East Coast Offshore. Think ahead to prevent headaches later. For major capital projects, it pays to consider risk at the outset

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1 Issue 26, February 2013 East Coast Offshore Think ahead to prevent headaches later For major capital projects, it pays to consider risk at the outset In this article, the first in a two-part series on issues facing major capital projects, we look at trends in delivery performance and why businesses need to act promptly to exert the greatest influence on project delivery success. East Coast Offshore highlights emerging legislative, regulatory and competitive issues affecting the Atlantic Canada oil and gas industry. All monetary figures expressed in CDN$ unless otherwise noted. Project pipeline fuels continued growth Atlantic Canada is experiencing significant major project activity. Recent estimates suggest that there is more than $54 billion in projects underway, and more than $56 billion in the pipeline.1 Not only are these projects of vital importance to organizations that are commissioning the work and to those that will play a role in their delivery this level of expenditure will be critical to the region s continued economic development. There s a lot riding on the successful delivery of these projects. For those projects that are in the pipeline, organizations need to take early action in the preinvestment project phase to help lay the foundation for the successful delivery of the project. In the pre-investment phase, consider the following: Is enough being invested up front? Have enough resources been set aside to reduce risk sufficiently before major expenditure begins? What capabilities are needed in house? Are the necessary skills, experience and processes in place? What form will the delivery organization take? What are the roles and responsibilities of the delivery partners? What contract arrangements are planned for suppliers? What are the incentives for delivery performance? Is sufficient funding in place to mitigate financial exposure from macro events? Is there a robust framework in place to mitigate risk and maximize opportunity once the delivery phase begins? Insights from those who have construction experience in the energy sector reinforce the value of upfront investment. On a billion-dollar project, you should expect to spend $100 to 150 million before shovels go in the ground, noted John Sauger, Vice President, Project Management and Construction, Bruce Power. As the IPA [Independent Project Analysis, Inc.] and other experts have confirmed, if you don t spend appropriate money up front, costs can escalate by up to 300%. 2

2 Continuing performance trends Globally, trends in major project overruns of time and costs continue. Andrew Gould, former CEO of Schlumberger, noted, many [oil and gas] greenfield projects suffer significant cost overruns. Indeed, as a general rule, 30% of such projects experience budget overruns of 50%. 3 Industry research has shown that two out of three projects finish over budget or behind schedule (Figure 1). And while companies invest in technical skills, project management training, certification and tools, and good practice across functional teams, projects continue to underperform. Why the continued underperformance? In many cases, companies treat capital programs as a sideline, not a core competency. A recent Ernst & Young market analysis found that over 50% of senior executives believe corporate effectiveness is constrained by a lack of delivery effectiveness in major programs, and 73% of captains of industry agree that their businesses are increasingly challenged to assess the risks and returns of major programs. If you find it difficult to assess the risks of major projects at an appropriately early stage, you won t be able to exert the necessary influence to control expenditures and schedules (Figure 2). Figure 1 Project performance Above budget Size of bubble indicates project size Development costs On time, but above costs Behind schedule and above costs Below budget Excellent performance Below costs, but behind schedule Advanced Actual project schedule Slipped Met or exceeded target Under delivery Source: Independent Project Analysis, Inc. (IPA) and Ernst & Young 2 East Coast Offshore February 2013

3 How can it be fixed? Act early To increase the likelihood of successful delivery of a major capital project, you have to act during the early planning, before any capital outlay is made (Figure 3). Figure 2 Relationship between ownership and control of costs over the project lifecycle $ - Costs Cumulative cost Rate of spend The company owns and controls costs and timelines The company has limited control over costs and timelines and is heavily reliant on contractors and exposed to multiple external and unpredictable factors The company owns and controls costs and timelines Time Project definition Engineering design Project procurement Construction Hook-up and commissioning Asset management Decommissioning and dismantling Conceptual Approve capital Front-end engineering Detailed engineering Contractor project management Procurement Fabrication and construction Transport and install Hook-up Commissioning Operations support Sustainment Decommissioning Dismantling East Coast Offshore February

