay agreements, and terms are negotiated Final sales agreements, LOI's and take-or-pay agreements, and terms are negotiated and agreed by all stakeholders.

4 =

3 =

2 =

1 =

Market Volumes (Products and By-products)

Market volumes, growth rates, supply and demand balances, Target markets, customers, sales agreements, and sales terms.

5 = 4 =

3 =

2 =

1 =

Table continues…

Market Pricing (Products and By-products) Market pricing strategies, historical and forecasted prices, pricing formulae, pricing agreements. 5 = 4 = Preliminary considered. Pricing strategy

Market pricing mechanisms identified and included in economic analysis Market pricing mechanisms identified and verified with historical data and reliable source forecasts, and included in economic analysis. Pricing mechanisms or formulae part of sales contracts and being negotiated with stakeholders Final Pricing mechanisms or formulae being negotiated with stakeholders and agreements reached. Uncertainty around the following: Chemical composition, Physical form, Raw materials, Catalyst, Allowable impurities, By-products and Wastes Uncertainty around four of the following: Chemical composition, Physical form, Raw materials, Catalyst, Allowable impurities, By-products and Wastes Uncertainty around two of the following: Chemical composition, Physical form, Raw materials, Catalyst, Allowable impurities, By-products and Wastes Chemical composition, Physical form, Raw materials, Catalyst, Allowable impurities, Byproducts and Wastes are known, but not agreed with owner, suppliers and customer. Chemical composition, Physical form, Raw materials, Catalyst, Allowable impurities, Byproducts and Wastes are known

3 =

2 =

1 =

Products (Quality & Specification)

The extent to which Product qualities, specifications, Chemical compositions , Physical forms, Raw materials, Catalysts, allowable impurities, of products, by-products and waste streams are all known and agreed.

5 =

4 =

3 =

2 =

1 =

and agreed with owner, suppliers and customer.

Table continues…

Logistics and Supply Chains The extent to which the inbound and outbound logistics and supply-chain plan are developed for feedstocks, utilities, materials, and products. 5 = 4 = Not Yet Considered Logistics and distribution elements identified and preliminary costs associated with them included Alternative logistics and distribution plans considered for both inbound and outbound supply chains of all feedstocks, utilities and other materials, and not documented Alternative logistics and distribution plans considered for both inbound and outbound supply chains of all feedstocks, utilities and other materials, and documented. Final Logistics and distribution plan selected and agreed by stakeholders. Not yet considered Bullet point commercial and some preparation formats list of all required agreements exists agreement are in in broad outline

3 =

2 =

1 = Other Commercial Agreements The extent to which all other commercial agreements - except the ones already covered in the Sales and marketing plans - are developed and agreed by stakeholders 5 = 4 =

3 =

All other commercial agreements are being compiled but not reviewed and agreed. All other commercial agreements are being negotiated with relevant parties All other commercial agreements are agreed with relevant parties and stakeholders

2 =

1 =

Table continues…

Feedstocks, chemicals and catalysts The degree to which the availability and consumption of feedstocks, Chemicals, and catalysts are known and agreed. 5 = Preliminary consumption and cost figures for Feedstocks, chemicals and catalysts are known Consumption and figures for Feedstocks, chemicals and catalysts are based on Conceptual design package, prelim FAV calculations and budget quotes. Consumption and figures for Feedstocks, chemicals and catalysts are based on Feasibility design package, FAV calculations and quotes, and documented Agreements to procure Feedstocks, chemicals and catalysts are negotiated with suppliers, and documented. Agreements to procure Feedstocks, chemicals and catalysts are agreed with suppliers and stakeholders. Preliminary consumption and cost figures for Utilities and Infrastructures, Services and other materials are known Consumption and figures for Utilities and Infrastructures, Services and other materials are based on Conceptual design package, and budget quotes. Consumption and figures for Utilities and Infrastructures, Services and other materials are based on Feasibility design package, and quotes, and documented Agreements to procure Utilities and Infrastructures, Services and other materials are negotiated with suppliers, and documented. Agreements to procure Utilities and Infrastructures, Services

4 =

3 =

2 =

1 =

Utilities and Infrastructures , Services and other materials

The degree to which the availability and consumption of utilities, infrastructure, services and other materials are known and agreed.

