Industrial Project Risk Technical Financial PHD

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PROJECT CAPITALIZATION AND RISK: A


MODEL FOR IDENTIFYING AND
EVALUATING BUSINESS, TECHNICAL AND
PROJECT MANAGEMENT RISK PRIOR TO
CONSTRUCTION OF INDUSTRIAL PLANT
PROJECTS

by

Pieter JC du Toit

A thesis submitted in partial fulfillment of


the requirements for the degree of

DOCTOR OF PHILOSOPHY (PhD)

MANAGEMENT OF ENGINEERING AND


TECHNOLOGY

SOUTHERN CALIFORNIA UNIVERSTY FOR


PROFESSIONAL STUDIES

2004
SOUTHERN CALIFORNIA UNIVERSTY

FOR PROFESSIONAL STUDIES

Abstract

PROJECT CAPITALIZATION AND RISK:

A MODEL FOR IDENTIFYING AND


EVALUATING BUSINESS, TECHNICAL
AND PROJECT MANAGEMENT RISK
PRIOR TO CONSTRUCTION OF
INDUSTRIAL PLANT PROJECTS.

By Pieter Johannes Christiaan du Toit

Chairperson of the Dissertation Committee:Professor William Kraus


Department of Business

(Abstract text to follow).


i
TABLE OF CONTENTS

[Click and insert Table of Contents]


ii
LIST OF FIGURES

Number Page
[Click and insert List of Figures]
iii
ACKNOWLEDGMENTS

The author wishes to [Click and type acknowledgments]


iv
GLOSSARY

Word. [Click and type definition here.]


1

Chapter 1
INTRODUCTION

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 efficiently constructed with a clear

understanding and agreement on the identification, evaluation,

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, potentially

applicable technologies, engineering design issues, 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 two-

pronged 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.


17

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. DEF Definitive Estimate


ii. IBL Inside Battery Limits
iii. IFL Inside Factory Limits
iv. OBL Outside Battery Limits
v. OFL Outside Factory Limits
vi. OOM Order Of Magnitude Estimate
19
vii. ROM Rough Order of Magnitude Estimate
viii. SDE Semi-Definitive Estimate
ix. 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.


21

Chapter 2

A REVIEW OF THE CURRENT LITERATURE THAT IS


RELATED TO THE STUDY

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 self-

contained, 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

L o c a l G o v e r n m e n t I n d u s t r ia l O r g a n is a t io n

S t a t e O w n e d C o m p a n y H o ld in g C o m p a n y ( S B U )
( 1 0 0 % O w n e d ) ( 1 0 0 % O w n e d ) ) O t h e r L e a d I n v e s t o r s
( C o - S p o n s o r s )
X % ( U s u a lly M aY j %o r i t y )

Z % ( U s u a lly M in o r it y )

F in a c ie r s
S e c u r it y T r u s t I n d e nV t au rr i e o u s L o a n F a c ilit ie s
P r o j e c t C o m p a n y
L i m i t e d L i a b i l i t y C a s h F lo w s

J o in t V e n t u r e A g r e e m e n t ( J V )

P r o d u c t P u r c h a s e r
C a s h F l o Sw es c u r i t y T r u s t e e
O f f t a k e A g r e e m e n t

M a n a g in g C o n t r a c t o r
T e c h n o lo g y S u p p lie r
E n g in e e r in g & P r o c u r e m e n t
T e c h n o l o g y L i c e n s e C o Cn t ar as ch t
S u p p l y C o S n u t rp a e c r tv i s i o n F lo w s
R e s p o n s ib ilit y
C o n t r a c t o r s
C o n s t r u c t io n C o n t r a c t s

T e c h n o lo g y , E n g in e e r in g , P r o c u r e m e n t , T r a n s p o r t a t io n & C o n s t r u c t io n C o n t r a c t o

________________________________________________________________________
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 self-

liquidating 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 risk-

management 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 front-

end 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 cost-

effective 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 I d e a P r e - B a s i c
P h a s e Gs
1 2 F e a s i b3 Ei l in t yg i n e4 e E r xi n e g c u 5 t i Oo
e n e r a Ft i eo an s i b i l i t y
np e r a 6t i o n

I d e n t if y I na vn e d s t i gD a e t ve e l o p E t xh e e c u t e
O b j e c t i vF e o s r m u l a t e O p e r a t e a n d
A s s e s s a t n h d e S e Pl e r c e t f e r Pr e r do j e c t w it h a
a n d N e w B u s in e s s E v a l u a t e
B u s in e T s e s c h n o T l oe gc yh n o l oF g i x y e d
A c t i v i t i e sI d e a P r o j e c t
O p p o r t Au nl t ie t yr n a At i v l t e e s r n a tB i v a e s e lin e

D e c i s i o n
G a t e s I s t h e I s t h e
W e r e A ll
B u s in e s s B u s in e s s
( H o l d I s t h e I d e a I s t h e I d e a O b je c t iv e s
S o lu t io n S o lu t io n
a S t r a t e g ic t h e R ig h t M e t ?
P o i n t s ) C o r r e c t ? C o r r e c t ?
B u s i n e s s F i Bt ? u s i n e s s ? C o m m is s io n
A r e A l l R i s kA s r e A ll R is k s
in t o O p e r a t io n .
D e f in e d ? A d d r e s s e 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
 A lig n w it h  C F o i nr pa ol i sr a e t e B u Cs i on se t s Es s t i m a t e :  E n s u r e S t a b le
S c o p e a g a in s t A c t u a l C o s t
V is io n C a s e & B e n+ 1 e 5 f i ~t s 3 0 % A c c u r a c y O p e r a t io n s
 C o s t E +s 1 t 0i m % Fa to e l l: o w t h e A g r e e d
M a j o r I s s u e esB
 O u t l i n e  n C e of i s t s t E& s t i m  Fa ti ne :a l i s e P r o c e s s  U p d a t e P r o je c t D a t a
A c c u r a c y P r o je c t S c h e d u le
C o s t s +2 0 ~ 4 0 % A Tc ce uc rh a n c o y l o g y a n d D r a w in g s
t o b e  S t a r t S t a k e Sh ot a l d r te Sr s t a k e Fh oi n l da en rc s i a' l M
 A g r e e
o d e l
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 n s &
S t r a t e g y & S A c d h m e di n u i sl e t rs a t i o n
A d d r e s A s l i eg n d m e n t oA n l i g n m e n t o C n o Pm r po l j ee t c e t M a in t e n a n c e M a n u a ls
 E n s u r e P r  o Cj e o c mt m u n i c a t i o n &
B u s in e s s I dS e c a o p e  G e t B o a r d B u y - in  E v a lu a t e P e r f o r m a n c e
R e a d in e s s R e p o r t in g
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 cost-

effective 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:

