Investment in capital projects is rising. First-rate contracting will help companies to get a significant leg up on their rivals.
Thomas Hundertmark, André Olinto do Valle Silva, and Jeff A. Shulman
June 2008
Spurred by rising global demand, the world’s suppliers of energy and energy-intensive commodities are greatly increasing their investments in power stations, chemical plants, oil rigs, steel mills, and other capital projects. Many of these undertakings are larger and more technologically complex than ever. The result is heated competition for the basic materials, equipment, and talent that all asset-intensive industries need to deliver multibillion-dollar capital projects successfully.
Skillful management and oversight of the contractors who supply the goods and services that a project requires has always been crucial to maximizing its economic value. In power generation or petroleum, for example, up to three-quarters of a typical budget goes to the contractors that supply engineering, procurement, construction, and project-management services. By raising the cost of delay and missed opportunities, today’s supercharged environment has elevated the importance of first-rate contracting.
Many asset owners, however, are struggling. Some companies approach every capital project as an isolated, individually tailored undertaking and fail to align the contracting efforts of individual project teams with their long-term capital strategy. Others hastily lock themselves into agreements; choose inappropriate contracting models; or misjudge the risks, organizational resources, or skills that capital projects involve. Such mistakes generate missed opportunities, significant delays, and cost overruns in the hundreds of millions of dollars.
Yet a few asset owners, having mastered the art of contracting, are benefiting from better project designs, lower costs, and fewer delays—a significant source of competitive advantage. To gain efficiencies across a number of projects, these companies standardize their engineering activities and modify boilerplate contracting models to adapt the economics of each project to their particular mix of skills and experience. They also look for ways to promote strong competition among the contractors hoping to work with them and conduct more detailed risk assessments than their less successful counterparts do. Finally, they invest in talent and encourage collaboration across functional boundaries to help maximize the net present value (NPV) of their capital projects.
An examination of the approaches these companies take offers lessons not only for providers of energy and energy-intensive commodities but also for other asset-intensive industries, including high tech, telecommunications, and automotive. These lessons are also relevant to public- and private-sector organizations that undertake large infrastructure projects, as well as to investors seeking to profit from them.
A changing environment
While economic growth in the developing world and rising demand for energy and energy-intensive commodities have created huge opportunities for asset-intensive industries, these forces have also greatly increased demand for essential materials, services, and equipment. As a result, contracting assistance is harder to obtain than it has been before. In some cases, this problem can change the economics of a project. In northwestern Canada, for example, the wages of people who work for contractors have skyrocketed as companies compete for labor to develop projects in the region’s oil sands; likewise, in the mining industry, delays in obtaining trucks, tires, and other equipment have forced lengthy (and, given record commodity prices, costly) delays in mine openings around the world. Such pressures will continue. Global capital spending is expected to exceed $71 trillion during the years 2008 to 2013—about a one-third increase from the levels of 2002 to 2007. Many asset-intensive industries will see increases of 50 to 80 percent (Exhibit 1).
