By: Robert A. King and Robert J. Hesse and Robert A. King, Inc. (RAKI), Houston

Every LNG facility is built to make the same product, !!MONEY!! Though owners' business managers know this, too often the message gets lost when responsibility is delegated, or sometimes abdicated, to those who are not stakeholders in the bottom line. It is initially entrusted to the Owner Project Management (OPM) team and later, during a critical step, to the engineering, procurement, and construction (EPC) contractor. This article focuses on the decisions by people concerned with achieving better financial return on the money invested in LNG facilities, including liquefaction plants, export and import terminals, and pipeline systems. First we introduce just a few technical and management topics that demonstrate the potential to save money and reduce losses on LNG facilities. This money then becomes the incentive to examine the role of OPM and the effective strategies for contracting the project work. The emphasis is on maximizing the use of assets and reducing the project time. Industry case examples, including a variety of LNG facilities, are shown in italics with money adjusted for inflation to 1998 US dollars. Obviously company identities must remain anonymous.

COST SAVINGS
The Total Installed Cost (TIC) for an LNG plant is typically distributed as follows: 3% OPM; 12% - Engineering; 50% - Equipment & Materials; 35% - Construction. Hence, what is described here as "Designing For Constructability" (DFC) is an essential element in reducing the capital cost. DFC is a form of value engineering in which the TIC is evaluated vis-a-vis all EPC steps, but especially material and construction. This review is conducted by field experienced engineers and usually reduces TIC by simplified, proven design criteria and techniques. Through the proper application of DFC, potential savings of more than 10% of the TIC is not unusual. There were two contemporary projects at different locations but of equal capacity, with the same owner, contractor, and licensor. The final TIC of one using DFC cost 30% less than the other without DFC.

When contractors estimate TIC they do a "take-off" i.e. count, of all bulk material, much of which is piping and valves. These numbers, together with local labor productivity and manhour rates, then become multiplicative factors in estimating the construction labor costs. The "take-off' numbers are significant because of their cumulative impact on the TIC since they contribute to defining both material and labor costs. The drawing that most affects piping and thus TIC is the Plot Plan. Many Plot Plans are analogous to the boxed grid of a low profile, rural town rather than the more radial pattern of a high-rise city. In a plant, the latter fundamentally reduces the "take-off" quantities by reducing piping distances between equipment. Keeping this in mind, we will describe two examples of ways effective OPM can significantly reduce material and equipment in order to dramatically lower capital costs. In soma cases such ideas are dependent on local field labor conditions. One example is large and one small but both are significant. These cost savings ideas were only a few recently considered for two large base load LNG plants, one of which is currently under construction. It was estimated that a 10% saving off the final TIC would be realized in each case.


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STACKED EQUIPMENT LAYOUT - Major lengths of large diameter pipe interconnect with the propane condensers and other air coolers. Figure 1 shows the air coolers stacked on top of a rack using quarter-point design. This saves significant money by reducing materials, especially piping, and by lessening the labor, particularly to pull pipe and cable through the rack instead of laying it on the wings of the structure. In many locations, either field-poured, tilt-up racks or pre-cast concrete racks can save additional money by reducing steel costs and eliminating fire-proofing. Monolithic mat foundations also eliminate the need for anchor bolts.

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BYPASS VALVE ARRANGEMENT - The dollars are in the details! Figure 2 shows the usual and DFC bypass valve arrangements. Not only does this eliminate half the number of welds, but also reduces the size of several valves. Normally, bypass and block valves are unnecessarily sized at the same internal diameter as the line. A valve twice as large often costs four times as much. This seemingly insignificant concept can save a sizable amount of money on a world scale plant, particularly on stainless steel. On one plant, over US $10 million was saved on carbon steel alone by utilizing DFC bypass valve design.

POTENTIAL OVERRUNS
The corollary to potential cost savings is cost overrun, which is a major concern: both the cost of capital and the capital cost can be critical to return on investment. We estimate a cost overrun of about 7% (compounded) per month of the TIC for schedule delays after mechanical completion. This percentage includes the costs of capital, management, operating labor, and loss of profit. A major LNG plant took over 5 extra months to start-up due to a serious problem with the performance of the main compressor that could have been avoided by competent OPM. This US $2.0 billion project incurred a staggering penalty in excess of US $700 million.

