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Newsletter December 2014


Welcome to the December 2014 issue of “RiskIntegral” - an occasional newsletter about the analysis and management of risk, mainly in projects, by Risk Integration Management Pty Ltd (RIMPL). In this issue our feature article was largely provided by our WA marketing representative, Peter Hudson, (a very experienced Project Manager and Project Director). It explains why Early Contractor Involvement (ECI) and Integrated Cost & Schedule Risk Analysis (IRA) go together very well.


We wish you a very refreshing Christmas/New Year break (if you have one) and a healthy, safe and successful 2015!


Please note that our office will be closing on Friday 19Dec14 and re-opening on Monday 12Jan15.


We conclude with some news of our recent developments and activities.


The Value of IRA in the ECI Project Delivery Model?

RIMPL News


The Value of IRA in the ECI Project Delivery Model


Early Contractor Involvement (ECI) – what is it?


Peter Hudson

ECI can take various identities and is used in a variety of sectors, including Infrastructure for Governments, Mining, Oil & Gas and chemical process projects for private companies. The common thread is for one or more Contractors to be paid under a service agreement (time & materials) by a Project Owner to develop a project design and execution plan and define the project scope, estimate and schedule in collaboration with the Owner, to the point where the Owner can select the Contractor and agree on the scope, risk-adjusted price and execution time for completion of the project, generally (but not always) under lump sum payment conditions. The following focuses on its use in the private sector. A process plant type of project is assumed.


ECI is being used in a wide range of project sizes in the resources sectors:


• Small (<$20m),

• Medium ($20m – to $250m) and

• Large (>$250).


These projects utilise Front End Engineering and Design (FEED) followed by Engineering, Procurement & Construction (EPC), or occasionally Engineering, Procurement & Construction Management (EPCM) delivery models. EPC is typically a Lump Sum contract while EPCM can range from a fixed management fee to a sliding scale of rates with incentives and penalties and is generally used for larger projects where scope definition and fixed pricing may be more difficult.


Single Contractor ECI processes are clearly more collaborative than when 2 or more Contractors are engaged by the Owner to compete for the project delivery phase. But the common factor for ECI processes is to agree upon a basis for the risk adjustment of the price and schedule. This is where Integrated Cost & Schedule Risk Analysis can play an important part.


ECI Strengths and Weaknesses


The following comparison of ECI strengths and weaknesses was developed by Stuart Cosgriff of Clayton Utz:



We look at the benefits of the ECI process and how IRA can help optimise risk in the project and deliver the crucial element of consensus on what forms a fair basis for moving to the “closed book” phase to follow.


ECI Benefits


Project Owner companies, particularly those that do not have a mature culture of project delivery and who may require external project funding (debt or equity), seek more certainty of project cost and schedule outcomes and look for more realistic identification and allocation of project risk elements. For these, the key attractions of the FEED/ECI/EPC delivery model include:


1. Involvement of the Contractor during the development of the FEED and the early stages of the detailed design brings practical procurement and construction input to the design phase (which is not always evident in the more traditional EPCM model).


2. Early input by the Contractor into the project execution schedule brings practical realism to the schedule in terms of a logical and achievable construction sequence and an assessment of construction labour and plant and equipment based on the experience of the Contractor and the prevailing market conditions (including the availability and costs of key inputs such as site labour and construction equipment).


3. Early input by the Contractor into the project cost estimate, exclusive of Owner costs and management reserve, tends to bring efficiencies to the cost estimate based on the recognition of market conditions rather than historical averages.


4. Identification of project execution risks, the development of mitigation plans with the Contractor and the appropriate allocation of risks to the party best able to manage those risks allows a more realistic assessment of risk or contingent funds that should be included in the project cost estimate as part of the finalisation of an EPC or lump sum contract price.


5. Identification of risk elements in the project execution schedule and the inclusion of any schedule contingent time periods, to reflect schedule uncertainties, produces a more realistic final delivery schedule to be included in an EPC contract.