1.7.2.1. To focus the team on a common vision of success


48
1.7.2.2. Define critical success factors

1.7.2.3. 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:

2.2.1.1. Define major decision points, decision makers,

deliverables and focus items

2.2.1.2. Identify resources needed

2.2.1.3. Measure success with appropriate metrics

2.2.1.4. Anticipated changes


54
Table continues

________________________________________________________________________

2.2.1.5. Contingency planning in the event of changes

occurring

2.2.1.6. Maximize asset profitability

2.2.1.7. 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. Optimization of power, steam, and cooling water

2.3. Instrumentation control and operating philosophy

2.4. Preparation of operating and commissioning guidelines with

framework plans

2.5. Environmental impact information

2.6. Manpower recommendations

2.7. 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) Economic data (inflation, tax rate, etc.)

ii) Construction data (construction costs and planning, etc.)

iii) Source of funds and amount (equity, credits, bonds, subsidies,

etc.)

iv) Financial data (characteristics of the credits, bonds, etc.)

v) Operation data (operation cost, traffic forecast, toll rate, etc.)

b) Results and summary sheets

c) Sheets with cash flow statement, profit & loss account and

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.
62
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 {(Di-

Ii)/(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 Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Project Engineering

Final Package Documentation Basic


Engineering
for PDP P
Manual only
for BEP P
for EBEP P
Document and drawing list P P P
Process Engineering

Process guarantee document P P P


Basic process engineering design data P P P Use Forms FA
0173-0199
etc.
Include
relevant data
on overload
for individual
units or
groups of
equipment,
turndown etc.
75

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Process description P P P Overall co-
ordination and
relation of
units to one
another to be
in general
volume for
multi-unit
plants. Ensure
Control
Philosophy is
adequately
handled.
Process block flow diagram P P P
Process calculations P P P Not as
deliverable.
Process flow diagram P P P

Table continues

________________________________________________________________________

Package Class Remarks


BEP

Docume Title
PDP

EBEP

nt
Number
Materials of construction diagram with P P See Working
materials memorandum Instruction
AG 0339.
76

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Material balance P P P For all
contractually
listed oper-
ating cases,
preferably
separate from
PFD to avoid
repetition in
PDS.
Note that
standard
estimating
procedures
only cater for
one operating
case.
Utility balance P P P … and/or
summary.
Ensure peak
rates are
included for
design basis
of offsite
units.
Energy balance P P P Be careful to
understand,
what the
Client expects
of this. There
are many
different
possibilities of
presentation,
with more or
less work
involved.
Utility flow diagram (UFD) P P
Offsite flow diagram (OFD) P P To extent
covered by
Scope of
Plant.
77
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Process equipment list P P P Incl. main
dimensions,
weights (worst
case)
Process duty spec for P Process duty
–equipment specifications
–Package units 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 data sheets for P P More detailed
–equipment than process
–Package units duty spec.
See above.
Clarify any
necessity for
supply in
electronic
form.
Pump calculation sheets P P P Hydraulic
assumptions
78

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Process data sheets for Instruments (P) P P Using data
sheets FA
0224-0229,
LOF 11168-
11172.
Clarify any
necessity for
supply in
electronic
form.
Process data sheets for relief valves (P) P P
79
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number

Health Safety and Environmental (HSE) data (P) P … Basis for


hazardous
area dwg.
Review
duplication
with 050190.
[… Review
duplication
with Safety
Manual ...].
Specification of P P P
- raw materials
- products
- utilities
Specification of catalyst and chemicals P P P If applicable
inert fill, e.g.
packing shall
be included.
Hazard and operability studies (HAZOP) (P) Participation
only.
Documentatio
n is part of
Detail
Engineering.
80

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Emissions and effluent summary P P P Separate for
gas, liquid and
solid streams.
Separate for
continuous,
non-
continuous
(deliberate,
e.g. at start-
up or not
deliberate e.g.
relief
emissions)
and seldom
occurring
effluents (e.g.
spent
catalyst).
Process philosophy for paving and drainage P P
Process requirements for safety systems P P P
Relief load summaries (P) (P) P
Cause and effect diagrams P P P
81
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number

Control narratives P P
Set point list P
Process engineering redundancy concept P

Description of analyzing methods P P 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 P P P
List of laboratory equipment (P)
Technical specification for laboratory (P)
equipment
Study of inherent/environmental hazards (P)
Operation sequence chart (P) (P) (P) For batch
processes
Operation manual for process plant P P P First issue

Rotating Equipment Engineering


Mechanical engineering and design (P) P
specification
Engineering/equipment data sheet (P) P e.g. for long-
lead items.
Vessel Engineering
Vessel engineering and design specification (P) P
82
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number

Engineering/equipment data sheet / (P) P Are estimated


Guide drawings for vessel (P) P weights
required for
early start to
civil/structural
design? If yes,
be careful
about
commitment
for vendor-
designed
equipment.
Note: LURGI
does not
recommend
the supply of
workshop
drawings
since the
requirements
are to closely
tied to ven-
dor'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 (P)
83

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
HVAC - Duty specification (P) To extent
required by
process

Piping Engineering & Design


Plant Layout
84
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Plot plan P P P
Area plot plan P P P In case of
several units
only.
Equipment arrangement drawing P P P In case of PDP
typical only

5.6.2 P&I Diagrams


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

5.6.3 Engineering Deliverables


General engineering and design
specifications (P) P
- Piping engineering (P) P P
- Pipe class index (P)
– Piping supports (P)
- Heat tracing (P) Process-
- Piping cleaning specific only
Pipe class sheet (P) P P
List - Safety relief valves (P)
Data sheets - Safety relief valves (P)
Line list P P
Piping study drawing (P) Requires more
definition, e.g.
for main
process lines
over 6” or
column
studies etc.
85