4 The period leading up to the investment decision presents a limited window of opportunity to influence a project s commercial outcomes and, ultimately, its long-term success. It s the busiest period for internal project functions, often with the fewest resources, and it s when most of the commercial decisions are made and management has the greatest ability to influence the risks for the project. Experience shows that action taken pre-investment can reduce cost escalation and safeguard estimated return rates as the project progresses. Failure to invest in early risk mitigation and commercial integrity activities may result in post-investment risks totalling over 40% of the budget. 4 The planning stage also offers the best opportunity for you to set priorities between time, cost and quality. Contracts and supplier appointments reflect decisions on governance, roles and responsibilities, incentives and performance measures, many of which will be in place for the duration of the project. These decisions are made during peaks of activity, often on a case-by-case basis, without full consideration of the related costs or schedule implications. When these implications become visible later, project owners are forced to either live with the consequences or make changes during the construction phase, which usually results in cost overruns and/or delays. Figure 3 The ability to influence Ability to influence - Cost - Schedule - Quality - Performance Cumulative cost Make us better Keep us out of trouble Project definition Engineering design Project procurement Construction Hook-up and commissioning Asset management Decommissioning and dismantling Conceptual Approve capital Front-end engineering Detailed engineering Contractor project management Procurement Fabrication and construction Transport and install Hook-up Commissioning Operations support Sustainment Decommissioning Dismantling 4 East Coast Offshore February 2013

5 Governance, risk management and project management To gain stakeholder confidence in your organization s ability to deliver the project, you need to be clear on in delivery activities during the pre-investment phase. A robust project integrity plan brings together all assurance activities. Taking a longterm view from the planning stages through to operation, it provides oversight of the complete control framework and offers flexibility and provision to cope with regulatory and commercial change. Introduced at the right time, a project integrity plan can promote the following: External stakeholder confidence through a clearly articulated and embedded culture of control and risk awareness Avoidance of cost escalation and impact on return rates through built-in flexibility and provision for regulatory and commercial changes No surprises and minimized risk of delays through consistent contractual and professional arrangements Once the project has started, robust integrity translates into strong governance, risk management and project management practices. Early action can ultimately define the success of the project and set the parameters for other programs. Three main areas form the basis of the pre-investment risk management approach: Set up the delivery organization (right people, technology and process) Operating model Senior appointments People and skills management Planning and stakeholder management Governance and approvals Lean processes IT landscape Early financial control Set up for successful investment appraisal (right assumptions and strategies) Commercial outputs Cost estimates Contingency Macro risk awareness Design freeze Consenting and planning delays Visibility of management information Employee relations strategy Budgeting for early risk-mitigation activities Foreign exchange and commodity plans Credit risk Contract strategy design Embed delivery assurance with the right partners and contracts Contract management plans Contract integration Supplier management information Safety culture Value engineering Change management controls Integrity plan Benefits tracking in place to assure delivery In the next issue, we ll look at some of the specific actions you can take to mitigate risk and deliver improved project performance. Richard Harrison, Manager, Advisory Services, East Coast Offshore February