OWNER MANAGEMENT
Only experienced OPM can ensure that all potential savings are realized and cost overruns avoided. In establishing an OPM team, the owner's management must recognize what makes an OPM team successful, what are the challenges staffing the team, and what are the criteria for selecting the team members. Proven MAXIMS for successful OPM can be summarized as follows:

MAINTAINING LEADERSHIP with hands-on, combat experience. A formal education alone does not make a successful leader. Managing for results is what pays-off.

A TO Z PLANNING and close the books every night. The contracting and execution plan, including a well defined scope of work and budget, needs to be established early in the project. The books must be closed nightly to manage the trends in the project by plotting them against the original plan. If there are gaps compared to the plan, corrective action must be taken immediately. On one major LNG chain, to save about $5 million, the receiving terminal tanks were designed at a low pressure. The pressure in the shipping vessel was slightly higher which would have caused a massive boil off during unloading. The receiving terminal tanks had to be reordered at an estimated penalty of over $20 million.

X-ECUTE DECISION COST CONTROL by the managers, supported by professional, experienced cost engineers. Timely and appropriate decisions can only be made based on accurate and timely cost data.

IMPLEMENT ACTION REPORTING, i.e. report for action not history. Computer technology has provided the capability to report the same data in almost an infinite number of ways. Throwing more money and technology at a problem can make it more complex without getting value-added results.

MONEY - STOP CHANGES before the start of EPC when a large amount of money is spent. Once the basic design is completed, changes must be stopped during the detailed engineering phase. Many engineers' strength of exactitude in design can be a weakness in not recognizing the impact on cost for that extra decimal point of accuracy.

SPEED is of the essence. With the right systems, smart people working fast can create a competitive edge. Time is money which goes directly to the bottom line.

OPM must be an experienced, multi-disciplined team with a proven successful track record on previous similar EPC projects, i.e., it must meet the MAXIMS principle. The team should be committed to deadlines. These people must be available in a timely manner for the duration of the project and preferably have previously worked together. Delayed schedule due to late OPM assignment will cost the project many times more than the 3% of TIC they cost the project.

Most importantly, OPM must be independent, having no conflict of interest by either being another owner or a contractor or associated with them. A consortium owner partner is not, "de facto", independent. On one LNG project, the managing partner also owned part of the local utility so was not interested in on-site cogeneration of power even though it would have benefited the other owner partners. Also contractors cannot effectively manage their competitors. On another $1.4 ion project, the managing contractor and execution contractor were both major E&C firms. The managing contractor convinced the owner that the execution contractor wes not performing satisfactorily. The owner was persuaded to switch the contractors' roles. Human nature combined with financial incentive dictated that the managing contractor was not working in the best interest of the owner but in its own best interest since the EPC contract afforded more profit potential. The client incurred an approximate penalty of over US $150 million due to the discord and discontinuity.

Many owners may not be able to staff the OPM team internally. Staffing problems may be due to a number of factors. The owner may lack the experienced people since few base load LNG facilities have been built since the 1970s. International assignments may cause some experienced employees, and their families, to be unwilling to live at the site. Many staffs have been recently re-engineered, i.e. "downsized", with little corporate interest in hiring full time professionals for only the duration of a temporary project. Lenders or partners may require that they staff part or all the OPM roles themselves. Most of these issues can be resolved by appropriately contracting OPM services from a third party.

COST VS. CONTROL
It is clear that there is a great potential for money to be saved or lost depending on the capabilities of the OPM team. But how does that team control the costs? By focusing on saving time, there is a cost reduction. We must review the time and phases during which the money is spent, which, for the purposes of this discussion, we will define as follows. Though generally sequential, these phases can overlap.

PHASE DESCRIPTION	CONTENTS
0 FEASIBILITY PLAN	Concept, Design Basis, Evaluation, Development, etc.
I BASIC ENGINEERING	Design Criteria, Cost Parameters, Contracts Awarded, etc.
II DETAILED EXECUTION	Implementation, EPC Execution, Plant Acceptance, etc.
III PLANT OPERATION	Start-up, Training, Operation, Maintenance, Marketing, etc.

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The classic "S" shaped curve for a project's capital cost versus time is shown in Figure 3. Projects start out slowly, spending little money in Phase 0 and I. This is the time when all goals, directions, and decisions are established which dictate success or failure on a project. Then during Phase II the spending enters a steep curve when the equipment and major materials are purchased and construction starts. Spending slows in the field approaching Phase III start-up and operation.

