The Performance of Australian Industrial Projects Prepared for the Business Council of Australia by Rob Young, Independent Project Analysis, Inc May 2012 Executive Summary Independent Project Analysis, Inc (IPA) is a U.S.-based company that specialises in benchmarking the performance of projects predominantly conducted by owner companies in the processing and extractive industries globally. It has evaluated over 650 completed projects conducted in Australia since the mid-1990s and is therefore in a good position to compare Australian industrial project performance against that of the rest of the world. The performance of Australian projects benchmarked by IPA varies significantly by project type, project complexity, and the relevant experience of the project team. On one hand, the performance of smaller, sustaining capital projects 1 has generally improved over the last 10 years and a few Australian sites now achieve international best standards. On the other hand, large (greater than $100 million), 2 technically complex Australian projects have a poor performance record with a failure rate of over 75 percent. Australian offshore oil and gas developments generally work, but the projects are amongst the most expensive in the world. On average 3, Australian industrial projects are more than 40 percent more expensive than similar projects conducted on the U.S. Gulf Coast. This is driven by the high cost of Australian construction labour coupled with the low construction productivity. In 2004, IPA measured the Australian labour productivity to be 1.30 compared with the U.S. Gulf Coast (meaning that it takes 1.3 hours in Australia to conduct work that would take 1.0 hour on the U.S. Gulf Coast). Anecdotally, the productivity factor has increased over the last decade and is now at least 1.35. Australia is a large country with a comparatively small population. The level of capital expenditure in the country has increased significantly over the last decade and, on a per capita basis, is now amongst the highest in the world. Projects are becoming larger and more difficult, and there is increasing pressure from the businesses to implement projects faster. On the other hand, Australia s engineering, project management, and construction capabilities have not kept pace with demand and these skills are now in short supply. Introduction IPA specialises in benchmarking the performance and drivers of capital projects conducted principally by companies in the processing and extractive industries around the world. IPA evaluates about 700 projects per year and data collected are entered into databases that contain data on over 13,000 projects. The data provide the basis for the quantitative benchmarking of project performance and to quantify key drivers of success or failure. The data have been collected since IPA started business in 1987 and all data are collected in face-to-face interviews with project teams. 1 Typical sustaining capital projects cost less than $15 million and are conducted at existing operating sites of oil refineries, minerals processing plants and chemical plants. 2 All costs are in Australian dollars unless specified otherwise. 3 The average is calculated as a straight average of the cost performance of all projects in the dataset and is not weighted for cost. If it were cost weighted, it would be significantly higher.
IPA established an office in Melbourne, Australia, in 1997 and has since collected data on over 650 completed projects conducted in Australia by companies predominantly in the mining and mineral processing, oil and gas, and chemical industries. The projects range in size from about $1 million for sustaining capital projects to over $40 billion for major gas developments. During the last 15 years, we have seen many changes in the Australian industrial project environment: The late 1990s saw a number of high-profile mineral processing projects 4 that failed through a combination of poor project management practices and a lack of understanding of the technologies being applied. As a result, some companies are now averse to building mineral processing plants in Australia and we have seen very few major mineral processing projects in the last 5 years or so. At the start of the last decade, the oil refining industry implemented major projects to allow Australia s oil refineries to produce cleaner fuels. Since then, the oil industry has focussed almost solely on sustaining capital work. We are unlikely to see any further major oil refining expansion projects in Australia because of the high capital and operating costs compared with world-scale refineries being installed in Asia. China s rapid growth appeared to catch the mining industry by surprise and, starting from around 2004, we have seen frantic activity to increase the production of iron ore out of the Pilbara and metallurgical coal out of Queensland. Development of gas fields off the coast of Western Australia has resulted in continuous project activity to increase the supply of liquefied natural gas (LNG) to Asia. While most industries slowed during the 2009 Global Financial Crisis, oil and gas development and associated LNG projects continued unabated. Recently, we have seen resource development projects move into a different paradigm in terms of size and complexity. Five years ago, projects costing more than $2 billion were relatively rare. Today in Australia, there are at least 10 projects or project programs with capital costs higher than $10 billion that are either under serious consideration or in execution. By their very size, these projects bring potential risks not only to each specific project, but to the Australian portfolio as a whole, because they all draw labour from the same resource pool. In his book on industrial megaprojects, 5 Ed Merrow describes how the risk of project failure 6 increases significantly with project capital cost and that megaprojects, which typically cost more than $2 billion, have a failure rate of over 60 percent. Merrow makes the point that the fragility of a project increases with project size and that megaprojects are either successful or they tend to fall apart. Further, the amount of effort needed to set megaprojects up for success is dis-proportionately higher than for say a typical $100 million project. Total capital expenditure in Australia has increased significantly over the last 10 years and, on a per capita basis, is now amongst the highest in the world. On the other 4 By mineral processing, we mean refining or smelting of ore, not just crushing and screening. 