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Battery limit list P P P In case of PDP
Process issue
only
86
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Tie-in point list (P) P

Pipe Coating and Insulation

Coating & Insulation


Coating specification (P) P
Insulation specification (P) P

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

Instrumentation & Control Systems


Instrumentation engineering and design (P) P
specification
General specification for DCS (P) P
Instrument list P P
Engineering data sheet for instrumentation (P)
Functional diagram for process sequences P P To extent
and plant control systems for DCS required by
process.
Functional diagram for ESD with description P P To extent
required by
process.
87

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number
Calculation sheets for flow instrument and (P)
control valves
88
Table continues

________________________________________________________________________

Package Class Remarks

PDP

BEP

EBEP
Docume Title
nt
Number

Civil, Structural and

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

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

Noise Control Engineering


Specification - Basis of noise control (P)
concepts

Purchasing
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 capital-

investment 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.

1.15.1.1 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. DEF Definitive Estimate

ii. IBL Inside Battery Limits

iii. IFL Inside Factory Limits

iv. OBL Outside Battery Limits

v. OFL Outside Factory Limits

vi. OOM Order Of Magnitude estimate

vii. ROM Rough Order of Magnitude estimate

viii. SDE Semi-Definitive Estimate

ix. VROMVery Rough Order of Magnitude estimate

(III) 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. Completing the estimate as per the agreed schedule

vii. 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


BASIC
EXECUTION
PRE FEASIBILITY / FEASIBILITY STAGE DEVELOPMENT
STAGE
STAGE
VROM/ ROM/ OOM ESTIMATE
ITEM REQUIREMENT SEMI-DEF DEFINITIVE
ESTIMATE ESTIMATE
CAPACITY EQUIPMENT CONCEPTUAL
(SDE) (DEF)
FACTORED FACTORED DESIGN

1 Product of proposed plant X X X X X


2 Design capacity of proposed
X X X X X
plant
3 Geographical location and
site information (e.g. Ground
X X X X X
formation & climatic
conditions) at proposed plant
4 If a similar, historical plant
exists, provide the capacity,
complexity, erected cost, X
location and construction
midpoint of such a plant
5 Differences between
proposed and historical plant X
e.g. number of trains
6 Plot plan of proposed plant
- Preliminary X X X
- Final X X
7 Rough sketches of proposed
X
plant
8 Process description X X X X X
9 Process flow diagram (PFD)
and/or Plant modification
diagram (PMD)
- Preliminary X X
- Final X X
10 Mechanical flow diagram
(MFD) or Process &
Instrumentation (P&I)
diagrams
- Preliminary X
- Final X
11 Equipment list and process
data sheets of the required
equipment items
- Preliminary X X
- Final (Priced) X
12 Quotations for complex, X
major mechanical equipment
100
BASIC
EXECUTION
PRE FEASIBILITY / FEASIBILITY STAGE DEVELOPMENT
STAGE
STAGE
VROM/ ROM/ OOM ESTIMATE
ITEM REQUIREMENT SEMI-DEF DEFINITIVE
ESTIMATE ESTIMATE
CAPACITY EQUIPMENT CONCEPTUAL
(SDE) (DEF)
FACTORED FACTORED DESIGN

(e.g. compressors, fired


heaters, large reactors &
columns)
13 Purchase orders for all major
mechanical equipment X
tagged items
14 Information on extraordinary
items not listed as equipment X X X
(e.g. large manifolds)
101
Table continues

________________________________________________________________________

BASIC
EXECUTION
PRE FEASIBILITY / FEASIBILITY STAGE DEVELOPMENT
STAGE
STAGE
VROM/ ROM/ OOM ESTIMATE
ITEM REQUIREMENT SEMI-DEF DEFINITIVE
ESTIMATE ESTIMATE
CAPACITY EQUIPMENT CONCEPTUAL
(SDE) (DEF)
FACTORED FACTORED DESIGN

15 Piping:
- Piping sketches X
- Piping planning studies X
- Isometric drawings X
16 Take-offs for bulks
- Preliminary X X
- Final X
17 Information regarding special
requirements, e.g. for health,
X X
safety, maintenance or envi-
ronmental protection.
18 Lump sum or unit rates
negotiated and contractually X
finalized
19 Contract prices (finalized) X
20 Sastech and outside
engineering services man-
hours and/or costs
- Preliminary X
- Final X
21 License fees/ Paid-up
XX XX XX X X
Royalties
22 Insurance XX X
23 First load catalysts and
X X X X X
chemicals.
24 Pre-production budget XX XX XX X X
25 Custom duties XX X
26 Spares XX X
27 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 X X X
- Final X X
102
BASIC
EXECUTION
PRE FEASIBILITY / FEASIBILITY STAGE DEVELOPMENT
STAGE
STAGE
VROM/ ROM/ OOM ESTIMATE
ITEM REQUIREMENT SEMI-DEF DEFINITIVE
ESTIMATE ESTIMATE
CAPACITY EQUIPMENT CONCEPTUAL
(SDE) (DEF)
FACTORED FACTORED DESIGN

28 Plan of execution (who,


when, what, how)
- Preliminary XX XX XX X
- Final X
Preferably - XX
_____________________________________________________________________
103
Table 2.9

___________________________________________________________________

Equipment List Design Data

EQUIPMENT NECESSARY ATTRIBUTES HELPFUL ATTRIBUTES

Boilers Capacity (steam t/h) 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
104
EQUIPMENT NECESSARY ATTRIBUTES HELPFUL ATTRIBUTES

