The skinny on cost overruns

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Thus far, my letters to The Telegram have mostly dealt with the arbitrary approach of the Dunderdale administration and the consequences of the ill-conceived Muskrat Falls, project both for the public treasury and for democratic government.

I am a fortunate person; having served two premiers for a total of 11 years, I left the service of government to become engaged in a business career — now spanning nearly three decades — that included construction and development. While I am not an engineer, I have learned much from some very good engineers and other construction professionals, including some of the things contained in this article.

Experience is often the ingredient that offsets construction risk. Right? Well, not always. Ask yourself this question: if experience alone were sufficient, why do oil sands projects continue to experience huge cost overruns despite the fact that large conventional projects can almost be now characterized as cookie-cutter? Even steam-assisted gravity drainage and similar technologies are far more technically simplistic.

Canadian Natural Resources, Imperial Oil and Suncor have been engaged in mega-projects in the oil patch for over 30 years. Vale Inco boasts lengthy world-class expertise, too. While experience is not nearly an antidote to cost overruns, having none is a seriously deficient method of warding off disappointment (a.k.a. bankruptcy).

Nalcor has no experience in large-scale construction.

Senior management will refuse to recognize the importance of experience now; but as design issues and other problems emerge on the Muskrat Falls project, their inexperience will start to show. Overwhelmed bureaucrats at Nalcor will increasingly defer to SNC Lavalin, the engineering, procurement and construction management organization chosen for the project.

Deferring to engineering houses, such as SNC, is one of the prime reasons that these mega-projects get in trouble. That is less a comment on SNC than on their and other similar companies’ orientation and self-interest.

Such organizations will not contractually take on any risk and they make most of their income from engineering hours. It is their bread and butter. When owners depend on such organizations, the heads of engineering houses gleefully rub their hands together and get ready for another big payday. Such deference suits their business model. It allows them to capitalize on the chaos in projects which owners realize only when it is too late, when such projects are off the rails.

In the engineering house, that cost reimbursable contract world, chaos equals cash. Suffice to say: deference to engineering houses is the equivalent of putting the fox in the hen house.

That’s the engineering side of the mega-project. Next is the contractor side. This is how one highly experienced project manager explained how the system works: as soon as the contract is awarded on a large project, the first to show up are not the ones who will fire up the machinery. No, the first people on the construction site are the contractor’s lawyer, the estimator and the project manager.  

Every word of the contract and the scope of work is reviewed and compared with what is demanded by the owner. Discrepancies and inevitable design changes become opportunities; their related costs start to be added up even before one piece of material or equipment arrives. In essence, he added, cost overruns begin before the project does. In the contractor’s business model, the claims department is a major profit centre.

As much as Nalcor may tell you that it has control over project costs, the simple realty is that it is in no position to estimate a final project price for Muskrat Falls. Nalcor will rely on an estimate most likely generated by SNC.

When engineering houses prepare estimates the process is hardly what one might call accurate or refined. They take an estimate of engineering hours and price it; then they add the cost of major equipment purchases (which they are reasonably good at pricing). However, to arrive at a full price estimate, they simply rely on multiplying factors to the engineering and equipment estimates to capture the remaining 70 to 80 per cent of the project costs such as materials and indirect and direct construction costs.

This use of factors is akin to sticking your thumb out into the wind to see which way it is blowing. And, as several decades of examples have proven, when it comes to estimating final costs of mega-projects, engineering houses are not very good at it.

Ultimately, all of this will get lost in the fog of managing a major construction project. Bureaucrats at Nalcor will keep on spending money until either the work is completed or the money runs out.

Problem is: it’s your money.

 

Des Sullivan is a former executive assistant to former premiers Frank Moores and Brian Peckford. He is currently a businessman in St. John’s.

 

 

Organizations: Canadian Natural Resources, Imperial Oil, SNC Lavalin

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Recent comments

  • Please listen to Mr. Sullivan, the frightening Cost Over Runs will occur as a result of the CHAOS that will erupt in the Muskrat Falls Projec as it progresses and those involved in the developmnt are aware of this. Please stop it now.
    November 02, 2012 - 07:57

    Mr. Sullivan I respect your opinons highly and what you have said in this piece is so true. I wish that all Newfoundlanders and Labradorians could read this article, if they do they will be able to see through the frightening aspects of the Muskrat Falls Project , especially the looming Cost Overruns which will arise from the "CHAOS" in the Project. I only wish the government/ developers of this project would come to their senses and put an end to it right now

  • James G. Learning
    November 01, 2012 - 17:46

    I fully realize everyone in Labrador is not against this Project, although we know with an initial phone survey 82% of us are, these figures extrapolated of course. So here we have the wolves of the Island discounting Labradoreans at every turn. Remember this power is for the Island. It will not be used for domestic purposes in Labrador, we were told this from the beginning. It certainly will not be used by the mining sector, these will be powered by Hydro Quebec (HQ). The only way Munsrat Falls power (MFP) will be used by the mining sector is if it is subsidized. When HQ is called on for power, this will mark the first time Power will flow from South to North in this Territory, I'm not sure if this is happening anywere else in Canada, Perhaps manitoba, B.C., and Alberta.The least cost option so called is still very expensive. Now back to my dispute with the Island promoters. Labradoreans will not be responsible for kicking up the 15% union penalties, we are not union members, it is outside of the Labrador perview, this is an Island thing only. Labradoreans are told from the get go, don't bother to apply for jobs at these sites if you are not union members. I know there are exceptions to this rule in Voiseys bay, simply because there is an Aboriginal component in the contract which demands this be so. So for those who are mixed bloods, we get no consideration. However we do have to live with the higher taxes this Project will demand, plus the environmental degredation. This is all very sweet don't you think. Only because we put up with it. After all the courts are not ours they belong to the Island. In Labrador the courts are to throw us in jail, not to intercede on our behalf in such cases.

  • David
    October 31, 2012 - 09:24

    If this thing costs anytohng less than at least $12 billion, I'll be shocked. It the governemtn says $7.4B, and you add the standard 50% 'government work' premium, and then the very predictable 15% Newfoundland labour union penalty (maybe more for long-term projects liek this....maybe 3 or 4 strikes before it's complete), you get to $12 B pretty easy. Given the completely dubious market assessment, and the skinny economics revealed already, this will be the whitest of all elephants. And instead of having paid down our provincial debt at a guaranteed return of 5% a year, with all that debt capacity available to fund some truly worthy, major initiative(s) in the future we will have doomed our province to eternal poverty, having taken our entire oil legacy and incinerated it.

  • Ken Collis
    October 31, 2012 - 08:06

    What business, may I ask, are you involved in?