Thursday, 1 November 2012

MUSKRAT FALLS: THE ‘SKINNY’ ON COST OVERRUNS

My Blog Posts and 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 eleven years, I left the service of government to become engaged 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 SAGD 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 thirty 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 (“EPCM”) 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 70-80% 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.

2 comments:

  1. Very good description of how these firms do business. Had the unfortunate experience of overseeing a construction project for a non profit on the Labrador coast.
    What a battle, won some lost some, could have made it all easy by turning blind eye or going over to the dark side.
    Chose the option of sleeping easy at night.

    Amazes me that this way of doing business does not garner more publicity.

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  2. The bigger they get, the more the chances of some form of large scale corruption seeping in. Many of the people within an organization may be blissfully unaware of these elements but every organization that has grown too large can fall prey to corruption.

    Our myopia with the mantra that "bigger is better" is what is helping push this mega dam project along. Politicians see the "big" job numbers, "big" business gets the lions share of the contracts, and so forth. Of course, with "cost plus" clauses built in, the corporations can't lose.

    Our province's obsession with mega projects and big business is partially to blame for the steady diet of failures over the past fifty years and comes from this "develop or perish" approach.

    Small business can be productive and stabilize an economy, but our governments want the glory and things that make a "big" splash.

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