Investment Cost Calculations in the Process Industry: Understanding Failures and Pursuing Accuracy

Frequent headlines and discussions lamenting budget overruns in infrastructure and industrial projects raise questions about the accuracy of investment cost estimates. Criticisms often target project management and the accuracy of calculations, prompting queries like, “Can't they manage projects? How difficult is it to calculate accurately?”

This text seeks to offer insights from AFRY and a technical consultant regarding investment cost calculations in the process industry. By addressing common questions and providing potential answers, we aim to shed light on this complex issue.

Challenges with the Investment Cost Estimate

Why estimate Investment Costs? The rationale behind investment cost estimates may appear straightforward: to ascertain the investment's cost, assess its profitability, and arrange financing. However, in certain contexts, alignment between those responsible for estimates and those making investment decisions isn't always evident. The axiom "one does not invest their own money," often rings true for individuals commissioning and conducting pre-project work, tasked with cost calculations within the industry. Sometimes, motivations for pushing an investment forward transcend short-term profitability, encompassing factors like job security, facility future-proofing, or personal involvement in the project. Consequently, those tasked with estimates may have incentives to minimize costs, either by underestimating or simplifying technically, prior to presenting to decision-makers. As consultants, we occasionally encounter directives such as, "We must keep costs below xxx million SEK, or the project won't proceed." However, once the investment decision is finalized, a shift in mindset may occur.

We often see this change in attitude, before and after the investment decision. Another factor influencing investment costs is the ease of bargaining and keeping ambition levels and costs low in smaller groups in the early project phases. However, as the project progresses toward implementation, the picture becomes clearer, prompting the project group to often expand with representatives from departments such as operations and maintenance joining. Requests from operations or maintenance representatives are often challenging for the project group to refuse, given that they will be responsible for the facility's operations for the next 30 years. Their demands frequently revolve around safety and security aspects.

Consideration might be given to having investment calculations conducted by individuals with no vested interest in the project's success to mitigate potential biases. In certain corporations, it is customary for estimates to undergo review by impartial parties outside the project team, preferably individuals from other sites within the corporation vying for the same investment funds.

Stepwise Approach to an Investment Cost Estimate

Are you preparing an investment cost estimate or outlining a pre-project? Consultants occasionally encounter comments like, “Do you need to calculate and design everything? Can't you just provide a cost?” While a qualified guess might occasionally prove accurate, achieving an estimate with adequate certainty and precision typically demands considerable effort and analysis.

An investment cost estimate typically stands as the most crucial and frequently sought-after deliverable in the initial project phases. If you're keen on avoiding surprises in terms of time and cost, it's advisable to allocate more resources to the early stages and enhance the pre-project maturity to mitigate risks during implementation. However, if your goal is to fast-track your unique project and prioritize time-to-market by skipping certain aspects of project development, be aware of potential pitfalls such as delays, budget overruns, and increased pressure on the psychosocial work environment for yourself, colleagues, and suppliers.

In various industries, including our own, we often encounter different terms and definitions for the early project phases such as Feasibility Study, Pre-Engineering, Basic Engineering, and FEED. To establish a robust groundwork for the implementation phase, we advocate for adhering to the Front-End Loading (FEL) development approach, illustrated in Figure 1. This method offers a unified perspective on the objectives and tasks of each phase, irrespective of industry, and generates valuable strategic insights that empower stakeholders to effectively manage risks and make informed decisions.

The different Front-End Loading (FEL) classes correspond to specific levels of accuracy required in developing the investment cost estimate. These FEL classes align with various classes defined by the Association for the Advancement of Cost Engineering (AACE), a recognized method for cost estimation. Each AACE class is associated with different expected accuracies, which improve as the project matures. AACE defines accuracy as a spectrum of potential outcomes, determined through risk analyses. The specified accuracy range for an investment estimate reflects an 80% confidence level that the actual cost will fall within these boundaries. The calculated investment cost is not a fixed amount but rather a range, within which there is a certain probability of accuracy. It's crucial for those preparing the total project budget to consider this variability. When crafting the total project budget, one should always factor in the accuracy range of the investment cost estimate and its anticipated upper limit.

Figure 2 describes the different AACE classes and their anticipated accuracy ranges.

Sources of Errors in Various Parts of Investment Cost Estimates

At AFRY, we engage with diverse process industry projects and encounter various perspectives on project management. While many clients have well-defined project visions, as consultants, we often aim to accommodate their preferences. However, this flexibility can pose challenges, particularly concerning investment cost estimates, potentially resulting in discrepancies between estimates and actual budgets. It's imperative for consultants to transparently communicate with clients regarding the achievable level of project maturity in the early phases, considering both time and budget constraints, the anticipated accuracy of estimates at that stage, and how investment cost estimates should be understood and interpreted.

An investment cost estimate relies on technical documentation and quantity calculations, influenced by numerous factors, decisions, and choices such as capacity, automation level, layout, materials, technology, and site conditions. Each decision contributes to shaping a cohesive technical solution—a functional plant. Once the design phase is complete, the cost estimation process unfolds in two stages: determining the required quantities of each component, followed by assessing the costs for procurement and installation.