5 Edward W. Merrow, Industrial Megaprojects: Concepts, Strategies, and Practices for Success, John Wiley and Sons, New York and London, 2011. 6 The definition of failure used by Merrow is that the project cost overran its budget by more than 25 percent, the cost index was 25 percent higher than industry average, the execution schedule slipped by more than 25 percent, the schedule index was more than 50 percent higher than industry average, or the project was suffering from significant production problems more than a year after start-up. 2
hand, Australia s engineering, project management and construction capabilities have not kept pace with demand. Benchmarking Project Performance Four sets of measures are important in assessing the success or failure of a capital project: safety performance during implementation and start-up, whether the project met the business objectives, whether the project was delivered on time and on budget (predictability measures), and whether the capital cost and schedule performances were competitive against global industry benchmarks. In benchmarking capital projects, IPA focuses on all of the measures described, but for the purposes of this paper, we will concentrate only on the cost performance measures. Cost competitive measures are expressed as an index in which the industry average is adjusted to equal 1.0. Cost indices greater than 1.0 are worse than average, while indices lower than 1.0 are more competitive. In benchmarking project performance, IPA s usual approach is to adjust for factors outside the control of the project team in order to focus on project management practices. Price escalations and currency fluctuations through the life of the project are adjusted out by converting all costs to U.S. Gulf Coast 2003 dollars. Adjustments are also usually made for local labour rates and some elements of construction productivity. Construction productivity is adjusted on the basis of productivity factors IPA developed for each of the project location countries 7 by conducting a series of twinning studies whereby the number of construction labour hours for a project in each country was compared against those for a project with a very similar scope conducted on the U.S Gulf Coast. Using this approach, Australian processing projects in non-remote locations were found to use, on average, 1.3 times as many field labour hours as similar projects on the U.S. Gulf Coast. 8 The Australian productivity adjustment factor has recently been increased to 1.35 based on feedback from clients that productivity in Australia is declining due to the dilution of construction skills, more onerous construction management processes, higher turnover, and other factors that are not as prevalent in the U.S. Australian Industrial Project Performance IPA s brief in preparing this paper for the Business Council of Australia was to provide a summary of Australia s industrial project cost performance compared with the rest of the world. As mentioned earlier, IPA s usual approach to benchmarking projects from all over the world is to convert the project costs to U.S. Gulf Coast 2003 dollars by adjusting for location however this approach masks the impact of higher wage rates and poorer construction productivity in countries such as Australia. For this Business Council of Australia review, we have reversed the location adjustment in order to compare the cost of Australian projects directly against the cost of conducting similar projects on the U.S. Gulf Coast. To better understand the performance of Australian industrial projects, we divided the sample of Australian projects into four groups and assessed the performance of each group compared with the global industry. As will be described, there are significant differences between the performances of each group. Table 1 provides a summary of the average cost of each group of projects compared with the cost of installing equivalent projects on the U.S. Gulf Coast without adjusting for Australian labour rates and construction productivities. 7 By each location, we mean each country for which IPA has a robust sample of projects for comparison. 8 This does not mean that the Australian workers work 30 percent slower than their American counterparts. Productivity is a function of many things, including project execution planning, construction management, logistics, labour practices, etc. 3
Table 1 Summary of Australian Project Cost Performance Without Location Adjustment Project Group Average Cost Compared to U.S. Gulf Coast Comments Sustaining capital projects Iron ore and coal developments Large, complex processing projects Offshore oil and gas developments 40 percent higher 38 percent higher 50 percent higher 200 percent higher Average performance has steadily improved over the last 15 years. Projects are generally predictable. Average cost and schedule overruns were about 5 percent. Costs are highly variable. Benchmark does not include the cost of projects that were abandoned during execution. Prices for lay barges and drilling rigs in Australian waters have risen steeply over the last 5 years. On average, Australian industrial projects are more than 40 percent more expensive than similar projects conducted on the U.S. Gulf Coast. The average is a straight average and is not weighted by project cost. If it were weighted, the average cost index would increase. 