5 =

4 =

3 =

2 =

1 =

and other materials are agreed with suppliers and stakeholders

Table continues…

Other Fixed and Variable Operating Costs The degree to which the other fixed and variable costs have been identified, defined and included in the Economic Analysis, e.g. Insurance Service charges Promotions & Advertising Customs duties & Surcharges Shipping Taxes Rentals Royalties Software Spares Maintenance materials Indirect Personnel Expenses Etc Etc. Necessary for this proposal - the degree to which different sites or fixed assets have been identified, evaluated and selected - the terms negotiated and agreed. 5 = 4 = 3 = Not considered yet Order of magnitude or factorized Operating costs considered Other Fixed and Variable Operating Costs are based on Conceptual design package, and budget quotes. Other Fixed and Variable Operating Costs are based on Feasibility design package, and quotes, and documented 1 = Final values for Other Fixed and Variable Operating Costs are agreed with stakeholders Not Considered Yet Preliminary sites/ other fixed assets, etc. identified, evaluated and preliminary costs of these included in the estimates. Final site and other fixed asset selection and evaluation and Plan for site acquisition developed and documented Negotiations for site, other fixed assets under way and terms discussed. Final settlement on fixed asset/ real estate purchase agreement and agreed with stakeholders. Not yet Considered Preliminary Business IT infrastructure and systems needs analyses done and documented Preliminary Business IT infrastructure and systems designed, alternatives considered and included in cost estimates and documented Final Business IT infrastructure

2 =

Real Estate / Site / Fixed Assets

5 = 4 =

3 =

2 =

1 = Business ITInfrastructure & Systems Systems and software to run the business (not the plant control system) have been defined and included in the capital and operational cost estimates. 5 = 4 =

3 =

2 =

and systems designed, alternatives considered and included in cost estimates, and documented Final Business IT infrastructure and systems designed, alternatives considered and included in cost estimates, documented and agreed. Not yet Considered Order of magnitude or factorized Royalties and / or License fees are estimated. Preliminary indications of Royalties and / or License fees from licensors are incorporated in evaluations Royalties & License fee plans are made, agreements drafted and negotiations are underway, and documented Final Royalties & License fee agreements are concluded and agreed with stakeholders. Not considered yet Bullet point list of potential Legal & Contractual Issues or restraints drawn up. Legal & Contractual Issues or restraints defined, and plans in preparation and documented. Detail plans in place to handle Legal & Contractual Issues or restraints and discussions under way with the relevant authorities and/or parties. Legal & Contractual Issues or restraints resolved with the relevant authorities and or parties and stakeholders agreements obtained. Business impact on proposal not yet considered. Potential Intellectual property issues listed and identified

1 =

Royalties & License fees

The degree to which Royalties and / or License fees for Intellectual properties have been finalized.

5 = 4 =

3 =

2 =

1 = Legal & Contractual Issues or restraints Are there any Legal or Contractual restraints to be planned for? E.g. Competitions acts, land use and land tenure laws, contractual restraints, i.e. marketing, or manufacturing or regional barriers, Local content requirements, Local employment requirements, Local Environmental legislation, etc etc. 5 = 4 =

3 =

2 =

1 =

Intellectual Property

Are there any other intellectual property issues (except licensing) That may have a bearing on this proposal?

5 = 4 =

E.g. Freedom-to-operate Trade marks Copy rights Risk of Infringing a Third Party's Claims 3 = 2 = Full business impact assessment of potential Intellectual property issues done and documented Recommendations of the intellectual property impact assessment incorporated into the business plan. Recommendations of the intellectual property impact assessment incorporated into the business plan, and agreed by stakeholders.

1 =

Table continues…

Financing The extent to which external finance is necessary for this proposal, financing options considered, relevant tax, securities and insurance issues considered and a final financing plan agreed 5 = Assumed full equity financing by the owner - thus no other financing needs considered yet Assess financing needs of the potential business owners and other participants. Assess financing options and develop a financing plan in writing. Consider legal, tax, security and insurance options. Refined financing alternatives. Negotiate financing term sheet and documentation. Concluded and agreed finance plan/s and arranged draw-down funding for project. No consideration given Potential risks identified that are killer concerns (stop the proposal), as well as risks that are manageable Assessment of risks (Exposure & Probability) and development of mitigation strategies (Contingencies, back-up plans, insurance, by-pass, manage), and documented Assessment of risks (Exposure & Probability) and development of mitigation strategies (Contingencies, back-up plans, insurance, by-pass, manage), documented and all KILLER concerns eliminated. Final detailed risk management plan incorporated into the business plan and mitigation strategies agreed by stakeholders.

