Feb 20 2015

On Cost Pressures in the Oil Sands

In the Globe and Mail:

The president of one of Canada’s biggest oil and gas producers delivered a stern warning to the oil sands industry, telling a room full of Fort McMurray business people that they need to start cutting costs or the industry will fall into a “death spiral.”

The “made in Fort McMurray cost” of doing business has risen too quickly and must end, Steve Laut of Canadian Natural Resources Ltd. told members of the local Chamber of Commerce.

Mr. Laut said oil sands producers were making three times the profit in 2004 when a barrel of oil cost about $40 (U.S.) than it did when the price hit close to $100 in 2013.

Laut is correct, except that he is missing out on a major part of the problem.  I have discussed this before.

One of the problems is that the oil companies have been driving costs up with behaviour that they THINK is driving costs down:

  • Micro-managing capital project execution, and involving far too many people in the effort.   Rather than having a small, but knowledgeable group clearly define what they want to achieve, they build bureaucracies with silos that are not aligned on the same goals.  The bureaucracies then hire contractor firms in different areas of expertise and try to manage the interfaces themselves.  Rather than define WHAT they want, they define cumbersome processes for HOW they think the work should be done.  I have recently worked on projects were the Owner’s Costs during design were higher than the engineering contractor costs.   Owner company personnel with limited experience quote textbooks on project management to contractors with 30+ years of experience successfully managing projects.
  • In doing the above, the management of interfaces is something that is very easy to talk about, but very challenging to perform well.  Failure to contractually ensure all the parties are aligned to the same goals, and not understand the big picture usually leads to disputes, claims, schedule delays and cost overruns.
  • Overwhelmingly trying to avoid the LAST mistake, rather than watching out for the new ones.  In hindsight, many failures are blindingly obvious, yet great effort is spent to ensure they are avoided when in reality those are not the failures that will screw up the NEXT project.   This tunnel vision for past failures usually leads to blindness towards the future.
  • Unwillingness to change, or as I mentioned last year – unwillingness to try something new.  If we want lower costs, perhaps we need to look at some of the most fundamental parts of what we are doing and seeing where the big costs REALLY are.  You can’t realistically expect to build the same thing as last time for 30% less unless the price of materials and labour drop precipitously.  Try new technology, try new approaches.  Stop being afraid of small failures.  Avoiding opportunities will doom you to bigger failures.
  • Cut the bureaucracy.  Look VERY hard at the work processes, procedures, systems and requirements you have for your own teams and your contractors and suppliers.  A lot of this appears to be there to cover someone’s ass so the claim of “it’s not my fault” can be hauled out later.  A lot of the requirements that have been built up over the last decade or two are not improving quality or controlling cost.
  • Push the government of cleanup and streamline the regulatory environment.   The biggest reason the government regulations in Alberta take so long to comply with is that they aren’t clearly defined.  Each project has to ask for specific permissions and get approved.  No two projects are alike – so each one has to flounder around in the dark, spending inordinate time and money to comply with unclear rules, and then react to new requirements and changes from the regulators.  How about just defining the rules for everybody ONCE?

Here are some numbers to give you a sense of why costs are rising and how the suppliers are not the only ones driving costs up:

  • Projects in Alberta today require about 2-3 times as many engineering effort hours as they did in the 1990s. No good reason for this.  Industry has better tools and can do “better engineering”, but are we really?  Or are we just making sure no one can be blamed for “imperfections” later.  And if we can do better design, why are we still using design margins and safety factors from the 1950s when we COULDN’T do as rigorous of calculations?
  • Projects in Alberta take WAY TOO LONG.  This is a combination of the engineering, regulatory, manufacturing and construction timelines, yes, but it mostly has to do with the speed of decision making.  If a decision can’t get made, progress slows or stops.   How is it that the Manhattan Project in the 1940s went from a science project under the stands of the football stadium at the University of Chicago in 1942 to a WORKING nuclear reactor by 1944 and a working nuclear bomb by 1945?  Yes, they had a lot of money, but the will was there to make decisions to make that project happen.  Today, we can’t build a plant to treat water, boil it and separator oil and water in less than 5 years that costs a SMALL fraction of what Manhattan cost.   This extension of schedule drives up costs too because you are paying all of those people for that much longer and giving them more opportunity to change their minds and interfere in the design and execution long after the value of those changes can be justified.
  • Some of the oil companies have identified that the number of people they have on staff for each unit of capital spend has risen dramatically (in some cases by a factor of 10) since the early 2000s.  The problem is that there are many in those firms who think the problem was lack of owner oversight, and the failure to get recent project rights means they need still more.  Doing the same thing over and over again hoping to get different results has been termed insane.

So I would challenge Mr. Laut and all of the other oil sands company executives to take a hard look INSIDE their own organizations to see what they are doing that is driving up project costs.



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