Compressors 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

___________________________________________________________________

EQUIPMENT NECESSARY ATTRIBUTES HELPFUL ATTRIBUTES

Pumps Capacity (m3/h) Medium pumped


kW NPSH
Type (e.g. centrifugal)
Steam or electric driven
Inlet pressure
Outlet pressure
Dryers Capacity (t/h)
kW
Material(s) of manufacture
Centrifuges Capacity (t/h)
kW
Material(s) of manufacture
Crushers Capacity (t/h)
kW
Material(s) of manufacture
Type (e.g. jaw)
Crystallizers Capacity (t/h)
Material(s) of manufacture
Ejectors Capacity (t/h) Pumping medium and
Medium pumped, suction and pressure
discharge pressures Number of stages
Evaporators Capacity (t/h) Total heating surface area
mW Type
Material(s) of manufacture
Mills Capacity (t/h) Inside diameter
kW Inside length
Type Speed
Mixers kW Speed
Material(s) of manufacture
Type
Refrigeration units Duty (MW) Capacity
Evaporator temperature
Type
Cooling towers Duty (MW) Cooling range
Capacity (water m3/h) Wet bulb temperature
Material(s) of manufacture
Type (e.g. forced draught)
Boiler Water Capacity (t/h) Quality of product e.g.
Treatment System Material(s) of manufacture parts per million total
dissolved solids.
Conveyors Length
Width
Type (e.g. inclined, bucket)
Capacity (t/h)
kW
Cranes Capacity (t)
Span
Type
106
Table continues

___________________________________________________________________

EQUIPMENT NECESSARY ATTRIBUTES HELPFUL ATTRIBUTES

Lifts Capacity (t)


Height
Type
Hoists 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 pre-

planned, 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 Pre-

production 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
116
117
Figure 2.3

________________________________________________________________________

Estimate Category by Functional Location Reference

(a) PROCESSING UNIT


OVERALL FACTORY
BOUNDARY LIMIT
(PRIMARY SECURITY
OFF-SITE FACILITIES FENCE)

(b) UTILITIES (c) STORAGE & SECONDARY


DISPATCH SECURITY FENCE

(d) INFRASTRUCTURE

• 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. Boilers, furnace, flares, stacks and gasifiers

ii. Heat exchangers and condensers

iii. Reactors

iv. Columns and towers

v. Tanks and drums

vi. Filters and separators

vii. Compressors, generators and pumps

viii. Miscellaneous equipment

ix. 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

Construction Engineering
Description Services
Supplie Labor Overhe Equipm Basic Detail Procur
s ads ent e-
Rental ment
Process Eng 1 1

Project Management 1

Excavation & 5 5 5 5 1 5
Earthworks

Concrete 5 5 5 5 1 5

Structural Steel 6 6 6 6 1 6

Buildings 5 5 5 5 1 5

Mechanical 2 3 3 3 1 1
Equipment

Piping 2 3 3 3 1 1

Electrical 2 3 3 3 1 1

Control Systems 2 3 3 3 1 1

Paint/Insulation 4 4 4 4 1 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)
127
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. The specific stage of process development/ project execution

b. The nature of the project, i.e. whether it is a Revamp/ De-

bottlenecking/ Brown Field project, or a New Facility/ Green

Field project
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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. The factors that affect contingency

e. The maturity level of the technology involved

f. 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.


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Table 2.11

_________________________________________________________________________

Contingency Determination Guide

People To Be
Anticipated / Contingency
Purpose Of Involved In
Estimate Type Project Stage Actual Plan Of Calculation
Estimate Risk
Execution Method
Assessment
OOM Business Economic Estimator Manual/Compu
- Conceptual Development Evaluation Proposer ter
Design - Idea (Usually A - Points
- Capacity Generation Technology Process Rating /
factored - Pre-Feasibility Comparison Engineer) Uncertainty
- Equipment “Informal” Evaluation
Factored (UE) Method
OOM Business Capital Anticipated Estimator Computer
- Equipment Development / Application - Proposer - @Risk for
factored Project Execution Project Eng / Lotus
- Feasibility EPCM/Turnkey, Manager - Crystal Ball
SEMI-DEFINITIVE or Eng/Design for Excel
- for-and-on- Disciplines
- Basic behalf Involved
Development “Formal”

SEMI-DEFINITIVE Project Execution Improved Actual Estimator Computer


- Basic Control Base - Proposer - @Risk for
Development Project Eng / Lotus
EPCM/Turnkey, Manager - Crystal Ball
DEFINITIVE or Eng / Design for Excel
- for-and-on- Disciplines
behalf Involved
- Execution Cost Control
“Formal /
Informal”
CONTROL Project Execution Cost- And Projects Manual/Compu
- Execution Scope Control Cost Control ter
“Informal” - Forecasted
ITC
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Table 2.12

_________________________________________________________________________

Percent Contingency Range

Percentage Contingency (Range)


Minimu REVAMP/DEBOTTLE-
NEW FACILITY
m Maturity NECK
Nature
Informat Level Of
Estimate Type Of
ion Technol DUPLICATE/ RELATIVELY/
Project
Require ogy ESTABLISHED DRASTICALLY
d TECHNOLOLGY NEW TECHNOLOGY

Revam
p / De- Duplicate
OOM
bottlen See /
- Concept
eck / estimate Establish
ual
Brown requirem ed
Design 10,9 to 35,0 15,6 to 50,0
Field ents as
- Capacity
New per Table Relatively
factored
Facility 1.6 /
- Equipment factored
/ Green Radically
Field New
Revam
p / De- Duplicate
OOM bottlen See /
- Equipment factored eck / estimate Establish
Brown requirem ed
8,5 to 14,0 12,2 to 20,0
Field ents as
New per Table Relatively
Facility 1.6 /
SEMI-DEFINITIVE
/ Green Radically
Field New
Revam
p / De- Duplicate
bottlen See /
SEMI-DEFINITIVE
eck / estimate Establish
Brown requirem ed
7,0 to 10,6 10,0 to 15,2
Field ents as
New per Table Relatively
Facility 1.6 /
DEFINITIVE
/ Green Radically
Field New
CONTROL Up to 7,0 Up to 10,0

_________________________________________________________________________
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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 Stage-

Gate process, of developing and executing their projects. In their article,

New Problems, New Solutions: Making Portfolio Management More


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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


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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.


136

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 Stage-

Gate 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 pre-

planning, 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:


140

Typical Allocation of Risk among Project Financiers


Gover
Resour Financi n- Insuranc Third
ce al ment e Party
Types of Develo Contra Owner Lende Suppli Consu Adviso Bodie IFC OPIC Compani Invest
Risk p-ers ct-ors s rs ers m-ers rs s * * es ors
Technolo
gy X
Credit X X X X
Bid X X
Completi
on X X
Cost
Overrun X X
Performa
nce X X X
Political X X X X X
Liability X X
Equity
Resale X X X X X
Off-take X X

*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 in-

house 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.