4 =

3 =

2 =

1 = Risks Assessment and Mitigation Actions The extent to which commercial risks and killer concerns have been identified, contingency plans drawn up and mitigating actions taken. Risks in these areas: Socio-political Marketse.g. antidumping duties MarketsSeasonality/cyclicality/vol atility. Small number of buyers Governmental/Legislative Technological Consequential liability Labour Relations Economic - e.g. Currency risk Credit risk. 5 = 4 =

3 =

2 =

1 =

Table continues…

Tax Regime (Taxes, Fiscal policies, Repatriation of earnings, Duties, etc. The extent to which taxation of the business proposal in the host country / government is understood, negotiated and agreements with relevant tax and other state authorities finalized. 5 = 4 = Tax not yet considered Understand current state and requirements of tax and fiscal regime by host government/authority and determine your desired state Developed communication and lobbying plan towards authorities to align desired state with current state. Negotiate, secure and document agreements, concessions and permits with relevant authorities. Agreements, concessions and permits with relevant authorities regarding Tax Regime finalized. Instantaneous Return - on investment (ROI) Economic evaluation done without consideration for longer term cash flow projections. Identify and gather all relevant business assumptions that need to be modeled in a deterministic economic analysis model, and started prelim runs on model. Modeled the business case in a deterministic economic analysis model, with updated business assumptions. Modeled the business case in a probabilistic economic analysis model including risks from risk analyses exercises, with final business assumptions. Final detailed economic analysis with Sensitivity and Monte Carlo probability simulation analysis included based on final operational and capital cost estimates.

3 =

2 =

1 =

Economic Evaluation & Sensitivity Analysis

The extent to which all the above commercial assumptions have been included in the proposals' economic and sensitivity analyses - as well as the level of analyses done

5 =

4 =

3 =

2 =

1 =

Table continues…

Social Community Issues / Are their any social issues regarding the local community or the host country that had to be taken into consideration and what is the status of these plans (if applicable)? 5 = 4 = Social issues considered were not

Social issues were considered, but no formal consultation with interested and affected parties Interested and effected parties were consulted, but there is still outstanding issues to be agreed Interested and effected parties were consulted and verbal agreement was reached on social issues Interested and effected parties were consulted and agreement was reached (in writing) on social issues. Not begun yet. Noted that a start-up plan is required, and bullet points have been drafted. The start-up plan has drafted in broad outline. been

3 =

2 =

1 =

Start-up Requirements

The extent to which the commissioning of the plant/s have been planned and the cross-impacts that would have on the rest of the enterprise has been considered (if applicable)?

5 = 4 =

3 = 2 =

The start-up plan has been completed but not reviewed and agreed. The start-up plan has been reviewed and agreed, and incorporated into the commissioning plan. Not begun yet. Noted that a training requirements document is required, and bullet points have been drafted. The training requirements document has been drafted in broad outline. The training requirements document has been completed, responsibilities and designated persons have been identified, but not reviewed and agreed.

1 =

Training Requirements

Have the training requirements for future plant operations been defined and responsibility established?

5 = 4 =

3 =

2 =

1 = The training requirements document, including responsibilities and designated persons has been agreed and finalized.

Table ends

214 4.4 The Project Readiness Review Process Every project is on a development time-line with specific

milestones for each of the deliverables, i.e. the project team establishes a schedule that shows when specific deliverables are planned to be completed, including all Business, Technical and Project Management issues that are relevant to the project scope. This is done in order to ensure that the risks associated with incomplete or poor quality work are properly identified. The schedule is agreed by all stakeholders and is approved by the organization’s top management. The project team therefore has the responsibility to report on their progress and to ensure the completeness and correctness of all the deliverables. As the project nears completion of a particular phase and approaches that time when the project team will approach their Board for capital approval to proceed to the next phase, it is in their project’ interest, as well in the interest of the all stakeholders and that of the organization, for the project team to ensure that they have covered all the bases, made provision for all foreseeable risks, and that the project is indeed ready to proceed to the next phase. Therefore the Project Risk Review Model is proposed to assist the project team to determine the completeness of the project’s deliverables and to highlight any outstanding risks and omissions. This facilitates the project team and ultimately their Board to ascertain whether the project’s expected financial returns are still within the parameters that were established by the Board for the particular