6. ECI identification of risk events earlier saves greater time and expense for treatment of risks later, as illustrated below.



The above factors, if addressed in an open and interactive way by the Owner and Contractor teams during the FEED/ECI phase, will lead to a more realistic cost estimate and execution schedule that have been prepared exclusive of hidden contingencies for cost or schedule elements. These “neat” elements are then able to be jointly assessed, by both parties, for appropriate contingencies (for cost and time) that can be included in an EPC contract.


While each project is different, the ECI phase would typically take about 20 - 22 weeks to complete.


Assessment of Cost and Schedule Contingencies


Traditionally, cost and time contingency assessments have been addressed separately. Additionally Owners have tended towards lower contingency percentages, partly based on (potentially false) assumptions that the project specifications and requirements have been sufficiently well defined so as to lower the expected levels of (risk or) contingencies.


Contractors, on the other hand, generally take a more conservative approach to the assessment of risks and contingencies. As a result cost estimates and schedules are likely to include higher contingencies that may unnecessarily increase the cost estimate or extend the execution schedule.


Use of Integrated Cost & Schedule Risk Analysis (IRA) in ECI


IRA offers the opportunity to identify properly and assess critically, cost and schedule uncertainties and risk events and apportion cost and schedule contingency between the parties in an agreed “risk-neutral” way. This will then enable the parties (if they wish to do so) to agree on a penalty/bonus contract structure for the EPC phase of the process.


It is important to note that all estimates and schedules incorporate risk in their assumptions, whether explicitly documented or not. The use of IRA enables the examination and incorporation of the full range of risk possibilities, from optimistic through most likely to pessimistic, across all the elements of uncertainty in the integrated schedule, overlaid estimate and identified risk events mapped into the IRA model.


The use of IRA also enables known risks to be allocated to the party better able to manage or mitigate each of them.


However the value of IRA will not be fully realised if both parties do not engage in an open and mature manner during the FEED/ECI phase.


Embedding IRA in the ECI Process – Steps and Timeline


The use of IRA in the ECI process should follow the steps set out below:


Step 1 The work breakdown structure (WBS) for the EPC execution phase of the project is agreed by the Owner and Contractor and confirmed for completeness and consistency. This activity should occur in the first 2 weeks of the ECI phase. The independent IRA practitioner can assist at this point to ensure that the EPC phase cost estimate and schedule are structurally aligned prior to IRA being undertaken.


Step 2 The design of the new facilities is developed by the Contractor to the point where process and utility process layouts are complete and plant layouts, equipment requirements and key design documents are nearing finalisation. These key design and specification tasks are required so that more detailed construction methodologies, cable schedules, instrument lists, etc. can be sufficiently defined so that pricing of all key elements can commence. At the same time the (level 3) integrated master schedule is being developed (to be completed by the end of the ECI).


In this period a detailed qualitative risk workshop would be facilitated, either by an Owner internal risk expert, or the IRA practitioner. In the former case, involvement of the IRA practitioner would help ensure cost and time impact risk events useful in the IRA process were included in the risk register, reducing the time required for the later IRA risk register review.


Key risk events are identified and assessed and mitigation actions planned (and included in the EPC phase cost estimate and schedule as appropriate). Residual risks are retained on a risk register for later allocation (to Owner or Contractor). During this period the IRA practitioner has little interaction apart from being informed as to progress and involvement with the risk assessments. Typically this phase of the ECI can take up to 9 weeks.


Step 3 Once the structure (overall logic and predecessors and successors) of the execution schedule has been completed, and durations detailed as far as possible (detailed design, equipment and materials procurement ordering and deliveries, construction task durations, commissioning, etc.), the IRA practitioner should be provided with a native copy of the schedule file. An “independent” assessment of the logic and structure (but not of actual task durations) can then be made and feedback provided to the ECI team. This assessment would be undertaken in about week 10.


