Capital and operating costs (capex and opex) are most important parameters for decision-makers to go ahead with refining projects. Capital cost estimation may have been the reason for the delayed decisions on many projects or for incurring cost overruns on ongoing projects.

There are a lot of uncertainties even when comparisons are made between two closely related projects due to factors such as differing quality of equipment and products, design differences, market conditions, location and so on. There are cost indexes published regularly by specialised journals and often used in estimations.

While they are a useful tool, their margin of error is becoming unacceptable in today’s multibillion dollar projects. In any case, costs have been going up sharply especially since 2000. The average of the major estimation indexes (Chemical Engineering Projects Cost Index, Engineering News Report Cost Index, Marshall and Swift Cost Index, IHS/Cera and the famous Nelson-Farrar Refinery Cost Index) have risen by close to 52 per cent between 2000-10. The Nelson-Farrar index has risen by 66 per cent between 2000-14.

Years ago tenders were announced based on limited process engineering studies, processing unit capacities, storage requirements and general specifications of equipment and products. Therefore, contractors differed widely in their submissions due to the differing engineering.

Hence, the contract award took too long to be finalised. Client engineers had to use approximations, rule of thumb and indexes to feel their way during negotiations against the more prepared contractor’s engineers. I once made the mistake by telling a contractor about a rule of thumb only to hear that one of his engineers wished to have my thumb to work with and make his life easier.

Errors in estimation

Depending on the degree of engineering design, the margin of error is reduced drastically and so is the contingency contractors usually add to their final estimate. If the engineering is 2 per cent complete, the margin of error in cost estimation could be minus 30 to plus 50 per cent compared to that of minus 5 to plus 15 when engineering is 60 per cent complete.

To reduce the level of uncertainties and errors in estimation, the industry has moved forward to what is now known as front-end engineering and design (FEED) before a tender for a final engineering, procurement and construction (EPC) is awarded. The FEED is usually based on site specific data and client requirements and therefore EPC submissions by different contractors can be close. And the selection is made easier.

It is not unusual in large projects for the client to have more than one FEED submission to select from or even to blend the two and get the best of each. It is even the practice of some owners to allow the FEED companies to submit for the EPC when the time comes.

The FEED usually covers about 90 per cent of the engineering where sometimes even lists and orders of major equipment are prepared.

Based on the FEED and client input with respect to charges, taxes, rent, employment costs and so on, operating costs can also be prepared. This is necessary for economic viability and rate of return of a project.

The lowest EPC bid may not be the best economically and the two parameters must be viewed together over the expected life of the project to make a decision. Especially as operating costs have been going up and differs widely between $2 to $6 (Dh7.34 to Dh22) a barrel depending on the degree of complexity and sophistication of the refinery.

Simple spreadsheet calculations

Estimates must not be done by estimators in isolation but with direct and continued communication with various and interdependent engineering disciplines. They should not be based only on past experience and simple spreadsheet calculations or adjustments made by the estimators.

Therefore, according to Aspen Technology, “the largest EPC companies globally expressed that the estimate is one of the most critical FEED deliverables”. According to a survey by the same source, “spreadsheets are the primary estimating tool used by 37 per cent of organisations worldwide, and 52 per cent in the Asia-Pacific region”.

And that “out of over 160 senior estimators and directors answering the survey, only about 50 per cent are satisfied with estimating performance overall in their organisations today, and 60 per cent identified increasing estimating accuracy as a key strategic issue in their organisations.”

For this reason, FEED and EPC contractors are served well by acquiring more sophisticated engineering and estimation models based on “better estimating software technology, combined with more collaborative business processes”.

The major refining and petrochemical projects in our region cost billions and owners should not shy away from spending a few millions to acquire sophisticated FEEDs and better estimation models. Exchanging data between countries will go a long way in improving overall performance.

The writer is former head of the Energy Studies Department at the Opec Secretariat in Vienna.