146

Chapter 3
METHODOLOGY

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


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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
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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…
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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.


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4. Discrete Event - Typical approaches of risk measurement use

decision trees, influence diagrams and utility theory. These

techniques are especially appropriate for analysis of known-

unknown 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.


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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.

1.20.3.1 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
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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.


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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.

1.20.3.2 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


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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
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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


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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


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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


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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


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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.


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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.
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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

response.
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_________________________________________________________________________

Figure 3.1 Risk Rating Chart

Likelihoo Consequenc
d e
Catastrophic -
A complete
Consequence
I
Frequent
system loss and Score
IV III II I
potential for
-happens 8 10 +
fatal injury or
16
Likelihood
regularly with
this type of
USD
Million
major Score 2 4 8 16
environmental
project
incident.
Major - major 12
B II system damage A 8 16 32 64
Probable 1 to
or Lost Time
Accident
8
4 10 potential.
8
-could happen
on this type of USD Localized
B 4 8 16 32 64
project Million environmental
incident.

III
Significant - C 2 4 8 16 32
C failure without
major damage
100 K
Occasional 2 to 1.0
nor serious 4
D 1 2 4 8 16
-heard of in the injury. Minor
USD
industry environmental
Million
incident.
Nuisance -
IV functional failure
D of
Less equipment/proc
Remote 1 than ess nor potential
2
-hard to imagine 100 K for injury. Slight
USD 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 author, using available literature and information as

described in Chapter two of this dissertation as well 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 manner, identify and furthermore evaluate the risk

implications of their projects. Furthermore, the Model enables

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

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.


190

Chapter 4
ANALYSES AND RESULTS

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, co-

operation, 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 Evaluation Description Evaluation of Completeness


Business This question is about 5 = No Consideration given.
Strategy and HOW this proposal would
Strategic Fit affect your ability to 4 = Proposal fits with Business Unit
deliver on your mission, Strategy.
vision or corporate goals.
If it is not a New Business 3 = Proposal Fits with both Business
Venture proposal (i.e. a Unit and Owner Corporate
revamp/ expansion) the strategy
question addresses the confirmed - and preliminary
key business or SBU business strategy designed - not
objectives. written up.
What are the key strategic
issues that need to be 2 = Detail Business strategy written
considered - and what up, not yet approved by
were the responses to stakeholders.
those?
Were changes in strategic 1 = Detail Business strategy written
goals considered? up, and approved by all
Were alternative stakeholders.
strategies considered?
Has the Strategic Fit of
the
Proposal been tested with
the corporate strategy?
Business and This question is about the 5 = No consideration given yet
Ownership assessment of different
Structure ownership and 4 = Assessed and Recommended a
partnership strategies, preliminary ownership/
structures, comparable partnership/ JV strategies and
visions & goals, synergies, forms of legal entity, based on
alignment of interests, compatibilities, synergies, risks,
markets shares, other and potential conflicts of
beneficial relationships. interest.

Other organisations to 3 = Recommended a preliminary


involve? ownership/ partnership/ JV
Options considered? strategy and form of legal entity
Risks considered? based on compatibilities,
Assessments made? synergies, risks and conflicts
Negotiations made?
Agreements prepared?
Cost Sharing 2 = Detail and joint partner
mechanisms? assessment where applicable,
Decision making and development of ownership
mechanisms? options and strategy –
Resource commitments ownership agreements in
made? preparation
Roles and Responsibilities
of parties? 1 = Final ownership structure
Work Processes? recommendation and
196
Infor Sharing? agreement in principle by
Exclusivities? stakeholders - ownership
Boundaries of relationship agreements are ready to be
or business proposal? signed - and agreed by all
Partnership/JV agreement? stakeholders

Table continues…
197

Cross - This question is about the 5 = No consideration given yet


Business assessment of the
Impact impacts this proposal 4 = Potential cross business unit
Analyses might have on other SBU's impacts identified - impacts not
- beneficial or otherwise in assessed.
terms of, e.g.Existing
and/or future - 3 = Cross Business impacts
- Markets analyzed
- Operations in detail and agreed with
- Feedstocks different
- Utilities stakeholders - preliminary plans
- Infrastructure ......... to manage impacts designed
2 =
........and the risks / Cross Business impacts
opportunities associated analyzed
with those impacts. in detail and agreed with
different
stakeholders - final plans to
1 = manage impacts designed

Cross Business impacts


analyzed
in detail and agreed with
different stakeholders - final
plans to manage impacts
designed and
agreed by stakeholders
Management This question is about the 5 = No consideration given yet.
Structure and whether a management
Organization structure and organisation 4 = Costs estimates for staff and
design staffing plan is available personnel based on factored
and whether all the costs estimates.
associated with the
organisation structure has 3 = Preliminary structure and
been estimated and staffing
included in the business levels defined - and included in
economics fixed costs

2 = Detail management structure,


organization design, and
staffing levels designed and
incorporated
in the fixed cost analysis
1 =
Detail management structure,
organization design, and
staffing levels designed and
incorporated
in the fixed cost analysis,
agreed by stakeholders

Table continues…
198

Industry This question is about 5 = No industry analysis done yet


Analysis and whether all the trends,
Competitive forces, opportunities and 4 = Understanding of basic industry
Advantages barriers relevant to this competitive advantages and
industry have been Key
analyzed and incorporated Performance Areas
into the business strategy 3 =
and market strategy. Industry analysis included
barriers to entry, new product
It considers the typical 5- and business trends, substitute
industry forces which is products, new and potential
used to investigate entrants, suppliers of raw
Product Substitutes, materials, customers,
potential New Entrants, competitive advantages and
Customer forces, Supplier disadvantages of the proposal,
forces, Internal Industry but not well documented.
Competition, New 2 =
technologies, etc. and an Well documented Industry
understanding of the Key analysis which included barriers
Performance Areas to be to entry, new product and
competitive in this technology trends, substitute
industry. products, existing, new and
potential entrants, suppliers of
It also aims to identify raw materials, customers,
whether competitive competitive advantages and
advantages have been disadvantages of the proposal,
identified and adequately and recommendations detailed.
exploited in this proposal. 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.