Step 4 The cost estimate and schedule would be finalised during the following 2 weeks. The estimate and schedule are deterministic, in that every element has a defined and fixed (most likely) cost or time duration. Care must be taken at this stage to ensure that the assumptions underlying the estimate and schedule are aligned, as well as the structures (otherwise the value of the IRA process will be degraded).


Late in this period the IRA practitioner will facilitate workshop sessions for schedule and estimate stakeholders in the ECI team so that ranges are assessed for all uncertain schedule and cost elements. Where elements have a greater certainty of correctness (e.g. tendered pricing vs. budget estimates or experience-based durations vs. rough time estimates) their uncertainty ranging will be smaller.


During these ranging sessions, Risk Factors (e.g., market conditions, productivity, quantity uncertainty) may also be identified that may apply to various groups of activities or cost elements. These are then assessed for their ranging and those factors driving ranging excluded from the general ranging applied to affected tasks and cost line items.


Step 5 Once the cost and schedule ranging sessions are completed, a review of the risk register for significant cost and schedule impact risk events will be facilitated by the IRA practitioner, ensuring that no “double-dipping” occurs (repetition of uncertainty in risk events that is already covered by cost and/or schedule ranging). In addition, risk events that may have been identified during the ranging sessions will be added to the risk register and reviewed for probabilities and impact ranges.


Step 6 The IRA model will then be built by the IRA practitioner and (Monte Carlo) analysis undertaken. Initial results will be provided to the ECI team (Owner and Contractor), comprising time and cost ranges for key milestones and cost summaries plus schedule and cost sensitivities indicating the main drivers of time and cost. The team may decide, based on these results, to adjust inputs (schedule logic, ranges, pricing or durations) and request that the IRA be re-run. This process will be repeated until the team decides that the results and the drivers make sense and the results represent the most risk-optimised IRA model practically achievable.


The time period for this step could be 1-2 weeks, the longer period being required if several analysis runs are performed due to extensive changes to schedule and/or estimate being required.


Step 7 The final output IRA report includes many details but the key results, based on Owner and Contractor agreed probability (P) factors, are:


• a dollar figure, expressed as the probabilistic cost contingency, and


• a time duration, expressed as the probabilistic time contingency.


These contingencies are added to the proposed (EPC) deterministic cost estimate and schedule to form the “Risk-neutral” points at which “the books will be closed” for the EPC phase. The Owner and the Contractor may also agree “carrot and stick” bonus and penalty clauses for sharing the gain or pain of early or late completion around the agreed P level date.



Reflections from a Recent Project


This overview of the interaction of IRA has been provided by the Project Director from a Tier 1 contractor executing a $250m project, via the ECI/EPC methodology, with an owner that was primarily a facility operator, and who did not have a mature internal project delivery capability or culture. The project included the “greenfield” development of a new oil and gas plant with some “brownfield” elements where the new plant and facilities would be tied into existing (and operating) plant with both process and utility connections.


The ECI phase of the project was planned to be approximately 17 weeks long. With reference to the above 7 steps the following occurred:


Step 1 The WBS was agreed by the owner and contractor however there was no independent verification of alignment of the cost estimate and execution schedule WBS structures. The IRA practitioner was not involved with this verification until about week 10 of the ECI and changes were required to ensure that the IRA analysis was optimal.


Step 2 The design of the new facilities was progressed and pricing obtained. The level 3 schedule was developed and the risk workshop was completed. The IRA practitioner was not involved with the risk workshop.


Step 3 In week 11 the IRA practitioner was provided with a copy of the draft schedule (to assess logic and structure) and a significant number of changes and corrections were required. After inclusion of required changes, (final) draft estimate and schedule were ready for IRA analysis by the end of week 12.


Step 4 Because of misalignment between members of the owner and contractor ECI teams the cost estimate included some growth and wastage elements that could not be agreed. The result was that the final cost estimate, which was supposed to be “neat”, included some conservative figures. Similarly so for the (level 3) draft EPC execution schedule – it was conservative not “neat”.


