Complexity is the key cost driver

Deep understanding of what inflates cost is vital to control field development project expenditure

Sakhalin Energy

The offshore oil and gas industry has regularly failed to stay within budgets and timetables set out in final investment decisions (FIDs) for field development projects. Compared with authorized capital expenditure (capex), FIDs underestimated costs by 16% on average, and more for deepwater (45%) and heavy oil (50%) developments, over the period 2009 through 2013.[1]

Lower oil prices are focusing minds on cost. A DNV GL survey of more than 360 senior oil and gas professionals worldwide found the percentage of respondents planning increased capex this year had fallen from 40% to 12% between October 2014 and January 2015.

“It is important to develop detailed understanding of cost drivers,” said Etienne Romsom, strategy and business development director, DNV GL - Oil & Gas. “Sometimes, answers that seem obvious – salaries, steel prices and so on – are not the whole picture. Cost inflation of this kind accounts for only a third of increased project expenditure seen in recent years.”

Identify the right targets
Scope inflation is a major issue, he stressed: “Greater development complexity further increases the cost per barrel produced. Companies that fail to understand this risk addressing targets less likely to impact significantly on profitability.”

Deferring projects or squeezing suppliers may not always be the best approach, he suggested. “The solutions lie in working smarter, for example through collaboration, sharing of assets, standardization, digital technology and joint innovation, and in taking a risk-based approach across the project and asset lifecycle.”

Many companies now need to identify these opportunities. “While future oil prices remain hazy, the cash wheel is getting stuck,” said Romsom. “Project cost escalation pre-2011 was partially offset by rising oil prices, but this evaporated as prices stayed flat before plunging.”

Unit costs in exploration and production have showed compound annual growth of 11% since 2000.[2] This has shrunk return on investment in real terms. The combined cash return on cash invested by global supermajors ExxonMobil, Shell and BP was around its lowest for 40 years by the end of 2013, and was forecast to decline further, even at assumed future oil prices at USD100 per barrel.[3]

DNV GL has looked closely at opportunities to assist the industry to align performance with justifications made for FIDs.

“Many projects fail to adequately address project risk during the planning phase and often have insufficient understanding of uncertainty related to scope changes,” said Elisabeth Rose, head of section, project risk management, DNV GL - Oil & Gas. “A core reason for scope inflation is rising customisation. A lack of replication or standardization adds to complexity,” she added.

Romsom warned that, beyond a certain point, additional specifications do little to reduce risks. “They just continue to add cost and erode value,” he said. “They can even start to increase risk as added specifications dilute focus, introduce needless complexity, limit supply-chain efficiency or increase exposure during project execution and/or operations. We are seeing many examples of unnecessary and costly spec-inflation.”

A risk-based response
In addressing these challenges, DNV GL is working with the industry on project risk, standardization and innovation. The company has taken the initiative to investigate solutions for cost challenges related to variations in technical requirements seen from both suppliers’ and oil companies’ perspectives. The outcome will be suggested improvement initiatives and changes to reduce conflicting and superfluous requirements that affect cost. These suggestions will cover company internal specifications as well as regulations.

“Working with the industry has shown us potential areas for significant cost reduction through smart choices of standards and company requirements,” Romsom said.

For example, DNV GL assisted an operator to assess the difference in impact between using industry standards and company specifications when building a rig to operate in harsh environments. It found that a similar safety specification could be achieved at about half the cost through a risk-based selection of standards.[4]

This ‘gap analysis’ of standards for offshore rigs in harsh environments aims to eliminate company-specific requirements where prudent and practical. The method involves comparing each of the applicable company specifications against Class rules and voluntary notations.

Where Class rules hold an equivalent standard of safety, company specifications could be eliminated with no impact on risk. Application of Class rules provide a cost reduction compared with company specifications as the former leverages on standardised work processes throughout the supply chain.

“If company specifications include requirements beyond the intention or scope of internationally-recognised codes and standards, the criticality of such a gap will need to be understood,” Romsom said. “A lifetime perspective will be required to fully understand the cost-efficiency and safety impacts of incorporating such additional requirements.”

Share knowledge early
DNV GL recommends that the process for risk-based evaluation and selection of standards starts even before the concept selection phase in the project lifecycle. “Proper front-end loading of a project is important to help you think through your options and total cost of ownership (TCoO) before making final decisions,” explained Rob van Velden, finance director at Sakhalin Energy. The Russian operator faces significant cost challenges in its oil and gas projects in harsh climatic conditions on the remote Sakhalin Island. “Front-end loading, and multi-disciplinary and independent reviews of the project at certain stages/ decision gates, helps Sakhalin Energy to avoid issues on projects,” he added.

“Appropriate technical verification of pre-FEED (front-end engineering design) and FEED is one possible solution to identify issues that arise during these stages and remedy flaws in them,” Rose observed.

Once sub-optimum specifications enter the supply chain, it can take significant effort and time to correct them. Examples in subsea have shown that correcting a specification throughout the supply chain can take eight months, adding to lead time and costs.

“Standardization that allows transparent certification services lets operators reduce uncertainty, lead time and cost,” Rose said.

“For capital projects, I see more focus around us, and in Sakhalin Energy, on standardization and replication,” said van Velden. “Reinventing the wheel is always costly and not always worth it. We are getting more careful here, and are less open for engineering creativity if there is no solid business case.”

It is not just about capital expenditure, he added. “On TCoO I note that capex is important, but also the operational expenditure after project start-up. It is not uncommon that a more expensive but easier-to-operate project generates more value to stakeholders.”

Relationships build value
Operators can gain more long-term value from sustaining business relationships with suppliers rather than squeezing them or retendering work in a downturn, says Eric Janvier, head of the capital projects practice at SBC, the management consulting arm of global oil services group Schlumberger.

“When you work long-term with a supplier on one solution with intelligent incentive, you can actually drive the costs down and the performance up through the years from project to project,” he said in an interview for DNV GL.

“It’s like trying to win a football game by changing the team and trainer each time you play: you do not have the continuity. In my opinion, this is what oil and gas has missed but the car industry has not. You simply could not build cars anymore by redesigning everything in a car for every model. Things would not work.”

[1] ‘380 projects to change the world – top 380 trip highlights a disconnect in two supply chains,’ Goldman Sachs, May 2013
[2] Analysis by Barclays based on International Energy Agency data
[3] ‘Global offshore prospects’, Douglas-Westwood presentation at The Energy Institute, London, September 2013
[4] ‘“Spec inflation” driving up costs’, Paul Cleary, The Australian, 9 March 2015

The Piltun-Astokhskoye-B platform
The Piltun-Astokhskoye-B platform in the Sakhalin-2 Project which faces costs related to harsh climatic conditions