Table continues…
199

Competitor This question is more 5 = Not Considered yet


Analysis and specific than the previous
Value Chain one in that it considers 4 = All Competitors Identified and
Comparisons key competitors' cash an understanding of their Value
costs or value chain costs Chains exists.
and compares them with
this proposal. 3 = Preliminary assessments made
of competitors' value chains
The idea is to establish and cash costs, and compared
how this venture would be to this proposal, but not well
able to compete with its documented
rivals on a purely value
chain cost basis. 2 = Well documented and Detailed
assessments made of relevant
It is therefore sometimes competitors value chains, and
necessary to compare cash costs, compared to this
potential alternative value proposal, and improvements
chains, e.g. different made to this proposal's value
technologies or locations chain to improve its cost
need to be assessed to competitiveness.
identify the most
competitive option/s. 1 = 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.
Plant 5 = The design rate, on-stream
Capacities factors, product yields (Saleable
products per year) are not
known
4 =
The design rate, on-stream
factors, product yields (Saleable
products per year) are based on
assumptions
3 =
The design rate and product
yields are well known, but on-
steam 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
1 =
The design rate, on-stream
factors, product yields (Saleable
products per year) are well
200
known, agreed with owner,
licensor and included in the
business case

Table continues…
201

Market This question determines 5 = Impact of market strategy on


Strategy the alignment between capital and operating cost was
the marketing strategy not considered
and the rest of the
proposal, particularly the 4 = Impact of market strategy on
scope of the design, the capital and operating cost was
operational costs and the only considered on a conceptual
impact of marketing level
decisions on capital
investment decisions. 3 = Impact of market strategy on
capital and operating cost was
considered, opportunities not
yet included in project

2 = Capital and operating cost are in


line with proposed marketing
strategy and optimization
opportunities are mostly
included in project

1 = Capital and operating cost are in


line with proposed marketing
strategy and all optimization
opportunities are included in
project
Market - Market volumes, growth 5 = Preliminary sales volumes
Volumes rates, supply and demand considered
(Products and balances, Target markets,
By-products) customers, sales 4 = Market volumes, growth rates,
agreements, and sales supply & demand balances on a
terms. regional basis, target markets
and potential customers
identified

3 = 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.

2 = Preliminary sales agreements,


LOI's and take-or-pay
agreements, and terms are
negotiated

1 = Final sales agreements, LOI's


and take-or-pay agreements,
and terms are negotiated and
agreed by all stakeholders.

Table continues…
202

Market - Market pricing strategies, 5 = Preliminary Pricing strategy


Pricing historical and forecasted considered.
(Products and prices, pricing formulae,
By-products) pricing agreements. 4 = Market pricing mechanisms
identified and included in
economic analysis

3 = Market pricing mechanisms


identified and verified with
historical data and reliable
source forecasts, and included
in economic analysis.

2 = Pricing mechanisms or formulae


part of sales contracts and
being negotiated with
stakeholders
1 =
Final Pricing mechanisms or
formulae being negotiated with
stakeholders and agreements
reached.

Products The extent to which 5 = Uncertainty around the


(Quality & Product qualities, following: Chemical
Specification) specifications, Chemical composition, Physical form, Raw
compositions , Physical materials, Catalyst, Allowable
forms, Raw materials, impurities, By-products and
Catalysts, allowable Wastes
impurities, of products, 4 = Uncertainty around four of the
by-products and waste following: Chemical
streams are all known and composition, Physical form, Raw
agreed. materials, Catalyst, Allowable
impurities, By-products and
Wastes

3 = Uncertainty around two of the


following: Chemical
composition, Physical form, Raw
materials, Catalyst, Allowable
impurities, By-products and
Wastes

2 = Chemical composition, Physical


form, Raw materials, Catalyst,
Allowable impurities, By-
products and Wastes are
known, but not agreed with
owner, suppliers and customer.

1 = Chemical composition, Physical


form, Raw materials, Catalyst,
Allowable impurities, By-
products and Wastes are known
203
and agreed with owner,
suppliers and customer.

Table continues…
204

Logistics and The extent to which the 5 = Not Yet Considered


Supply Chains inbound and outbound
logistics and supply-chain 4 = Logistics and distribution
plan are developed for elements identified and
feedstocks, utilities, preliminary costs associated
materials, and products. with them included

3 = Alternative logistics and


distribution plans considered for
both inbound and outbound
supply chains of all feedstocks,
utilities and other materials, and
not documented

2 = Alternative logistics and


distribution plans considered for
both inbound and outbound
supply chains of all feedstocks,
utilities and other materials, and
documented.

1 = Final Logistics and distribution


plan selected and agreed by
stakeholders.
Other The extent to which all 5 = Not yet considered
Commercial other commercial
Agreements agreements - except the 4 = Bullet point list of all required
ones already covered in commercial agreements exists
the Sales and marketing and some agreement are in
plans - are developed and preparation in broad outline
agreed by stakeholders formats

3 = All other commercial


agreements are being compiled
but not reviewed and agreed.

2 = All other commercial


agreements are being
negotiated with relevant parties

1 = All other commercial


agreements are agreed with
relevant parties and
stakeholders

Table continues…
205

Feedstocks, The degree to which the 5 = Preliminary consumption and


chemicals and availability and cost figures for Feedstocks,
catalysts consumption of chemicals and catalysts are
feedstocks, Chemicals, known
and catalysts are known
and agreed. 4 = Consumption and figures for
Feedstocks, chemicals and
catalysts are based on
Conceptual design package,
prelim FAV calculations and
budget quotes.

3 = Consumption and figures for


Feedstocks, chemicals and
catalysts are based on
Feasibility design package, FAV
calculations and quotes, and
documented

2 = Agreements to procure
Feedstocks, chemicals and
catalysts are negotiated with
suppliers, and documented.