Step 6 The first IRA analysis of the cost estimate and schedule took nearly 2 weeks because some of the base data was changed by the ECI team as more cost and duration information became available from suppliers and sub-contractors. Once the draft results were provided to the ECI team a number of changes were made to costs, schedule durations and sensitivities, again due to differences of experience, opinion and culture between the senior owner and contractor ECI personnel. Several IRA analyses were required before a final outcome (probabilistic cost and schedule contingencies) was agreed by all parties. As a number of re-runs were required this phase of the ECI took nearly 2 more weeks – a total of 4 weeks.


Step 7 Another week was required to produce and approval a final Risk Report. Thus a total of 5 weeks was required to complete the risk analysis process.


All in, the ECI phase took a month longer than planned. Late alignment of the WBS, late cost inputs to the estimate (as a result of changing design requirements from the owner), a poorly structured schedule that required significant logic changes and fundamental misalignment in critical areas of cost and task duration between the owner and the contractor all contributed to delays.


As highlighted earlier in this document owners tend to take a less conservative approach to risk and contingency assessment. In addition owner companies try to convince construction and EPC contractors that risk levels of P50 are acceptable. Contractors, on the other hand, are more conservative and prefer risk levels of P90 if possible. In the case study above the agreed risk level was P75.


In starting off the ECI the owner had taken the view that, as the project was a repeat of a similar plant facility, the risk levels should be low. However the contractor, who had not been involved with this client before, but had some knowledge of the performance of the last (and similar) project undertaken by the owner company, deliberately took a more conservative approach.



IRA Outcomes


The cost outcome of the IRA analysis was that the contingency fell almost in the middle between the owner’s and the contractor’s original internal estimates (prior to ECI commencement). Whilst this outcome may appear fortuitous it was arrived at after an extensive involvement with the ECI team and a systematic and documented approach via the IRA process. Thus the cost outcome was defendable and explainable to both the owner and contractor executive managements.



Project Outcomes


While complete information on the project EPC cost and schedule outcomes are not published there is clear anecdotal evidence that the IRA process added value and provided an objective and documented methodology and process where otherwise subjectivity, opinion engineering and different cultures may have resulted in a different project result.



RIMPL NEWS


Quantitative Risk Analyses


RIMPL has recently completed an Integrated Cost & Schedule Risk Analysis of a hydrocarbons condensate plant in PNG.


We are to perform an IRA on a proposed manufacturing facility early in 2015.


Conferences


We presented four papers at conferences in Milan, Bangkok and Melbourne in October and November. The Milan and Bangkok conferences were both concerned with Total Cost Management. The Melbourne conference “Mastering Complex Projects” formed part of the inaugural Engineers Australia Convention, to be held every 2 years.


All four papers are described in our News section of the website for 12-Sep-14 and are available for download from our Knowledge Base under Reference Material.


Technical Advances


Robert Flury

RIMPL’s Principal Programmer, Robert Flury has been developing enhancements to the software toolset we use to support our quantitative risk analysis methodology since late 2005. His efforts are complemented by the work of Matt Dodds, our Principal Consultant, who develops Excel-based tools and defines the requirements and interfaces for our tools. Without these we could not provide the speed or realism of analysis expected by our clients.


Running Men

Recently, Rob has been working on speeding up Quantitative Exclusion Analysis (see Knowledge Base on the IRA Process). This is one of the final steps in our methodology where the major drivers of time and cost, identified through sensitivity analysis, are systematically excluded and complete simulations re-run to enable their contributions to be measured. This is important but very calculation intensive work and can take many hours. Through advanced programming techniques external to Pertmaster/Primavera Risk Analysis, including multi-threading, Rob has been able to reduce the time required by orders of magnitude in tests. We are expecting this work to result in much faster QEA software supporting our IRA methodology becoming available early in 2015, with the possibility of extending the benefits to all our simulations later in the year.