Why Pakistani oil and gas projects fail

Owner decision-making, flawed EPC terms and weak evaluation criteria are to blame

ISLAMABAD:

Pakistan has recently made a number of hydrocarbon discoveries, which need rapid and economical development. This led me to study some associated project execution practices currently in vogue and share suggestions which may help.

Although a project always has two major parties – the owner and the contractor – it is my considered belief that a project's success essentially pivots around how its owner takes certain crucial decisions including those associated with unanticipated challenges during execution. This article also revolves around this concept.

Same challenge, two responses

In the first case a project had hardly progressed for more than two years since award. As a result a new project manager (PM) was brought in. Upon studying the records, he realised that the owner having lost all trust in the contractor had started making direct payments to the subcontractors. Similarly, while most of the project's equipment was yet to be delivered, due to flawed payment terms, 70% payment had already been made. As if this was not enough, both the parties were at daggers drawn and heading for litigation.

The new PM was able to draw the attention of the senior management in the corporate head office and explain the urgency of the required corrective measures. Reacting swiftly, they replaced the CEO of the concerned subsidiary with a capable manager. Losing sight of the bigger objectives of the company, the earlier CEO was reluctant to find solutions. The intervention helped the PM implement a remedial plan and the completed project proved to be the mainstay of the company's later growth.

There was also another project in crisis as badly as above when a new PM assumed its charge. Mapping the project's status, he realised that challenges had started with petty disputes between the company and the contractor. However, undue procrastination on the part of the company had converted them into festering sores, which had virtually brought the project to a complete halt. Topping it all, rationality and objectivity, the tools which come most handy in resolving such situations, had long been lost to negativity and mistrust. Thus ill-informed views dominated the associated discourse in the owner's board rooms.

Still the PM was able to put the project back on track and it started progressing rapidly. However, within a few months the CEO of the pertaining business unit was replaced with one having no experience of carrying any corporate P&L accountability ever. Such corporate disasters do not happen alone. They, rather, come in a swarm of all sorts of petty prejudices and focus on trivialities; generally, coupled with a campaign of corporate McCarthyism. The project proved just one of the victims of the madness which followed in this case. The contract was terminated and the project got lost in the quagmire of litigation, which ensued after the termination.

It is obvious that in the first case, the senior management was able to perceive and process what was presented to them, which enabled them to take a correct decision. In the second it failed in this critical aspect.

Discussion and analysis

The challenge generally starts with shoddy scopes for basic engineering and weak and absurd bids' evaluation criteria, which leads the owner into the miserable arms of an incompetent or a confused engineering consultant. This results into poor scopes for the next phas – project execution. It generally goes hand in hand with a weak contract replete with meaningless, hazy and even contradictory statements, which makes contractors bid high values. This situation can be easily avoided by observing due caution while preparing engineering scopes and also avoiding to patronise weak consultants in the name of cost saving. It does not save anything except creating badly engineered expensive steel jungles in place of required facilities, which could easily have been established in many cases at one third of the cost or even lesser.

Secondly, companies sometimes assign tasks to in-house resources for which they lack capacity. This results in undue disputes and delays. Lack of capacity also begets fear of the unknown, thereby tending the owner to be more and more conservative. This factor probably also has some role in the current widely used payment structure in EPC contracts in Pakistan. As per the same, the contractor becomes entitled to the release of its Advance Payment Guarantee (APG) after the performance test (PT) of a completed facility conducted after the commencement of sales. The sequence of the release is fine; however, many owners prefer to keep it intact at its original value till this stage. In my view, in many cases, contractors can be allowed to periodically reduce its value corresponding to the progress of the project, thereby reducing its financing cost for them.

The PT is followed by a month-long reliability guarantee test (RGT) and then a year-long defect liability period (DLP). A substantial portion of contractual payments, way larger than even the possible 10% liquidated damages (LD), is released after the DLP. This amount generally also includes the cumulative retention money deducted from all the preceding payments. In addition, the performance guarantee (PG) is also kept valid till then. Thus not only a lot of project's cash remains blocked when needed most i.e. during execution, but the conservative terms themselves also make the contractors bid high. Therefore, in order to achieve necessary balance, the entire structure needs a thorough review and rationalisation.

Of course, it can vary from contract to contract too. The current structure may be justified in cases of technologies involving higher complexity factors. However, when conventional technologies are being used, then we should try to align the terms accordingly. Similarly, if the payment milestones are not spread out in short intervals, then there is a great likelihood of the project facing frequent cash-straps. Also, I have seen projects suffering if sizeable payments are not integrated with major progress milestones such as commencement of sales.

Thirdly, a lot of damage is also caused by capacity deficient individuals who just happen to be in the decision tree at the top by virtue of their position.

The decision makers who by exercising considered discretion find wiser solutions to unanticipated challenges succeed in overcoming them as happened in the first example above. That discretion, of course, comes only with holistic relevant knowledge honed over extended periods by practicing it. A decision tree lacking in this capacity can easily end up in tragedies like the one described in the second example above. Our SOEs carrying cumulative losses of around $24 billion are living examples.

Fourthly, companies should prefer small and agile teams for project management equipped with well rounded engineering and commercial competency.

I am confident that a holistic consideration of the above factors can go a long way in radically improving the associated project economics.

THE WRITER IS A PETROLEUM ENGINEER AND AN OIL AND GAS MANAGEMENT PROFESSIONAL