215 project, and also to ensure that the capital which is being requested will be sufficient to complete the project. Project evaluation at the stage of capital application for Principal Approval is also a function of how effective the review process is done and how effective the Project Company and organization at large work together on the capital project value chain. Therefore this Model presents a project risk review tool that also captures the levels of efficiency of the Project Company’s own internal relationships and responsibilities around that project. The flow sheet in Figure 4.1 below outlines the process as it normally should be conducted. Although the review can be conducted during any stage of the project’s development, it is recommended that the project review should at least be done prior to capital application to the Board, which takes place at the end of the Feasibility phase and again at the end of the Basic Engineering phase, or on mega projects at the end of the Front End Engineering and Design (FEED) phase. The flow diagram in Figure 4.1 below is described in sequence as follows: Step 1 - Initiate: The project team arranges a Project Risk Review meeting set for a certain date, when they anticipate that the project will be ready to proceed to the next phase in its development and will therefore require additional capital and Board approval of the economics of the project.

216 Step 2 - Internal Quality Assurance: The internal quality assurance review would firstly consist of a separate review of the work comprising each of the Business, Technical and Project Management issues and is conducted separately by the project team representatives of each of those categories. The actual deliverables of the respective categories of the project should be looked at, the quality assessed and specific questions of the Project Risk Review Model should be addressed. To try and do all this together for all three categories at the same time will take a lot of time, unless the respective project representatives have already assured themselves that all of their respective deliverables are complete and correct. This activity is also useful for all of the project team members to agree among themselves regarding the status of their project deliverables. Once the project team members are all agreed to proceed, they can finalize the date for the formal Project Risk Review meeting with the Peer Review Team. Step 3 - Project Risk Review Meeting: Only when the internal discussions have been completed and a good understanding obtained by all category reviewers does the key project team members meet with the Peer Review Team to discuss the project as a whole, including its Business, Technical and Project Management issues. This exercise will take approximately a whole day

217 in total for medium sized projects. For mega-sized projects, the exercise could take several days. The risk review meeting is conducted at a venue preferably near to the existing project team’s offices, so that necessary documentary proof pertaining to any of the project deliverables can be readily at hand. As each of the questions are posed by the Peer Review Team to the key members of the Project Team, the discussions among the meeting members will inevitably lead to details that will require documents and clarifications in order to demonstrate the status of particular

deliverables. Once the group reaches agreement on the completeness and quality of deliverables related to any of the questions in the Risk Review questionnaires, the group can then agree to a score for that specific question. As can be seen from the right hand columns of the questionnaires of the respective project categories shown in Tables 4.1, 4.2 and 4.3, a score ranging from 1 to 5 is given, whereby the lower the score the more complete and correct the deliverables are. Higher scores denote questions where the deliverables are not yet sufficiently addressed by the project team. Every project team and their organization’s executives will know that, for example at the end of a project’s feasibility phase, prior to starting Basic Engineering, most if not all of the Business track’s deliverables should be substantially complete, and so too with the technology and core process related issues. It stands to reason that the

218 Board would be reluctant to give approval for additional capital to be spent unless those issues have already been resolved satisfactorily. On the other hand, Mechanical or Structural design and detailed Project Management issues will not be much advanced at all by the end of the project’s Feasibility phase; these deliverables can be expected to addressed during the Basic Engineering or FEED phase. Thus the Risk Review score of any particular industrial capital project should be substantially higher at the end of its Feasibility Phase than it will be at the end of its Basic Engineering or FEED phase. The higher score at the end of the Feasibility phase therefore reflects that the project’s deliverables are substantially incomplete and that the project is by far nopt yet ready to begin with its construction phase. In this way the stakeholders and executive management does not have to rely on faith or assume and hope that the quality of a project’s deliverables are complete and of sufficient quality, and that the project economics are still satisfactory. Step 4 – Risk Review Report Once the Project Risk Review meeting is held and the score results are evaluated by the Peer Review Team, an integrated risk assessment is done by the Peer Review Team and an overall feedback session, which may last 3 hours or so, follows where the respective Business, Technology and Project Management scores and risk evaluations results