In essence, three primary factors often lead to exceeding investment budgets:

1. Deviations between the actual construction and the preliminary project design.
2. Discrepancies in the quantities of equipment and material required compared to the design specifications.
3. Incorrect assumptions regarding equipment, material, and contract costs.

Understanding these factors is crucial for achieving accurate investment cost estimates and ensuring successful project execution.

Our experience at AFRY, coupled with insights from industry peers and clients, indicates a relative proficiency in point 2: calculating quantities of pipes, cables, concrete, etc., based on process flow diagrams and layouts. However, a notable challenge in this domain lies in comprehending and incorporating elements not explicitly depicted in the existing documentation. Ideally, comprehensive documentation should encompass as many equipment and components as possible to facilitate informed investment decisions. Nonetheless, there are always items that are not designed during the development phases, potentially resulting in underestimations in the quantities used for investment estimates. To cover the missing items, allowances are used, which could be up to 25% in the development phases.

Addressing Point 3 has intermittently proven challenging, particularly due to external factors such as global events, including the pandemic, and periods of inflation. At AFRY, we prioritize transparency and actively share pricing information with our clients to collectively review and evaluate costs. Depending on the project phase, we gather price information and quotes from suppliers. While this approach isn't foolproof, it remains challenging to surpass. Crucially, it's vital to ensure alignment between the supplier's perspective on delivery and scope and that of the project (via clear battery limits, procurement strategy and contract models), preventing potential cost oversights. Moreover, clear definitions of procurement, construction, and assembly strategies are essential. Early-phase estimations often underestimate site and construction costs. Inadequate site investigations can result in unforeseen expenses, such as handling contaminated materials or extensive piling requirements.

The most significant source of error, often leading to substantial budget overruns, lies in point 1: the final construction deviates from the design used in the initial estimate. Why does this occur? There are several reasons, but in essence, it stems from insufficient maturity levels in earlier project phases. The maturity level refers to the extent of development and refinement across various project aspects. This isn't a novel issue, and numerous companies and organizations have devised methods over the years to ensure that the maturity of project work aligns with achieving a reasonably accurate investment cost estimate.

Solution for a Better Investment Cost Estimate

At AFRY, one of the methods we employ to address this challenge is the Project Definition Rating Index (PDRI)[1], a tool designed to evaluate and gauge the clarity and maturity level of a project, comparing it against industry standards. PDRI is closely aligned with the Front-End Loading (FEL) methodology illustrated in Figure 1. Within PDRI, specific deliverables for each FEL phase are delineated, along with the desired level of maturity for these deliverables. This framework enables cost estimation with a certain degree of accuracy. While some PDRI-recommended deliverables are typical outputs of engineering consultants, such as process flow diagrams, layouts, and single-line diagrams, PDRI also encompasses requirements for less conventional deliverables, like maintenance philosophies and process simplifications. These deliverables are crucial to define early in the project lifecycle, as their absence may lead to disruptions during execution, potentially impacting actual investment costs. By ensuring the early definition of critical aspects, the likelihood of late changes is minimized, thereby enhancing the project's adherence to the investment budget.

PDRI serves as a valuable tool for identifying essential deliverables and design decisions. This method not only provides metrics for measuring maturity but also incorporates experiential knowledge to prioritize key aspects at each project phase, thereby focusing efforts and minimizing late-stage design alterations.

It's crucial to recognize that the total costs of equipment and contracts collectively constitute the estimated cost for the facility under consideration. Any modifications to the design inevitably impact this estimate, sometimes in unforeseen ways. The early project phases present a prime opportunity to influence investment costs and mitigate risks, as depicted in Figure 3 below. As the project advances into execution, changes carry increasingly significant implications, affecting a broader range of stakeholders and necessitating adjustments at various levels, often incurring substantial costs.

Conclusion

Production plants in the process industry often entail substantial costs for construction or modification/rebuilt. These facilities are typically extensive, housing numerous costly equipment and components. Hence, a well-founded investment cost estimate forms a critical basis for assessing the project's profitability and determining appropriate financing.

As consultants, it's imperative that we clearly articulate the prerequisites necessary to achieve the desired level of accuracy in the investment cost estimate. Collaborating with clients and potential suppliers, we must ensure that the project attains the technical maturity prescribed by established methodologies, refusing to base estimates on insufficiently supported grounds. Additionally, we must maintain sufficient independence to counter any biases within the project team, ensuring that the facility designed during the pre-project phase remains relevant and viable during execution.

Moreover, we must elucidate the development process of the estimate, delineating the conditions under which it can be applied, the expected cost range, and the probability of it remaining within these boundaries. It's essential for the client or the individual overseeing the total investment budget to comprehend how to interpret the calculated investment cost estimate and consider the anticipated uncertainty.

Given conducive conditions and shared objectives between consultants and clients, it's feasible to generate a reliable and accurate estimate. Such an estimate serves as a robust foundation for investment decisions and successful project execution.