1 = Agreements to procure
Feedstocks, chemicals and
catalysts are agreed with
suppliers and stakeholders.
Utilities and The degree to which the 5 = Preliminary consumption and
Infrastructures availability and cost figures for Utilities and
, Services and consumption of utilities, Infrastructures, Services and
other infrastructure, services other materials are known
materials and other materials are
known and agreed. 4 = Consumption and figures for
Utilities and Infrastructures,
Services and other materials are
based on Conceptual design
package, and budget quotes.

3 = Consumption and figures for


Utilities and Infrastructures,
Services and other materials are
based on Feasibility design
package, and quotes, and
documented

2 = Agreements to procure Utilities


and Infrastructures, Services
and other materials are
negotiated with suppliers, and
documented.
1 =
Agreements to procure Utilities
and Infrastructures, Services
206
and other materials are agreed
with suppliers and stakeholders

Table continues…
207

Other Fixed The degree to which the 5 = Not considered yet


and Variable other fixed and variable
Operating costs have been 4 = Order of magnitude or
Costs identified, defined and factorized Operating costs
included in the Economic considered
Analysis, e.g. 3 =
Other Fixed and Variable
Insurance Operating Costs are based on
Service charges Conceptual design package, and
Promotions & Advertising budget quotes.
Customs duties & 2 =
Surcharges Other Fixed and Variable
Shipping Operating Costs are based on
Taxes Feasibility design package, and
Rentals quotes, and documented
Royalties 1 =
Software Final values for Other Fixed and
Spares Variable Operating Costs are
Maintenance materials agreed with stakeholders
Indirect Personnel
Expenses Etc Etc.
Real Estate / Necessary for this 5 = Not Considered Yet
Site / Fixed proposal - the degree to
Assets which different sites or 4 = Preliminary sites/ other fixed
fixed assets have been assets, etc. identified, evaluated
identified, evaluated and and preliminary costs of these
selected - the terms included in the estimates.
negotiated and agreed.
3 = Final site and other fixed asset
selection and evaluation and
Plan for site acquisition
developed and documented

2 = Negotiations for site, other fixed


assets under way and terms
discussed.

1 = Final settlement on fixed asset/


real estate purchase agreement
and agreed with stakeholders.
Business IT- Systems and software to 5 = Not yet Considered
Infrastructure run the business (not the
& Systems plant control system) 4 = Preliminary Business IT
have been defined and infrastructure and systems
included in the capital and needs analyses done and
operational cost documented
estimates. 3 =
Preliminary Business IT
infrastructure and systems
designed, alternatives
considered and included in cost
estimates and documented
2 =
Final Business IT infrastructure
208
and systems designed,
alternatives considered and
included in cost estimates, and
documented
1 =
Final Business IT infrastructure
and systems designed,
alternatives considered and
included in cost estimates,
documented and agreed.
Royalties & The degree to which 5 = Not yet Considered
License fees Royalties and / or License
fees for Intellectual 4 = Order of magnitude or
properties have been factorized Royalties and / or
finalized. License fees are estimated.

3 = Preliminary indications of
Royalties and / or License fees
from licensors are incorporated
in evaluations

2 = Royalties & License fee plans


are made, agreements drafted
and negotiations are underway,
and documented

1 = Final Royalties & License fee


agreements are concluded and
agreed with stakeholders.
Legal & Are there any Legal or 5 = Not considered yet
Contractual Contractual restraints to
Issues or be planned for? 4 = Bullet point list of potential
restraints Legal & Contractual Issues or
E.g. Competitions acts, restraints drawn up.
land use and land tenure
laws, contractual 3 = Legal & Contractual Issues or
restraints, i.e. marketing, restraints defined, and plans in
or manufacturing or preparation and documented.
regional barriers, Local
content requirements, 2 = Detail plans in place to handle
Local employment Legal & Contractual Issues or
requirements, restraints and discussions under
Local Environmental way with the relevant
legislation, etc etc. authorities and/or parties.

1 = Legal & Contractual Issues or


restraints resolved with the
relevant authorities and or
parties and stakeholders
agreements obtained.
Intellectual Are there any other 5 = Business impact on proposal not
Property intellectual property yet considered.
issues (except licensing)
That may have a bearing 4 = Potential Intellectual property
on this proposal? issues listed and identified
209

E.g. 3 = Full business impact


Freedom-to-operate assessment of potential
Trade marks Intellectual property issues done
Copy rights 2 = and documented
Risk of Infringing a Third Recommendations of the
Party's Claims intellectual property impact
assessment incorporated into
the business plan.
1 =
Recommendations of the
intellectual property impact
assessment incorporated into
the business plan, and agreed
by stakeholders.

Table continues…
210

Financing The extent to which 5 = Assumed full equity financing by


external finance is the owner - thus no other
necessary for this financing needs considered yet
proposal, financing
options considered, 4 = Assess financing needs of the
relevant tax, securities potential business owners and
and insurance issues other participants.
considered and a final
financing plan agreed 3 = Assess financing options and
develop a financing plan in
writing. Consider legal, tax,
security and insurance options.

2 = Refined financing alternatives.


Negotiate financing term sheet
and documentation.

1 = Concluded and agreed finance


plan/s and arranged draw-down
funding for project.
Risks The extent to which 5 = No consideration given
Assessment commercial risks and killer
and Mitigation concerns have been 4 = Potential risks identified that are
Actions identified, contingency killer concerns (stop the
plans drawn up and proposal), as well as risks that
mitigating actions taken. are manageable

Risks in these areas: 3 = Assessment of risks (Exposure &


Socio-political Probability) and development of
Markets- e.g. anti- mitigation strategies
dumping duties (Contingencies, back-up plans,
Markets- insurance, by-pass, manage),
Seasonality/cyclicality/vol and documented
atility.
Small number of buyers 2 = Assessment of risks (Exposure &
Governmental/Legislative Probability) and development of
Technological mitigation strategies
Consequential liability (Contingencies, back-up plans,
Labour Relations insurance, by-pass, manage),
Economic - e.g. Currency documented and all KILLER
risk concerns eliminated.
Credit risk.
1 = Final detailed risk management
plan incorporated into the
business plan and mitigation
strategies agreed by
stakeholders.