219 are discussed with the relevant project team members and the following are considered: 1. Are there any killer concerns, i.e. must the project be stopped or substantially reworked before it can proceed to its next phase 2. If not, what key risks exist that risk mitigation plans should be developed for 3. How will these risks be managed, what are the mitigation actions and how will this be followed up 4. What are the financial implications of the identified risks and mitigation plans on the viability of the project economics.

Step 5 – Finalize Report: The final Project Risk Review Report will be submitted to the organization’s executive management, normally at the same time that the Project Team submits their Board Application for project capital approval. Therefore this final report should clearly highlight any risks that will or may have a significant impact on the achievability of the organization’s goals and on the viability of the project economics. The report should discuss areas of particular concern followed by their reasons for concern, and should also include constructive

recommendations for improvement and risk mitigation plans for the

220 project. It is also expedient to include explanatory notes and/or comments from the Project Team themselves. An example of an actual Project Risk Review Report is shown below in Table 4.4. This report pertain to a review of a project at Gate 3, i.e. at the end of its Feasibility phase. The project name and owner particulars are withheld for confidentiality purposes. Necessary attachments are also shown, in Table 4.5 below.

1 Figure 4.1: Project Risk Review Process Flow Sheet

Step 1: Project Team Initiates Project Risk Review Process

Step 2: Project Team Conducts Internal Quality Assurance  Project Management Team Internal Verification Checklist of Phase Deliverables Deliverables complete Documentation upto date If required, Risk Review Process is postponed pending readiness of the Project Team

Business Issues > Business Plan > Marketing Plan > Economics Technical Issues > Technology > Engineering Design > Value Improvement Project Management > Resources > Schedule > Execution Plan Set Risk Review Date As Informed by Project Team

 

Prior to Capital request Prior to proceeding to the next phase of the project

   

Step 5: Finalize Report

Step 4: Risk Review Report

Step 3: Project Risk Review Meeting

  Decision  

Project Team and Peer Review Team discuss the Draft Report Incorporate Project Team's response on Business, Technical and Project Management issues Evaluate the potential financial impact of identified Risks Transmit Report to the relevant Authorities, such as the Board

    Peer Review Team compiles the Draft Report Business, Technical and Project Management issues are reviewed Identify and assess the risks to successful business realization and project outcome Propose Risk Mitigation Plans

Official Review done by a peer group of relevant experts who are not members of the project team Key Proect Team members are present All project documents on hand Open discussion and concensus on project scope Evaluation and score on completeness of deliverables and documentation

   

1 Figure 4.5: Project Risk Review Report For XYZ Project - Gate 3 – end of Feasibility Phase A Project Risk Review of the project was conducted on 19 June 2002, to assess the level of scope definition and to highlight the risks of the project. The review was done with the attendance of all key project members from business, project management and engineering tracks. Questions raised during the review were clarified with participation by all attendees and the review was updated during the meeting. The results of this review is thus based on mutual agreements obtained during the meeting, based on the available information and insight that was gained during the meeting. The project team was very well prepared, and the review team would like to complement the XYZ Project team on their easy to understand and comprehensive project execution and business plans that were resented.
P rojec ts with < 200 points has the Best c hanc e f or S uc cess

Over all Result



Overall Score Poorest Score

100 200 300 400 500 600 700 800 900 1000 1100 1200

The overall Project Risk Review score is 235 while a score below 200 is considered best to ensure successful project completion, at the end of the Basic Engineering phase. The team achieved an excellent overall score of 365, which is well below the norm of 400 at the end of the Feasibility phase. Within the context of this project, including its proposed schedule as well as its associated risks, this score is considered more than sufficient for project authorisation to proceed through Gate 3 to Basic Engineering. The main contributing factors to this score are given below.

