Total Cost Management Dr. Nick J. Lavingia, P.E. Chevron Project Management Consultant APEGGA Annual Conference, Calgary April 26-27, 2007 Nick Lavingia

Dr. Nick J. Lavingia, P.E. Project Management Consultant Chevron Nick has over 30 years of Global Project Engineering, Management, Consulting and Training experience in the Energy industry. As a Project Management Consultant at Chevron, he provides Consultation and Training to Project Professionals worldwide. Nick has a B.S. and M.S. in Chemical & Petroleum-Refining Engineering and a Ph.D. in Engineering Economics & Management from the Colorado School of Mines. He is a registered Professional Chemical Engineer in the State of California. Nick is a member of Project Management subcommittee for Athabasca Oil Sands expansion project. He has published and presented many papers at technical organizations and is a recipient of industry award from Pathfinder for outstanding Contribution to the advancement of Project Management Technology and Chevron Chairman’s award for implementing Value Engineering throughout the corporation. Nick Lavingia

Agenda Total Cost Management: Economic Analysis Cost Estimating Planning / Scheduling Benchmarking Contracting / Procurement Performance Measurement Cost Control / Forecasting Progress Reporting Finance / Audit Nick Lavingia

DEVELOP Preferred Alternative Total Cost Management Phase 1 IDENTIFY & Assess Opportunities Phase 2 SELECT from Alternatives Phase 3 DEVELOP Preferred Alternative Phase 4 EXECUTE (Detail EPC) Phase 5 OPERATE & Evaluate Economic Analysis (NPV, ROR, Payout) Cost Estimating (Conceptual) Planning/Scheduling (Milestone) Benchmarking (Cost / Capacity) (Funding +/- 10% Accuracy) (Definitive) (Cost Collection / Analysis) (CPM Bar Chart) (CPM Resource Loaded) (Monitor & Update) (Set Pacesetter Target) (Pre-Funding Assessment) (Post-Project Assessment) Contracting/Procurement (Strategy) Cost Control/Forecasting (WBS) Progress reporting Finance/Audit (Pre-Qualification) (Award / Monitor) (Closeout) Performance Measurement (Establish Progress Payments) (Earned Value) (Establish Cost Accounts & Budgets) (Trend / Forecast) (Capital versus Expense) (Asset Accounting) P&ID $ EST AFE PFD D Legend: AFE = Appropriation for Expenditure NPV = Net Present Value PFD = Process Flow Diagram D = Decision Point ROR = Rate of Return P&ID = Piping & Instrumentation Diagram EPC = Engineer, Procure & Construct CPM = Critical Path Method WBS = Work Breakdown Structure Nick Lavingia

Tradeoff Between Cost, Schedule & Quality Safety is an underlying value! Safety is the foundation on which we build projects & conduct our business: Technology selection Facility layout Detailed design / procurement Construction Commissioning & start-up Ongoing operation We manage safety as a fundamental part of conducting our business Cost Schedule Quality Safety Project management council – wants to see an improvement Projects bigger, more of them, competitive advantage Nick Lavingia

Economic Analysis Nick Lavingia

Profitability Criteria Net Present Value (NPV)… “Show Me The Money” Definition: Sum of the Net Cash Flow discounted to time zero using a discount rate Benefits: Incorporates time value of money ; easy to understand; recognizes magnitude of profit Can be used for screening and ranking Disadvantages: Independent of the size of the cash flows Nick Lavingia

Profitability Criteria Rate Of Return (ROR)…“Interest Rate” Definition: Discount rate which equates the sum of the Net Cash Flow after tax to zero Benefits: Incorporates time value of money Easy to understand Easy to compare with the cost of capital Disadvantages: Independent of the size of the cash flows Can be difficult to determine Assumes reinvestment at same rate Nick Lavingia

Profitability Criteria Payout… “Time The Money Is Hanging Out There” Definition: Time for Cumulative Net Cash Flow after tax = Investment Benefits: Simple Indicator of investment risk Disadvantages: Ignores time value of money No indication of what happens after payout Nick Lavingia

Profitability Criteria Discounted Profitability Index (DPI)…“Bang For The Buck” Definition: DPI = 1 + (NPV of Net Cash Flow / NPV of Investment) Benefits: Accounts for the relative size of the cash flows Used for screening / ranking Recognizes magnitude of profits Disadvantages: Does not give as good an indication of sensitivity to additional investment as NPV Nick Lavingia

Cost Estimating Nick Lavingia

} What is a Cost Estimate? Realistic representation of final project cost at any stage of project development to meet a specific project objective Basic Components: Base Estimate + Contingency Total Cost Estimate Accuracy around the total } Nick Lavingia