6 New E&P budgets commit to Atlantic Canada s offshore Exploration and production (E&P) companies are showing a renewed commitment to investing in Atlantic Canada s offshore industry. Capital expenditure programs for 2013 include the following: Exxon Mobil has confirmed it will invest $14 billion in the Hebron project. The project will recover more than 700 million barrels of oil and is slated to begin production in The project is expected to employ 3,500 in Newfoundland and Labrador during the construction phase. 5 Chevron has renewed its commitment to the Hebron project as part of its US$36.7-billion overall capital and exploration budget. Over 90% of its budget is slated for E&P, as Chevron pushes to increase production to 3.3 million barrels per day (b/d), from 2.7 million in Husky Energy has slotted Atlantic Canada development as one of its three growth pillars. The pillars, which also include the oil sands and Asia-Pacific, will receive 50% of Husky s 2013 capital expenditures of $4.8 billion (US$4.75 billion). To support its future drilling and exploration activities, Husky signed a five-year contract for a new harsh-environment semi-submersible rig, the West Mira, which is scheduled for delivery in Pre-sanction work continues at West White Rose, while Husky anticipates first oil at the South White Rose Extension project in Canadian units of BP plc and Royal Dutch Shell were successful bidders for eight parcels offshore Nova Scotia. With bids of almost $1 billion and $32 million, respectively, the companies have made the largest total investment commitment to date. BP executive vice president of exploration Mike Daly called the Nova Scotia offshore acreage essential to the company s future growth, adding, This entry to Nova Scotia s offshore plays to our strengths in the deepwater and subsalt. 8 Shell increased its position in the Laurentian sub-basin off Newfoundland and Labrador. The $97-million bid for five parcels grants exploration rights for over 1.3 million hectares. 9 Volatile commodity prices, shifting legislative and regulatory controls and other unexpected costs can challenge any major capital program. The $950-million Deep Panuke project offshore Nova Scotia was initially planned to be operational in 2010, but is now slated to be operational in Unanticipated process equipment repairs and testing of the offshore platform are the most recent challenges delaying the 300 million cubic feet per day project. 10 Encana reports that past delays have not impacted costs. However, Canaccord Genuity cautions that funding gaps may result in Some provinces rely heavily on natural resources to boost revenues, placing added pressure on offshore projects to perform. Provincial treasuries can be impacted by shifts in market fundamentals. For example, the Newfoundland and Labrador government has adjusted its expected budget deficit of $258.4 million, as tax revenues have declined almost 13% since the budget was set and oil production decreased by approximately 1.8 million barrels. 12 One third of the province s revenues are impacted by volatile oil prices. Similarly, Nova Scotia adjusted its provincial budget downward, projecting a $277-million deficit for the fiscal year, a $66-million increase compared with the budget tabled in April. 13 The province is counting on several major projects, including Deep Panuke, to stimulate the economy. On the brighter side, the RBC Economics Provincial Outlook forecasts Newfoundland and Labrador to lead provincial growth at 4.4% in 2013, fuelled by increased oil and mineral production. The return to full production at Hibernia the largest contributor to GDP will elevate Newfoundland and Labrador to the top spot in the provincial growth rankings, said Craig Wright, senior vice president and chief economist at RBC. 14 Ultimately, project development challenges can impact East Coast Offshore performance. Controlling unnecessary expenditure continues to be top of mind for company executives heavily invested in East Coast offshore. Ensuring strong governance and risk management and practising strong project management will ultimately benefit major capital projects. 6 East Coast Offshore February 2013