2 Business Development
B us i ness T r ack

0 50 100 150 200


Section 1 Score Poorest Score

• • • •

• •

See the attached Business Track report as written by the Peer Review Team. Important aspects of their report are quoted herein. Overall Business viability. The project’s business track scored 30 out of 220, which is very good (the lower the score the better). With the information available it was possible to ascertain that the project’s overall business is robust, sensitivities were identified and an overall sustainable competitive advantage was demonstrated. Although the team has done identification of risks already, this process needs to be followed through. A complete risk analyses together with risk mitigation strategies and a scope of work for each strategy needs to be done for the three tracks (Engineering, Project and Business). Particular attention needs to be paid to the change over and implementation process from a three-plant operation to a one-plant operation, the logistical requirements, and the market impact. A thorough sensitivity analyses and Monte-Carlo simulation need to be included in the Economic analyses. Especially take cognizance of the effect the Rand/US $ exchange rate may have on project viability.

The graph below illustrates the evaluation of the business “Elements”

40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 •

Engineering Development

The PROJECT RISK REVIEW rating for engineering was very good, and quite in line with what should be done during a Conceptual Development Phase. Elements that had an adverse effect on the engineering score are those matters that will receive attention during the next Basic Development phase.
0 50

Engineering Track

Section 2 Score Poorest Score

100 150 200 250 300 350 400 450 500 550 600 650 700 750

A few elements are highlighted here, to give an overall idea of the development work on this project. • Reliability - Extra allowance of silo storage was necessary to accommodate grade changes. Support systems allow for 3 feeders, of which one is standby. • Operating Philosophy – The number of operators (14) agreed with client, HSE, etc. Levels of operators also agreed with all stakeholders. 4 shifts are required to maintain production capacity; it is preferred to run the machines continuously to avoid product loss. Necessary level of segregation and clean out between grades have been allowed for in the design - 2 hours allowed between grade changes. • Process Chemistry - Existing 'book of knowledge' for making various grades of product is proprietary Polifin technology that has been proven for over 40 years. Currently 96 different chemical dyes (powdered pigments) are required. Automation for

4 dye addition was investigated but found to be too expensive. Dye addition will have to be done manually, as at present. . An additional step to facilitate the process is being investigated, i.e. to pre-mix the colour dye followed by dosing with a screw mixer. This is standard practice on modern plants. Two existing plants were visited to verify this technique. Process Technology - The extrusion process is very well proven. New models of extruders (from the selected supplier) are being investigated to evaluate possible benefits. The decision on extruders will be taken during the next project phase. The selection of the machine is recognized by the team as a possible high risk . Therefore, selection criteria have been established to ensure proper selection of the right machine. If the new machine is selected, the design will be for 2 tons/h (due to technology advances, reliability, etc.) instead of 3.5 tons/h as per the machine capacity used for the base case. This mitigates the risk of the new machines. Framing/Alignment - Alignment after gate 2 was done with all stakeholders, facilitated by Freek van Heerden. Appropriate VIP's were identified and subsequently executed. An additional 2 meetings were held with all stakeholders & Steering Committee to discuss/agree all business and engineering issues. A 3rd stakeholder meeting was scheduled for 30 Jan 02 to address all outstanding issues. Project Design Criteria - PFD's, preliminary P&ID's and a Record of Decision from EIA have been signed off. Imported aluminum silos were found to be less expensive than local CS silos and specification discussions are ongoing with client. Sasol specs are being applied. No impact is expected from any of the surrounding infrastructure and tie-ins. Site Characteristics: Available vs. Required - Raw material silos, offloading and logistics have been studied. Plot Plan has been completed but not yet approved. Capacity requirements were calculated based on actual consumptions and performance of existing plants with same design basis. All calculations have been demonstrated and accepted by client, operations, Steering Comm, Business, etc. Raw water specs are being investigated to ensure compatibility - especially with regards to possible scaling in the cooling circuit. This is a risk issue that needs to be addressed by the team. Design and interface of existing building and warehouse and new building have been agreed and designed, but not yet signed off. Supporting cost estimates have been obtained from Cost Estimating. Agreement with client must be reached in writing that standards (e.g. finishing) will be similar to existing buildings & warehouses.

