1. AACEI Contingency Forum Contingency Management
EPCM Consultant : Owner’s Representative
Prepared by Haitham Kamil
Montreal October 28, 2003

2. Agenda Definition Relationship with Project Phases
Estimating the Project Contingency
Contingency vs Risk
Who Owns the Project Contingency?
Contingency Management

3. Definition
Project contingency is an integral part of the project estimate, calculated based on available information to cover the following items:
Estimating accuracy (quantities & prices)
Minor errors and omissions
Normal market conditions
Minor labour disruptions
Design development (excluding enhancements)

4. Definition (cont’d)
Project contingency does not cover the following items:
Project Risk (Technical, Labour, Acts of God), Project risks shall be identified and managed (Mitigated, Avoided, Transferred, or Accepted)
Scope Changes !!
Project enhancements (improvements or options)
Force majeure
Major changes to the estimate basis and assumptions
Foreign Currency Fluctuations
Price Escalations

5. Definition (cont’d) Project Contingency – a balancing act !
Estimates prepared with little information (No or very little engineering at OME level)
Owners would like the contingency to cover all items such as Risk, Scope change, Enhancement, changed conditions, force majeure, etc (EPCM firm expected to have a crystal ball)
To cover for all potential risks, the estimate may have to be increased to a level that is unacceptable and makes the project unfeasible and deter the owner from proceeding
Owners arbitrarily cut contingency allowance claiming it will never be needed and to put some added pressure on the EPCM team
Sometimes owners would like to see a very rosy picture and work with the EPCM team to base the estimate on very optimistic assumptions

6. Definition (cont’d) Real world situations and proposed solutions:
EPCM firms do not have a crystal ball
EPCM firms work with and on behalf of the clients to build the most economical plant
Owners, EPCM firms, contractors, and vendors should work together to identify and manage potential project risks
Owners should carry a global reserve fund (risk allowances) for all their operations and capital projects, therefore a catastrophic event will not be covered within the project (Many major companies have this fund managed at the corporate level and need risk assessment from all their operations to evaluate requirements)
Project success should be shared by all stakeholders (Unrealistic expectations will hurt all parties)

7. Relationship with Project Phases
Project contingency varies depending on the phase or stage of the project.
Conceptual (Order of Magnitude estimate)
Contingency = 30% to 50%, Accuracy = +/- 40%
Development (Pre-feasibility estimate)
Contingency = 30%, Accuracy = +/- 25%
Definitive (Bankable estimate)
Contingency = 15%, Accuracy = +/- 15% to 20%
Implementation (Definitive estimate)
Contingency = 10%, Accuracy = +/- 10%
Regular periodic cost forecasts during implementation (Contingency management)

8. Relationship with Project Phases (cont’d)

9. Estimating the Project Contingency
Contingency is estimated based on the confidence level in estimating each part of the project
Estimating confidence could be assessed by facility or by procurement package and contingency estimated accordingly
Contingency requirements could be simply estimated by assigning a contingency amount to each item and the aggregate will represent the overall project contingency requirements
Or a more sophisticated probabilistic model could be used to establish the contingency requirements for a given confidence level of the estimate

10. Estimating Project Contingency Probabilistic Approach
This approach is based on:
Identifying potential variables (Price, Labour Hours/Rate, Quantity, Technical, etc)
Assigning confidence levels for each item or group of items in the estimate (Pessimistic, Most Probable, Optimistic) for each potential variable
Using commercial software such to establish the overall project contingency at a selected confidence level
Owner selecting a contingency level with a full understanding of the probability of completing the project within that estimate

11. Estimating Project Contingency Typical Probabilistic Model

12. Contingency vs Risk
Project contingency covers normal predictable events within the project team’s control
Project risk covers events that cannot be controlled by the project team and may have a huge impact on the project if they occur, some examples include:
Unproven technology risk
Catastrophic events during implementation such as loss of major, custom-made equipment shipment, major labour disruption, bankruptcy of single-source supplier, changing conditions, changing government regulations

13. Who Owns the Project Contingency ?
Major scope changes and project risk shall be covered by the corporate global reserve fund and not within each project
The project can use risk management techniques such as mitigation, avoidance, etc.
The owner should have a separate management reserve to cover:
Minor scope changes
Minor changes in conditions and project assumptions
The EPCM Project manager shall own the project contingency to cover estimating accuracy
Each contractor/vendor usually carry contingency in their prices to cover their own risk on fixed price contracts (this is usually transparent to the owner except he pays for it anyway)

14. Contingency Management
Contingency should be re-evaluated at the end of each project phase
A reasonable contingency amount should be carried for each project phase
Contingency shall not be distributed or transferred to cover overruns; variances for each package shall be measured against the base estimate
During implementation, contingency should be evaluated periodically and forecasted to reflect actual needs
Contingency should not be automatically depleted to balance the overall project forecast