9 Below we describe each group: Sustaining Capital Projects: Sustaining capital projects are usually smaller, stay in business-type projects that typically cost less than about $15 million and are conducted at existing sites by the site engineering organisations. Examples include modifications to oil refineries, alumina refineries, etc. Of the overall sample of 650 completed Australian capital projects studied, about 400 were sustaining capital projects. There has, on average, been steady improvement in the performance of sustaining capital projects over the last 15 years. The best Australian sites are now amongst the best in the world in terms of project delivery performance (after adjusting for location). Iron Ore and Coal Developments: These are large materials handling-type projects that involve the mining of iron ore or coal, crushing and screening, movement by truck and rail, and stockpiling and ship loading. The sample consists of 28 projects, 16 of which were completed and 8 that are in execution. The projects have typically had high returns on investment and the businesses were keen to have the projects implemented as quickly as possible. The average cost and schedule overruns were about 5 percent. The average cost of the projects was 38 percent higher than U.S. Gulf Coast but this figure reduces to 15 percent after adjusting for location. 9 The average cost index of the aggregated Australian project sample is calculated as 1.43. That is, Australian industrial projects are, on average, 43 percent more expensive than an equivalent project on the U.S. Gulf Coast. By equivalent project, we mean a hypothetical project implemented under US Gulf Coast conditions. 4
Large, Complex Processing Projects: The sample consists of 28 completed projects that had a capital cost of more than $100 million and that involved chemical and/or thermal processing of oil, minerals, or chemicals. The sample contains major oil refinery upgrades, innovative mineral processing plants, and brownfield expansion projects. The average capital cost was $1.05 billion and many could be classed as megaprojects. Of the sample of 28 projects, only 4 projects were delivered on time and on budget and worked as expected. A further two projects had cost and/or schedule overruns of between 10 and 25 percent, but worked as expected. The remaining 22 projects (79 percent of the sample) were classed as failures with cost and/or schedule overruns of more than 25 percent. Over half of the failed projects were ultimately abandoned after incurring major cost overruns. Offshore Oil and Gas Developments: IPA has benchmarked the cost of installing a typical offshore oil and gas facility 10 in all major oil and gas producing regions of the world. The study showed that Australia and Norway were the most expensive locations in which to install offshore facilities for the production of oil and gas. A typical offshore asset installed in Australia is more than three times as expensive as a similar asset installed in Thailand or the Gulf of Mexico. Location Adjustment and Productivity As has been described, in benchmarking capital projects, IPA location adjusts the project costs to U.S. Gulf Coast 2003 dollars. If we take the average cost index of 1.43 described above and adjust for Australian construction wages and some of the factors that reduce Australian construction productivity, the average cost index becomes 1.19. In adjusting for location, IPA assumes that engineering, major equipment, and bulk materials can be purchased on the world open market and, as a result, makes no adjustment for these items. Only site construction labour and first line supervision are treated as country specific and adjustments are made for local wages and conditions. The location adjustment is calculated using the rates and productivities shown in Table 2. An exchange rate of A$1:00 equals US$1.00 has been assumed. Table 2 Construction Labour Adjustment Australia U.S. Gulf Coast All-in construction wage rate close to a capital city $80/hour $68/hour Productivity factor 1.3 1.0 Using the information shown in Table 2, the amount of construction that could be purchased for $1.00 in non-remote parts of Australia would cost 68/(80*1.3) = $0.65 on the U.S. Gulf Coast. As will be discussed, this figure falls to about $0.20 for remote parts of Australia. That is, the cost of construction work in remote parts of Australia is about five times the cost of construction work on the U.S. Gulf Coast. Table 3 shows a typical make up of costs (in say millions of dollars) on an Australian project and the conversion to U.S. Gulf Coast dollars using the above construction cost 10 A typical offshore facility consists of a well head platform, a platform mounted processing facility, subsea tie-backs and an export trunkline that links the platform to the shore. 5
adjustment and assuming that engineering, project management, equipment, and bulk material costs remain the same. Table 3 Location Adjustment between Australia and US Gulf Coast Australia US Gulf Coast Equivalent Engineering and project management 21 21 Equipment and materials 30 30 Construction labour and field supervision 49 49*0.65=32 Total 100 83 Thus, the location factor for Australia compared with the U.S. Gulf Coast for the situation described above is 100/83 = 1.20. The above calculation is a best case scenario because it assumes that Australian projects can purchase engineering, project management, and bulk materials at world open rates, but this is not the case for most Australian projects. Australian engineering and project management rates are considerably higher than those for the U.S. Gulf Coast or even London. Bulk materials (steel and concrete) are also more expensive. Further, labour rates are significantly higher and productivity is usually lower for projects in more remote locations in Australia. Typical