5 • • Equipment Utility Requirements - Overall utilities calculations were based on detailed list of equipment and vendor requirements. Lists were available and were reviewed. Power Source & Substation Requirements - Substations are designed for CAP Substation Upgrading, and this project is able to include its equipment into their project. Total distribution system and all voltage levels have been reviewed and updated. Part of CAP Substation Upgrading Project. CADD/Model Requirements - Existing building has been modeled, and it will also be done for the new building. Drawing standards have been agreed with vendors, to tie-in to the 3D model.

40 35 30 25 20 15 10 5 0
0.0 5.0








P roject Track

Mechanical Equipment List
Reliability Philosophy Maintenance Phil. Operating Phil.

The graphs below illustrates the evaluation of the Engineering “Elements”

Project Management • The score rating for project management was very good, and quite in line with what should be done during a Conceptual Development Phase. Elements that had an adverse effect on the project management score was the POE.


Line List Tie-in List
Process Chemistry Process Technology Framing / Alignment Project Design

Piping Speciality Item List Instrument Index Equipment Status
Site Characteristics: Dismantling &


Loading & Storage In Plant Transportation Control Philosophy Logic Diagrams Area Classifications Power Source & Substation Electrical One Line Diagrams Instrument & Electrical Specs / CADD/Model Requirements Deliverables Defined in the

Lead / Discipline Schedule Process Design & Material Design for

1 00

Equipment Location Drawings Equipment Utility Requirements Civil & Structural Requirements Architectural Requirements Effluent Disposal / Treatment

Geographic Location Surveys and Soil Environmental Permit Requirements Utility Sources with Fire Protection & PFDs H&MB's P&ID's Process Safety UFD's Specifications Piping System Plot Plan / Site Plan

1 50



Poorest Score

Section 3 Score


7 • POE - All project control issues are clearly described, except that the POE must be customised a bit more specifically to the realities of this particular project, and regularly updated to reflect the ongoing influence of information on the execution strategy for the project. Issues such as Cost Estimates can also be more clearly specified. The graph below illustrates the evaluation of the Project Management “Elements”
35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 Distribution Matrix Procurement Responsibility Matrix Project Accounting Requirements Project Controls Owner Approval Requirements Risk Analysis Identify Long lead Items / Critical Equipment & Materials Engineering/Construction Plan and Approach Procurement Procedures and Plans Shutdown / Turnaround Requirements Commissioning Planning

The peer review team would like to acknowledge and thank the project team for the obvious effort in their presentation and in making information available in an open and frank manner. PEER REVIEW TEAM

8 Chapter Five: Conclusions, Limitations & Recommendations Summary

5.1 Summary This section is your opportunity to review all of the previous chapters. It is here that you need to emphasize the literature that you reviewed within the field of study, summarize your research model, and focus on the research you have completed within your field of study. The summary section should also state whether your research supports or contradicts generally accepted theories and studies in your subject area. While being concise, you also want to make your summary

detailed enough so that a reader could understand your dissertation by only reading this chapter.

5.2 Conclusions Here the researcher focuses on what conclusions can be drawn from the findings. These conclusions need to be discussed fully and

justified according to the data obtained in the study. Here you bring focus on the problem statement and the research questions that you presented in the proposal. Discuss each of the

research questions answering the question or indicating how your findings impact these issues.

9 5.3 Discussion If the findings are not definitive, but are open to interpretation, should be stated and discussed.


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15. Pollio (1999)

2 16. Rutterford and Montgomerie (eds), Handbook of UK Corporate Finance, 2nd Edition, (1992) Butterworth. 17. Sapte (1997) 18. Songer, A. D., Diekmann, J., Pecksok, R. S. Risk analysis for revenue dependent infrastructure projects, Construction and Management Economics, Volume 15 (1997), p377-382. 19. Teall, John L. Financial Market Analytics, Quorum Press, 1999. 20. Tinsley (2000) 21. Tiong, Robert L.K. BOT projects: Risks and securities, Construction Management and Economics, 1990, Volume 8, p 315-328. 22. US Department of Commerce, Patent and Trademark Office (2003) 23. World Bank, 2003 24. Wynant, Larry. Essential elements of project financing, Harvard Business Review. May-June 1980, p 166. 25. Yescombe, 2002 26. Zakrzewski, Rafal A. Risk Minimization In Project Finance. Seminar paper at “The Law and Business of International Project Finance”, Brisbane, Australia, 1999.

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