The same figure contains the approximate inverse of the cost curve which reflects the OPM's ability to control costs for the same time period. At the beginning of the project, the OPM team has the most ability to control the ultimate TIC because it is at that time that they define the scope. In the extreme case, should the project be immediately cancelled, there is little or no cost for the careful planning. In the other extreme, should the project be mismanaged and not started up on time, the project is guaranteed to overrun.

CONTRACTING OPTIONS
We now recognize that there is a potential for substantial time and thus money to be saved and earned. We also know that it is up to the experienced, independent OPM team to lay the ground work to accomplish this objective early in the project, when they have the most control. Time management and DFC savings are examples of ensuring such savings. But the critical step in this equation is when the contract is let to the EPC contractor; when the most control is lost as shown in Figure 3. There are two fundamental contracting options available: Reimbursable, sometimes known as Cost Plus or Time and Material (T&M), provides for payment based on hourly rates for personnel or unit rates for defined tasks plus non-payroll costs such as equipment, material, and fee.

Lump Sum is sometimes known as either Fixed Price or, if plant start-up and commensurate performance guarantees are included, Lump Sum Turn-Key (LSTK). Lump Sum provides for payment of an all-inclusive price for the defined scope.

There are considerable differences between these options that directly affect project schedules, cost and control, payment terms, management flexibility, and other issues. Reimbursable agreements offer the owner the greatest flexibility to modify scope by allowing a partial overlap of Phases I and !1. Lump sum gives the OPM the least flexibility for late scope modifications since there is a distinct break between Phases I and II. With flexibility comes obligations. Reimbursable contracts require the OPM to take greater responsibility to control costs compared to lump sum.

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Reimbursable contracts offer the greatest potential for saving the investor money! But this depends on experienced OPM. The cost comparison of reimbursable versus lump sum in Figure 4 does not show all possible eventualities but will assist in the following discussions with terms in bold. For the purpose of this comparison we will assume that both contracting approaches start with the same Base Estimate of TIC, are bid on a competitive basis, and contain differences based on typical percentage variances of the TIC. The overall result of the following evaluation is that it is not unusual for the Revised Estimate to yield a Final Price for a lump sum contract that is over 10% higher than for a reimbursable contract.

Contingency is added to the Base Estimate to cover Design Allowance and unknowns. Design Allowance is for undefined items, for instance small nozzles, lifting lugs, and "take-off" errors that historically are always present, but at a known amount of about 5% of TIC. When combined with unknowns that cannot be predicted, a total Contingency of usually 10% of TIC is added to the estimate in order to cover the risks of converting to a lump sum price. Such price must also include the contractor's lump sum bidding costs which are typically 0.50-0.75% of TIC. A well managed project should not use the unknown portion of the contingency. In that case, such unused contingency accrues to the owner's account on Reimbursable and the contractor's account on Lump Sum. Contingency is so important that it is one tool for controlling the overall project costs.

Changes to the scope almost always cause the Final Price to be higher than the Contract Price. Changes are often referred to as Change Orders, especially for lump sum. They usually originate from new owner requirements but also come from third party requirements that were not anticipated in the contractor's original scope. In either case, lump sum contractors will price the positive changes at a higher rate than negative changes. Since almost all projects have net positive changes, the result is a cumulative higher price for changes to a lump sum contract than to a reimbursable contract, It is not unusual for changes to a lump sum contract to be double those of a reimbursable contract.

Designing For Constructability (DFC) - principles are applied more effectively under a reimbursable contract because of the flexible relationship between OPM and the contractor in changing scope. But the responsibility for meaningful DFC input during Phase 0 and I still clearly remains with the OPM team.

Schedule is key to a successful project, whether lump sum or reimbursable. Time is of the essence; the schedule must be fast track to reduce capital cost. For lump sum, the contractors' bidding time is usually 3-4 months with an extra 2-3 months for a comprehensive Request for Proposal preparation and bid evaluation by the OPM. Phases I and II do not overlap and the overall project schedule is extended by 4-6 months. For reimbursable, it only takes a few weeks for the contractor to bid its reimbursable rates and the OPM to evaluate those bids. The benefits are more effective use of time and improved on-time delivery of product. This directly improves return on investment which is not shown in Figure 4 since the amounts depend on project-specific economics.