figures for a remote Australian location such as in North West Western Australia are an all-in rate of $120 per hour and a productivity of 1.60 compared with the Gulf Coast. If we substitute these numbers into the calculation shown in Table 3, the Australian location factor becomes 1.70. Note that the rate of $120 per hour does not include fly-in flyout or camp and accommodation costs. If these are included, the rate exceeds $200 per hour. Many of IPA s Australian clients report that construction productivity is deteriorating with time. Factors cited as contributing to the deterioration include: The aging construction workforce and reducing number of skilled and experienced tradesmen Fewer experienced front line supervisors willing to work in remote locations More stringent induction and safety management processes A decline in the quality of engineering caused by a lack of experienced engineering personnel. Mistakes in engineering inevitably lead to re-work in the field, which reduces productivity. Australian Project Cost Performance The average cost index of Australian projects after adjusting for location as described above is 1.19, but the range is large. 11 There can be many drivers of the additional 19 percent in cost, including: 11 The combination of the cost index and location adjustment described above means that an average Australian project located close to a capital city is 43 percent (1.19*1.2 = 1.43) more expensive than the average equivalent project on the U.S. Gulf Coast. 6
Factors described above that contribute to the decline in productivity Poor project definition prior to project approval that will then cause problems with engineering and procurement and result in poorer construction productivity Poor control of project cost, schedule, quality, and logistics during execution How Can the Australian Government Help? The reason the Business Council of Australia commissioned this paper is to promote dialogue with Australian governments over how to address the issues faced by both governments and Industry in implementing the ever-growing portfolio of work. IPA s view is that responsibility for success or failure of any project ultimately lies with the project owner, be it a company or a government department. Responsibility cannot be contracted out. That said, Australia is entering into a new paradigm with the number and scale of megaprojects being considered or implemented. These high-profile projects have many stakeholders and getting alignment amongst stakeholders is one of the most difficult challenges facing any major project. For example, managing the interfaces between companies and the various state and federal government departments needed to obtain the requisite project approvals is a major, time consuming activity. The Canadian government recognised a similar situation and set up its Major Project Management Office 12 in 2007 with the objectives of improving project coordination and streamlining the interfaces between projects and government departments. The objectives show good intent and are particularly relevant to the Australian situation, although feedback from IPA s Canadian clients is that they are yet to see significant benefits. Another area that will need to be addressed is the lack of engineering and construction resources in Australia. This topic has been discussed in the press for years, but there are few signs of improvement. Many of the barriers to global competition have been removed (e.g., through the removal of tariffs), but one area that is not fully open to global competition is access to competitive engineering and construction resources. Conclusions In absolute terms, Australian projects are significantly more expensive compared with projects conducted on the U.S. Gulf Coast. On average, it costs over 40 percent more in U.S. dollar terms to implement a project in Australia compared with the U.S. Gulf Coast. The costs are driven up by a combination of the high exchange rate between the Australian dollar and U.S. dollar, high cost of engineering and construction wages in Australia, poorer construction productivity, and a range of other project management factors. If we adjust for factors such as currency exchange rates and price escalation that are outside the project team s control, the performance of Australian industrial projects varies from being equal to the world s best for some of the recent small, sustaining capital projects to being amongst the most expensive in the world for offshore oil and gas developments to having very high failure rates for large, complex processing projects. The level of capital investment in Australia has significantly increased over the last 7 years. Looking forward, the level of project activity in Australia is expected to increase due to the large number of projects about to start implementation. Many of the planned projects are larger and more complex, meaning they will be more difficult to implement compared with recent experience. On the other hand, there has not been a commensurate increase in 12 See www.mpmo-bggp.gc.ca 7
Australia s engineering, project management, and construction capabilities. Further, many of IPA s clients advise that they are seeing a decline in construction productivity. We conclude that Australia will struggle to successfully implement the total portfolio of projects planned for the next 5 years. Australia already has an international reputation for poor project delivery performance and this reputation is likely to continue unless there is strong leadership from industry and government to address the issues discussed. About the author Rob Young a Master Analyst for Independent Project Analysis, Inc. He joined IPA when it opened its Melbourne office in 1997 and since that time IPA has taken an active interest in trying to improve the performance of Australian industrial projects. More information about IPA can be found at www.ipaglobal.com. 8