Industrial Megaprojects

Concepts, Strategies, and Practices for Success

Edward W. Merrow

• Publisher: Wiley
• Year: 2011
• ISBN:
  9781118067505
• Edition: 1
• Topic: Business
• Subtopic: Operations
• Index: Business

Avoid common pitfalls in large-scale projects using these smart strategies

Over half of large-scale engineering and construction projects—off-shore oil platforms, chemical plants, metals processing, dams, and similar projects—have miserably poor results. These include billions of dollars in overruns, long delays in design and construction, and poor operability once finally completed.

Industrial Megaprojects gives you a clear, nontechnical understanding of why these major projects get into trouble, and how your company can prevent hazardous and costly errors when undertaking such large technical and management challenges.

• Clearly explains the underlying causes of over-budget, delayed, and unsafe megaprojects
• Examines effects of poor project management, destructive team behaviors, weak accountability systems, short-term focus, and lack of investment in technical expertise
• Author is the CEO of the leading consulting firm for evaluating billion-dollar projects

Companies worldwide are rethinking their large-scale projects. Industrial Megaprojects is your essential guide for this rethink, offering the tools and principles that are the true foundation of safe, cost-effective, successful megaprojects.

PART ONE

Understanding the Projects

CHAPTER 1

Megaprojects—Creators and Destroyers of Capital

If you have spent much time hiking in the woods, you have probably had that uncomfortable occasion when, after walking for several hours, perhaps chatting with a friend along the way, you suddenly realize you have absolutely no idea where you are or how long it has been since you knew where you were. Many a megaproject director has encountered that same feeling while trying to bring a large and complex project safely home. This book seeks to explain how and why we so often find ourselves lost when trying to develop and execute very large industrial projects. If we can understand how and why we tend to get lost, we will better recognize when we are leaving the trail, find our way back if we do get lost, or at least know when to plead for directions.

Industrial corporations create their capital assets primarily through projects. The first decade of the twenty-first century has seen more very large and complex projects executed by the process industries—oil, chemicals, minerals, and power—than any comparable period in human history. These projects satisfy the world’s demand for energy, metals, chemicals, and other products. Without them, modern society as we know it could not exist.

Projects have increased in size and complexity for a number of reasons: easily accessed resources close to markets have largely been depleted; international oil companies must venture into deep water and other difficult environments because national resource holders control more easily developed oil and gas; and chemical companies seeking lower-cost feedstocks need to exploit economies of scale to compete globally and often must go to the source of the feedstocks to make the project viable. The need for extensive infrastructure development means that many projects will have to be very large to spread the infrastructure costs over a wide enough base of beneficial production to be economic.

As the projects have increased in size and complexity, they have become much more difficult to manage. Cost overruns, serious slips in completion schedules, and operability problems have all become more common. Many of these very large projects end up being disappointing to their sponsors; a fair number turn out to be massive destroyers of shareholder wealth; and a few are horrendous with respect to anything and everything involved—the investing companies, the local population, and the environment. When megaproject disasters become public knowledge, which is rarely the case, they damage reputations and even jeopardize continued existence.a

The research program of Independent Project Analysis, Inc. (IPA) on megaprojects over the past five years shows clearly that virtually all of the poor results of these projects constitute self-inflicted wounds. The sponsors are creating the circumstances that lead inexorably to failure. And that is profoundly good news! Problems we cause ourselves, we can fix.

Who Should Read This Book?

Anyone with responsibility for large, complex, or difficult capital projects will find things of interest in the pages that follow. My particular goal is to help those who sponsor, direct, or work on large projects guide the projects to safe and successful outcomes. My special focus is on what I call “industrial megaprojects”—very large projects sponsored by the petroleum, chemicals, minerals, power, and related industries.

Anyone interested in complex projects, even if they fall far short of megaproject status, will find the story of these projects informative to their situation. Most of the basic principles of doing megaprojects well are the basic principles of doing all projects well. Megaprojects display some attributes that are common to megaprojects and uncommon in smaller projects, and we will focus our attention on those. But if the reader is interested in projects, megaprojects will always be fascinating.

I very much hope that members of boards of directors of companies that sponsor megaprojects read this book. To be blunt, when it comes to the governance of large projects, most boards strike me as brain dead. They are not asking the right questions, and they are not asking questions early enough in the process to deter bad decisions.

Those who finance major projects should find a great deal of interest (forgive the pun) in the book. In many respects this book is all about large project risk, which is a key concern for banks and others involved in project finance. It is my observation that bank financing often increases cost while doing nothing whatsoever about project risk.

Those who are concerned about the management of the modern publicly owned industrial corporation and teach others about how it should be done will also find this book interesting, and perhaps very disturbing. The failure of these projects is symptomatic of the core problems of the modern firm: too much outsourcing of key competencies, poorly informed decision making, a woeful lack of accountability for results, and a pathological focus on the short term at the expense of the long-term health of the corporation and its shareholders.

What Is an Industrial Megaproject?