Quality of Estimate Nick Lavingia Contingency column is illustrative only, should evaluate contingency for a specific project based on that project’s status and risks. Include a copy of the full table in the handout package for the training session Chevron makes Class 1-3 estimates, contractors make Class 2-5 estimates Reference: CEM, Section 103, Figure 103-1 (extract only) Nick Lavingia

Estimate Methods Phase 1 Estimate--Cost/Capacity curves Phase 2 Estimate--Factored estimate based on major equipment costs Phase 3 Estimate--Detail estimate based on bids for major equipment and bulk takeoffs Nick Lavingia

Estimating & Contingency Determination Phase Phase Phase 1 2 3 +/- 50% +/- 25% +/-10% Estimated Cost Final Actual Cost 1.0 Evaluate Alternative Develop Detailed Design Construction Startup Conceptual Contingency Variance Base Estimate Nick Lavingia

Contingency Frequency of Occurrence Minimum $0.8 $1.4 Maximum $1.0Million Cost (-20%) (+40%) Cost Most 50/50 Value Likely MEDIAN Value MODE Nick Lavingia

Cost Estimate Confidence 90 % Chance that cost will not be exceeded cost will be exceeded Equal Chance of cost exceeding or being lower 90/10 50/50 Base 10/90 Contingency Allowances Identified Scope Nick Lavingia

Evolution of Estimate Accuracy COST 50% 10% 90% PHASE 1 IDENTIFY Minimal Engineering Low definition detail Wide accuracy PHASE 2 SELECT More Engineering More Definition Moderate accuracy PHASE 3 DEVELOP (AFE) Adequate FEL (15-30% Engineering) Well defined +/- 10% accuracy Nick Lavingia

Planning / Scheduling Nick Lavingia

Project Time Management - Scheduling Project Time Management includes the processes required to ensure timely completion of the project: Activity Definition - identifying the specific activities that must be performed to produce the various project deliverables Activity Sequencing - identifying and documenting interactivity dependencies Activity Duration Estimating - estimating the number of work periods which will be needed Schedule Development - analyzing activity sequences, activity duration and resource requirements to create the project schedule Schedule Control - controlling changes to the project schedule Nick Lavingia

Schedule Level Definitions Nick Lavingia

What Is A Plan? METHODS MEANS LOGIC IDEAS A Plan Defines Activities Involved in a Project, Their Logical Sequence, and Their Inter-Relationship Nick Lavingia

Contingency or Float is Added to Estimates to Reduce the Risk of Overrun. Estimates are inaccurate because they are predictions of future events and the amount of variation that will actually occur is unknown. Cost Estimate Probability Analysis 150 145 140 Appropriated Value 135 130 Cost ($millions) 125 120 115 Cost w/o contingency 110 Schedule Probability Analysis 105 28 100 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 27 Appropriated Value Probability 26 25 Schedule (months) 24 23 Base Schedule 22 21 20 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Probability Nick Lavingia

Contracting / Procurement Nick Lavingia

Current Trends in Contracting & Procurement Materials & Equipment Lead times are increasing Prices are increasing Inventories are decreasing Material shortages Services Contractor capacity is decreasing Craft workforce shortage Labor rates increasing Fabrication Shop loading is high Pricing is volatile Marketplace Marketplace is strong Global mega projects Suppliers have choices Nick Lavingia

What Can Buyers Do? Demand Planning Market Intelligence Plan requirements well in advance Aggregate demand Leverage volume Market Intelligence Use market data to mitigate cost increases Monitor supply/demand Investigate new market entrants Commercial Considerations Have and stick to Strategy Tie cost increases (future decreases) to major underlying cost components Leverage volume & spend Lengthen term of agreement Define work scope & manage contractors Supplier Relationships Exploit long term relationships Qualify additional suppliers Don’t let supplier know you are desperate Nick Lavingia

The Contracting Process Assess Contracting Opportunities Develop & Review Alternative Contracting Strategies Pre-qualification Bidding/Negotiating Evaluation and Agreement Execution of Contract Administration Nick Lavingia

Types of Contracts Cost Reimbursable Guaranteed Maximum Unit Owner’s Owner’s Control Cost Reimbursable Fixed Price Owner’s Risk Unit Guaranteed Maximum In addition to deciding how many contractors we need, we must also decide what is the most effective type of contract to use. There are a variety of contracting methods available. Nick Lavingia

Selection of Contracting Strategy Item Lump Sum Reimbursable Scope Definition* Market Condition Owner Participation Owner Control Owner Risk Good Slow Low Minimum Poor Busy High Tight * Do not award lump sum contracts without good scope definition. Nick Lavingia