Table continues…
211

Tax Regime The extent to which 5 = Tax not yet considered


(Taxes, Fiscal taxation of the business
policies, proposal in the host 4 = Understand current state and
Repatriation of country / government is requirements of tax and fiscal
earnings, understood, negotiated regime by host
Duties, etc. and agreements with government/authority and
relevant tax and other determine your desired state
state authorities finalized.
3 = Developed communication and
lobbying plan towards
authorities to align desired state
with current state.

2 = Negotiate, secure and


document agreements,
concessions and permits with
relevant authorities.
1 =
Agreements, concessions and
permits with relevant authorities
regarding Tax Regime finalized.
Economic The extent to which all the 5 = Instantaneous Return - on -
Evaluation & above commercial investment (ROI) Economic
Sensitivity assumptions have been evaluation done without
Analysis included in the proposals' consideration for longer term
economic and sensitivity cash flow projections.
analyses - as well as the
level of analyses done 4 = Identify and gather all relevant
business assumptions that need
to be modeled in a deterministic
economic analysis model, and
started prelim runs on model.

3 = Modeled the business case in a


deterministic economic analysis
model, with updated business
assumptions.

2 = Modeled the business case in a


probabilistic economic analysis
model including risks from risk
analyses exercises, with final
business assumptions.

1 = Final detailed economic analysis


with Sensitivity and Monte Carlo
probability simulation analysis
included based on final
operational and capital cost
estimates.

Table continues…
212

Social / Are their any social issues 5 = Social issues were not
Community regarding the local considered
Issues community or the host
country that had to be 4 = Social issues were considered,
taken into consideration but no formal consultation with
and what is the status of interested and affected parties
these plans (if
applicable)? 3 = Interested and effected parties
were consulted, but there is still
outstanding issues to be agreed

2 = Interested and effected parties


were consulted and verbal
agreement was reached on
social issues

1 = Interested and effected parties


were consulted and agreement
was reached (in writing) on
social issues.
Start-up The extent to which the 5 = Not begun yet.
Requirements commissioning of the
plant/s have been planned 4 = Noted that a start-up plan is
and the cross-impacts required, and bullet points have
that would have on the been drafted.
rest of the enterprise has
been considered (if 3 = The start-up plan has been
applicable)? drafted in broad outline.

2 = The start-up plan has been


completed but not reviewed and
agreed.

1 = The start-up plan has been


reviewed and agreed, and
incorporated into the
commissioning plan.
Training Have the training 5 = Not begun yet.
Requirements requirements for future
plant operations been 4 = Noted that a training
defined and responsibility requirements document is
established? required, and bullet points have
been drafted.

3 = The training requirements


document has been drafted in
broad outline.

2 = The training requirements


document has been completed,
responsibilities and designated
persons have been identified,
but not reviewed and agreed.
213
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

Business Issues
> Business Plan
Step 1: Project Team Initiates Step 2: Project Team Conducts
> Marketing Plan
Project Risk Review Process Internal Quality Assurance
> Economics

 Project Management Team


Internal Verification Technical Issues
 Checklist of Phase > Technology
 Prior to Capital request Deliverables > Engineering
 Prior to proceeding to the next  Deliverables complete Design
phase of the project  Documentation upto date > Value
 If required, Risk Review Improvement
Process is postponed pending
readiness of the Project Team Project Set Risk Review Date
Management As Informed by Project Team
> Resources
> Schedule
> Execution Plan

Step 5: Finalize Report Step 4: Risk Review Report Step 3: Project Risk Review Meeting

 Official Review done by a peer group


 Project Team and Peer Review
 Peer Review Team compiles the of relevant experts who are not
Team discuss the Draft Report
Draft Report members of the project team
 Incorporate Project Team's
 Business, Technical and Project  Key Proect Team members are
Decision response on Business, Technical
Management issues are reviewed present
and Project Management issues
 Identify and assess the risks to  All project documents on hand
 Evaluate the potential financial
successful business realization  Open discussion and concensus on
impact of identified Risks
and project outcome project scope
 Transmit Report to the relevant Evaluation and score on completeness
 Propose Risk Mitigation Plans 
Authorities, such as the Board
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 368 1134


Overall Score
0 100 200 300 400 500 600 700 800 900 1000 1100 1200 Poorest Score

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 30 220 Section 1 Score •
0 50 100 150 200 250 Poorest Score •

• See the attached Business Track report as written by the Peer


Review Team. Important aspects of their report are quoted here-
in.
• 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”
3

40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0

1.24.1.1 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.

Engineering Track 235 717


Section 2 Score
Poorest Score
0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750

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.
0
5
10
15
20
25
30
35
40
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0

Mechanical
Equipment List Reliability Philosophy

P roject Track

0
Line List Maintenance Phil.
Operating Phil.
Tie-in List
Process Chemistry
Piping Speciality
Item List Process Technology

Instrument Index Framing / Alignment

50
Project Management
Project Design
Equipment Status
Site Characteristics:
Equipment
Location Drawings Dismantling &
Equipment Utility

81
Lead / Discipline
Requirements

100
Civil & Structural Schedule
Requirements Process
Architectural
Requirements Design & Material
Effluent Disposal / Design for
“Elements”

Treatment
Geographic Location

150
Loading & Storage

project management score was the POE.


Surveys and Soil
In Plant
Transportation Environmental

Control Philosophy Permit Requirements


Utility Sources with
Logic Diagrams

200
Fire Protection &
Area

197
Classifications PFDs
Power Source & H&MB's
Substation
Electrical One Line P&ID's
Diagrams Process Safety

Poorest Score
Instrument &

Section 3 Score
UFD's
The graphs below illustrates the evaluation of the Engineering

Electrical Specs /

quite in line with what should be done during a Conceptual


• The score rating for project management was very good, and
6

Development Phase. Elements that had an adverse effect on the


CADD/Model Specifications
Requirements
Deliverables Piping System
Defined in the Plot Plan / Site Plan
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

Owner Approval
Distribution Matrix

Project Accounting
Responsibility Matrix

Risk Analysis
Project Controls

Shutdown / Turnaround
Identify Long lead Items /

Engineering/Construction
Procurement Procedures

Commissioning
Requirements
Requirements
Critical Equipment &

Plan and Approach

Planning
Procurement

Requirements
Materials

and Plans

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.


1
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