The projects that are the subject of our research are a subset of all projects and even a subset of large projects. We focus on industrial megaprojects. By industrial, we mean projects that make a product for sale, for example, oil, natural gas, iron ore, nickel, gold ingot, diamonds, and high-volume chemicals. All of the projects under scrutiny were intended to make an economic profit, at least eventually, for some if not always all of the sponsors.b By confining ourselves to industrial projects, we have excluded several classes of important projects: military developments, purely public works and transportation projects, monuments, works of art, and so forth. By excluding these sorts of projects we have excluded some megaprojects from our analysis. We have a couple of reasons for doing so:

• Confining ourselves to projects that are intended to make money simplifies the task of assessing outcomes, not necessarily simplifying the range and complexity of objectives in the projects. Although it is true for almost all of our projects that someone wanted and expected to make money on the result, it does not follow that all of the sponsors expected to make an economic profit. Some were motivated by jobs creation, political ambition, general economic development, and other “public” goals. These “mixed motive” projects as we call them are an interesting class and pose challenges for for-profit sponsors.
• Having some economic profit motive disciplines and constrains the objectives of the projects in important ways. Some public works projects have objectives that are hard to fathom by mere mortals. Some military acquisition programs appear to continue almost solely on the strength of political patronage long after the military rationale has become obsolete or discredited.c And some “prestige projects,” such as the Concorde supersonic transport, have objectives that must forever be in the eye of the beholder. Who is to say whether prestige has actually been enhanced, and was it by an amount sufficient to justify the opportunity cost of the project? Industrial projects tend to have at least some nicely tangible objectives.

What makes an industrial project an industrial mega project? Megaprojects, as the name implies, are very large. To provide a simple and simply applied definition, we are defining a megaproject as any project with a total capitald cost of more than $1 billion (U.S. dollars) as measured on January 1, 2003. In 2010 nominal dollar terms, that would amount to about $1.7 billion due to the effects of rapid escalation in project costs in the last decade. One can reasonably object that this definition is simplistic; it totally disregards the effects of complexity (however measured) and the project environment on whether the project is a megaproject. The objection is noted but must be dismissed. If we include consideration of aspects other than size in our definition, we forfeit the ability to examine the effects of those aspects on the outcomes and management of our projects. One can also most certainly object that the $1 billion criterion is completely arbitrary. Why not $500 million or $2 billion? Yes, the $1 billion figure is arbitrary, but it is somewhat less arbitrary than it may seem. In the neighborhood of a billion dollars is where we see project outcomes begin to deteriorate sharply.

Why Study These Projects?

There are four compelling reasons to study and understand megaprojects:

1. There are many more of them than in times past, and this will continue for decades to come.

2. These projects are important. They are important to the societies in which they are being done; they are important to the health of the global economy; they are important to the sponsors and others putting up huge amounts of money.

3. These projects are very problematic. They are failing at an alarming and unsustainable rate.

4. There is not much published that speaks directly to the types of projects considered here.

I will discuss each of these reasons to worry about megaprojects in turn.

Increasing Numbers

Industrial megaprojects have become much more common. For much of the 1980s and virtually all of the 1990s, there were few very large projects, even in the petroleum industry. The Norwegian and UK North Sea had been home to a number of megaprojects in the 1970s. These projects had a very difficult go, and without the rapid rise in crude oil prices in the wake of the overthrow of the Shah of Iran, almost none of the megaprojects in the North Sea would have been profitable ventures.1 Most of the megaprojects that had been in planning stages in the late 1970s died abruptly when commodity prices fell in the early 1980s.

However, a number of factors have converged to make megaprojects much more common in the first decades of the twenty-first century, and these factors give every indication of being enduring drivers of very large projects. The first factor driving the current wave of megaprojects has been the rapid rise in the demand for almost all major commodities; iron ore, coal, copper, and petroleum have all experienced very rapid increases in demand (and therefore price) since 2003. Previously, most prior commodity price fluctuations had not been synchronized; prices might rise for one or two metals, oil and gold prices might rise for political reasons, but not all at the same time. The underlying common driver this time was the rapid industrialization of China and India in the context of reasonable overall global growth. None of the major commodities are actually facing imminent global depletion; however, most are facing upward sloping long-run marginal costs.

The different commodities have had somewhat different drivers for large projects:

• Opening up a new major mineral ore body has long been expensive. Most major new mines today are in places that require major infrastructure development to be practicable. When a good deal of infrastructure is needed, the production volume must be very large to spread those infrastructure costs across a broad enough base for the venture to be profitable. This makes large size the only avenue to development.
• Crude oil is a special case, at least partially. A large portion of oil that remains relatively inexpensive to produce is held by state companies.2 To stay in the oil business, international companies have been pushed quickly into places where oil is difficult and costly to develop, usually deep water. International companies also have gained access when reservoirs are difficult to produce, for example, offshore heavy oil production in Brazil, very heavy oil onshore in Venezuela, the very sour oil and gas reservoirs in the Caspian area, the very harsh climate off western Russia, or in inaccessible areas such as central Africa. As a consequence, the marginal capital costs of production h...