Preferred Contracting Strategy Work Facilities Process Units Utilities Offsites No. 1 No. 2 No. 3 Project Management Owner Management Support Consultants or Contractors Proprietary Technology Owner / Licensor Basic Engineering Package Detailed Engineering Procurement Reimbursable Cost Construction Management Construction Construction Contractors--Lump Sum Commissioning/Start-up Four design categories which range from low cost, relatively simple, short lived plants to high cost, complex facilities. Category 1 = Volkswagen Category 2 = Chevy Category 3 = Mercedes Category 4 = Rolls Royce There is typically a 25% cost increase between Category 1 and 4. Watch example: Casio Seiko Bulova Rolex Category 1 2 3 4 Capacity 12 hr 24 hr 24 hr 24 hr Day-date Day-date Alarm Life 1 yr 3 yr 5 year 10 yr alkaline lithium solar Environment Water 10m 30m 100m Resist Nick Lavingia

Performance Measurement Nick Lavingia

Project Control Cycle - Establish Plan Project Objectives Scope Definition Establish Plan AFE Contracting Plan Estimate Control Budgets WBS Work to Plan Schedules Physical Progress Actual Hours Actual Costs Measure Cost Variance Schedule Variance Productivity Performance Identify the scope and develop a project plan as the first steps of any project. Evaluate vs. 1. Example inputs for developing a project plan are: Project objectives. Scope definition. WBS template structure. Cost estimate. 2. Using the plan inputs, the engineer or project manager will establish a plan which includes: Expenditure request (E/R) and Appropriation Requests (A/R). Contracting Plan. Contracting Budget. Project Schedules. 3. The project objectives and scope identifies the purpose and goals of the project. The project plan will usually break these goals into smaller, measurable, and executable pieces. Plan Cost Summary Forecasts Performance Curves Schedule Status Trends Correct Deviations Nick Lavingia

Performance Measurement EARNED HOURS ACTUAL HOURS POOR P E R F O M A N C GOOD TIME 1.0 The Downstream Operability Index is the product of two things: 1) Utilization ratio - Average production, in the second six months of operation, divided by the maximum demonstrated production. 2) One minus the percentage of unplanned downtime (divided by 100) Nick Lavingia

Cost and Schedule Performance Curves Budgeted SV = Scheduled Variance CV = Cost Variance DT = Time Variance } SV $ or Work Hours } CV Earned Actual DT Time Nick Lavingia

Cost Control / Forecasting Nick Lavingia

Costing System to Support Cost Control Summarize Actual Costs Vs. Progress and Compare to Budget Identify Accounts With Major Variance Accumulate Cost at Project Completion Include in Historical Estimating Data Base If Appropriate Breakdown of Estimated Costs Using the Standard Code of Accounts Do Some Work Account for Costs Account for Workhours Measure Progress Take Corrective Action Nick Lavingia

Cost Control System Spreadsheet or Database COMMITMENTS Purchase Orders and Supplements Contracts and Change Orders Owner Costs EXPENDITURES TRENDS BUDGETS Spreadsheet or Database COST REPORTS Summary Detail TREND LOG Purchase Order Log CONTRACTS Status Summary Change Log Nick Lavingia

Progress Reporting Nick Lavingia

Progress Report No. 1 Nick Lavingia

Progress Report No. 2 Nick Lavingia

3000 – Budget at Completion (BAC) Date Now 2000 – Actual Cost (AC) 1600 – Planned Value (PV) 1200 – Earned Value (EV) Nick Lavingia

Progress Report No. 3 1. Cost Variance (CV) = Earned Value (EV) – Actual Cost (AC) CV = 1200 - 2000 = - 800 2. Schedule Variance (SV) = Earned Value (EV) – Planned Value (PV) SV = 1200 - 1600= - 400 3. Cost Performance Index (CPI) = Earned Value (EV) / Actual Cost (AC) CPI = 1200 / 2000 = 0.6 4. Schedule Performance Index (SPI) = Earned Value (EV) / Planned Value (PV) SPI = 1200 / 1600 = 0.75 5. Estimate To Complete (ETC) = [Budget At Completion (BAC) – Earned Value (EV)] / Cost Performance Index (CPI) ETC = (3000 - 1200) / 0.6 = 3000 6. Estimate At Completion (EAC) = Actual Cost (AC) + Estimate To Complete (ETC) EAC = 2000 + 3000 = 5000 Nick Lavingia

Summary Structured Project Development & Execution Process and Total Cost Management can help achieve World-Class Project Performance: Better Cheaper Faster Safer PROJECTS Nick Lavingia