STRATEGY SELECTION
There are a number of issues that can affect the selection of one contracting strategy over another. In most cases, the arguments against taking advantage of the reimbursable approach can be overcome.

OPM qualifications are critical to either option but especially for reimbursable. Owners are wagering that their OPM team can shorten schedule, implement DFC, and manage the risk of cost overruns better than the contractor can under a lump sum contract.

Lender requirements may dictate that the project be lump sum to lessen risk. But the reduction in risk is not nearly as great as many lenders think. Even if the lump sum contractor is properly bonded, secondary costs can have a big impact on the owner. If a contractor is subject to contractual non-performance, the liquidated damages it will pay will not normally exceed its profit or about 10% of the lump sum price. This will barely cover one to two months schedule loss after a failed start-up. On one LNG plant, the EPC contractor could not complete its work so the owner lost substantial money in transferring the responsibility to another contractor.

Schedule restraints may prevent a lump sum approach since the contractor's bidding cycle can add as much as 4 - 6 months to the overall project schedule. The restraints can be caused by many factors including the need to meet a weather window or the relative sensitivity of the economics to early product delivery.

The qualified contractors may be flush with work. This can cause contractors to be unwilling to either bid lump sum or to do so at a reasonable price. Scope definition and its level of detail, if not available early in the project, can also demand a reimbursable contract.

Other considerations, for instance geopolitical, may require the use of local contractors which can affect the normal contracting strategy. Labor availability or process expertise may dictate the need for splitting the EPC contract between engineering/procurement and construction. The engineering and separately the construction may need to be further split into multiple sub-contracts. On some occasions, OPM must pre-arrange or at least encourage associations between contractors in order to best meet the interests of the investors. Such splitting of contracts lends itself to a reimbursable approach.

INCENTIVE TERMS
Incentive terms are a means of sharing revenues between the contractor and owner in order to enhance team performance in meeting specific objectives. Such terms become very useful in addressing project specific requirements like the ones just discussed or in seeking to modify the general results outlined in Figure 4. These terms are usually just variations of the reimbursable and lump sum approaches and should be made quantitative wherever possible.

GUARANTEED MAXIMUM is a reimbursable contract with a guaranteed, not to exceed, price. A contractor will normally estimate the "cap" as if it were a lump sum price. So it will include contingency, some of which may be in the contractor's reimbursable rates. Most contractors are reluctant to contract on this basis since they own the risk and their client owns the reward.

SHARING UNDER-/OVERRUNS from an estimated price, sometimes called a Target Price, is a more equitable way of providing incentive to a contractor than a guaranteed maximum. This approach shares both the risk and reward between the owner and contractor thus encouraging a stronger team effort.

COST PLUS FIXED FEE, sometimes called an Omnibus Fee, is a reimbursable contract with a lump sum fee. This has the advantage of encouraging the contractor to finish the work quickly since no further profit is gained if it continues. Indeed, additional contractor profit maybe lost should it be possible for the contractor to assign the same professionals to other profitable projects.

BONUSES AND PENALTIES as incentives, can be applied to either lump sum or reimbursable contracts. A combination of such incentives is recommended since that fosters greater cooperation between the owner and contractor. They should be quantitative on such things as schedule, field safety, global process guarantees, field rework, variances from Target Price, Change Order values, implemented DFC savings, etc. When applied to DFC, savings can accrue even on lump sum contracts which would lower the final price shown in Figure 4. Incentives can be qualitative on such things as labor relations, team cooperation, etc. but these should be at the sole discretion of OPM. Many incentives are only effective when individuals in the contractor's, and sometimes owner's, organizations share in the bonuses during the course of the project. One major revamp project used open shop construction labor at a plant being operated by union labor. Labor relations were critical, and a bonus program that included the construction laborers successfully prevented potential major losses due to work stoppage.

CONCLUSIONS
It is critical to have an experienced, independent OPM team that defines the scope of work early while incorporating all the latest DFC cost savings ideas. Once the EPC contract is let, the OPM team must not allow the design to be changed. With strong OPM the contract should preferably be reimbursable but should have incentive terms to encourage TIC savings even if it is lump sum. Continued OPM management should emphasize a fast track schedule, measuring time to control cost, with successful implementation of all the design requirements. Prompt start-up is essential to prevent major cost overruns.