7 Noteworthy news The Canadian Transportation Agency has approved plans by AP Moller-Maersk to use Maersk Beater for ice management, including ice surveillance for Hibernia Management & Development Company (HMDC) and Statoil. 15 Group 2041 continues to argue that gas is a viable option to supply Newfoundland with energy, rather than the Muskrat Falls hydro project. Group 2041 s Cabot Martin argues the use of gas discovered by Husky Energy at its White Rose field remains a viable alternative. 16 The Bull Arm information centre officially opened at the end of October. Bull Arm, along with St. Mary s, is providing fabrication support for Hebron s drilling support module and accommodations module. The Hebron project is expected to generate $20 billion in revenues in the province over 30 years. 17 Shell Canada Limited will de-risk two deepwater exploration blocks in the Shelburne Basin offshore Nova Scotia. Depending on seismic program findings, a drilling program could commence in late 2014 or The Canada-Newfoundland and Labrador Offshore Petroleum Board (C-NLOPB) appointed Ed Drover as Chairman and Max Ruelokke as acting CEO in October. 1 Atlantic Provinces Economic Council (APEC), Major Projects 2012, 6 June 2012; Major project investments in Atlantic region no passing trend, says think-tank, The Canadian Press, 6 June 2012, via Factiva. 2 Ernst & Young report, Passing the starting line: nuclear construction risk, 14 September 2010, via ey.com/publication/vwluassets/nuclear_construction_risk/$file/nuclear%20construction%20risk.pdf. 3 Cost overruns common on oil projects, Reuters News, 2 June 2011, via Factiva. 4 Ernst & Young, Commercial excellence in capital projects: Pre-investment Getting it right before the investment decision, ExxonMobil sanctions Hebron offshore eastern Canada, NGI s Daily Gas Price Index, 8 January 2013, via Factiva, Intelligence Press; ExxonMobil to start Hebron oil project to proceed off Canada s east coast, Professional Services Close-Up, 9 January 2013, via Factiva, Close-Up Media. 6 Chevron Annual report 2011, Chevron at a glance, via chevron.com/annualreport/2011/chevronataglance/; Chevron announces FY12 CapEx plan of $32.7B, Flyonthewall, 7 December 2011, via Factiva. 7 Husky Energy announces new initiatives and 2013 production guidance and capital expenditure program, ENP Newswire, 6 December 2012, via Factiva, 2012, Electronic News Publishing. 8 Joy as BP commits to Nova Scotia offshore, Upstream, 23 November 2012, via Factiva; BP commits $1B to explore offshore Eastern Canada, Oil Daily, 22 November 2012, via Factiva, 2012 Energy Intelligence Group. 9 Shell extends Canadian reach, Upstream, 9 November 2012, via Factiva. 10 Deep Panuke start-up jinxed again, Natural Gas Intelligence, 19 November 2012, via Factiva, 2012 Intelligence Press, Inc. 11 ibid. 12 Newfoundland lowers oil revenue forecast, The Daily Oil Bulletin, 14 December 2012, via Factiva, Nickle s Energy Group; Newfoundland and Labrador Department of Finance, Mid-Year financial update released, Department of Finance press release, 13 December Michael Macdonald, Nova Scotia s deficit projected to grow to $277 million after tax revenue drop, The Canadian Press, 13 December 2012, via Factiva. 14 Atlantic Canada s economy set to improve in 2013: RBC Economics, Canada NewsWire, 13 December 2012, via Factiva; rbc.com/economics/market/pdf/provfcst.pdf. 15 Maersk cleared for Hibernia, Upstream, 30 November 2012, via Factiva. 16 Iain Esau, Call for gas projects to replace Muskrat Falls plans, Upstream, 30 November 2012, via Factiva. 17 Tonya Zelinsky, Hebron players agree to pay to resolve fabrication dispute, 19 October 2012, via Factiva. 18 Elsie Ross, De-risking planned for Shell deepwater block acquisition offshore Nova Scotia, 22 November 2012, via Factiva, 2012 Nickle s Energy Group. East Coast Offshore February

8 Contact us Our Atlantic Canada Oil & Gas team consists of 189 people in St. John s, Halifax, Moncton and Saint John. We bring you deep technical knowledge, global experience and a local perspective. We re part of Ernst & Young s global network of 167,000 professionals, working together to share our knowledge, resources and integrated technology. This global reach means we can co-ordinate a team to address your oil and gas needs anywhere in the world. For more information about our team or East Coast Offshore, please visit ey.com/ca/oilandgas or contact one of the following professionals: Darrell Bontes Halifax, Nova Scotia darrell.bontes@ca.ey.com Mark Cook mark.cook@ca.ey.com Richard Harrison richard.harrison@ca.ey.com Dan LeBlanc Moncton, New Brunswick dan.leblanc@ca.ey.com Keith Mercer keith.c.mercer@ca.ey.com Dean Mullin Saint John, New Brunswick dean.mullin@ca.ey.com David Steele david.steele@ca.ey.com Mike Wilson mike.j.wilson@ca.ey.com Ernst & Young LLP Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com/ca. About Ernst & Young s Global Oil & Gas Center The oil and gas industry is constantly changing. Increasing regulatory pressures, price fluctuations and geopolitical complexities all present significant challenges. Our Global Oil & Gas Center brings together a worldwide team of professionals to help you achieve your potential a team with deep technical experience providing assurance, tax, transaction and advisory services. The centre works to anticipate market trends, identify the implications and develop points of view on relevant industry issues. Ultimately, it enables us to help you meet your goals and compete more effectively. It s how Ernst & Young makes a difference. ey.com/ca 2013 Ernst & Young LLP. All Rights Reserved. A member firm of Ernst & Young Global Limited This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. ED None