Construction Management Performance

Readiness Assessment for Managing Large Projects January 2008 Contents

The Construction Management Landscape is difficult and getting worse — Construction costs continue to escalate — Global construction activities increasing, fuel continued demand-driven cost increases — Competition for key construction resources (e.g., project managers, heavy equipment, etc.) to complicate domestic / U.S. power projects — Compressed project schedules as owners wait for environmental picture to crystallize Construction Management Tables Have Turned — Owners held the trump card previously when construction and supplier over-capacity was rampant; now contractors and suppliers have the leverage Building (or Rebuilding) Construction Management Skills — Owners need to build (or rebuild) a number of construction management skills, both organizational and individual, to succeed in the new environment How ScottMadden Can Help You

Worldwide Economic Growth Stimulates Skilled Labor — Vital to Construction — Construction Inflation Is More Costly, As Well What Does This Mean for Utilities? The world economy continues to grow at a brisk Labor scarcity, especially skilled workers, will likely The cost increases are impacting all infrastructure pace, led by China. This growth has sparked a drive up labor costs long-term, as firms increase projects—generation-, transmission-, or distribution- significant run-up in construction inputs, both for wage rates to attract candidates to the construction related—and they will impact utilities in direct and commodities and equipment like transformers and trades. Indeed, skilled labor supply and demand indirect ways. For example, rising copper prices will turbines curves crossed in April 2007 increase T&D cable costs Oil price increases have impacted materials From January 2000 through January 2007, the This creates sizeable challenges for utilities. transportation costs as well as inflation. Crude oil Skilled Labor Index increased at a 4.1% CAGR; this Infrastructure spending must continue. U.S. electric domestic prices during 2005-06 were on par in real rate was 4.8% between 2003 and 2007 utility net plant is over $700 billion today, and CERA terms with their highest levels in the late 1970s and projects that $800 billion needs to be invested in the early 1980s While less dramatic than materials cost increases, North American power industry over the next 15 years labor wage inflation contributes significantly to (excluding potential CO2 reduction-related capex). With From January 2000 through January 2007, the construction cost increases, given labor’s cost as a a current market capitalization of just over $500 billion, Material Price Index increased at a 2.3% CAGR; percentage of total energy and utilities’ construction investor-owned electric utilities have not faced this level prices decreased from 2000 to 2003 but have since costs of investment in 30 years escalated at 6.8% per year Shop and fabrication costs have increased as well, This spending will likely be in steadily increasing The United States is also hampered by lower compounding this problem increments rather than a quick peak with an abrupt fall- currency valuation, so imported goods are now more off expensive across the board Rate cases, which had been dormant for years, might Manufactured equipment prices have risen proliferate. There is some risk of 1970s-style rate case dramatically in 2005 and 2006. Estimated price “pancaking” if the environment is significantly inflationary escalations for major power plant components were 13.0% in 2006 and 9.3% in 2005

Long-term interest rates have …But commodity prices …And infrastructure equipment remained relatively stable have spiked in recent years prices have increased U.S. Treasury Yield Curve Selected Materials Prices vs. Annual Price Increase (Recent and 6-Months, One Year & Three Years General Inflation (Index: 1997=100) for Selected Equipment (By Year) 300 80% 6% Ago) Source: Edison Foundation Copper 2003 2004 2005 2006 275 70% 5% 250 60% 225 4% 50% 200 Steel mill 3% 175 products 40% 150 Yield (%) Current 30% 2% Cement 6 Months Ago 125 20% 1 Year Ago 100 1% Prives (vs. 1997)Relative GDP Deflator 3 Years Ago 10% Source: SNL Financial 75 Sources: BLS; Edison Foundation 0% 50 0% 3 Month 6 Month 1 Year 2 Year T 3 Year T 5 Year T 10 Year 30 Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Columns, Line Pipe Exchangers Switchgear Pumps & Compressor Structural Other Vessels Drivers & Drivers Steel Equipment T Bill T Bill Bill Note Note Note T Note T Bond (BEY) (BEY) (BEY) Sources: The World Bank; Edison Foundation; The Keystone Center; U.S. Geological Survey; SNL Financial; U.S. Bureau of Labor Statistics; U.S. Bureau of Economic Analysis; EIA; The New York Times; Platts Electric Utility Week (Feb. 19, 2007) 3 (citing CERA) Copyright © 2008 by ScottMadden. All rights reserved. The Construction Management Landscape Global Construction Activities Increasing

Many industries across the globe are increasing construction activities, creating demand on labor, heavy equipment, logistics, engineered components, and commodities Petroleum Industry NationalNational Average Average Labor Labor Cost Cost Index Index

— “Oil refiners are continuing to roll out plans for expansions and Labor for Heavy Construction and Reinforced Concrete Common Labor Craft Labor GDP Deflator 1 upgrades …” 180

• Similar projects have been canceled or delayed due to rising 170 costs, labor shortages, and equipment delays 160

• Seventeen expansion projects were planned in the U.S. from 150 late 2006 through the year 2010 140 — Maintenance projects were pushed backed due to “delays of ordered 130

equipment and the availability of construction contractors” said Index = (1991 100) Chevron Corp. spokeswoman Stephanie Price and “there were labor 120 shortages as skilled workers flocked to the Gulf Coast to work on 110 Source: The Brattle Group Brattle The Source: repairs on facilities there. This created a backlog that continues 100 2 today.” 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Power Generation Year — New nuclear constructions is ongoing in Europe, looks likely in U.K. and France, and is being considered in the Netherlands and Canada while India and China “have some of the world’s most robust” construction programs3 7% Construction Equipment Equipment Price Price Hikes Hikes 6.9% — China added 102 GW of capacity in 2006 and is expected to more 6% than double that capacity by 20204 — Many U.S. power generators are re-evaluating plans to build new 5% generation as a result of estimated construction cost increases 4% — Limited resources worldwide to provide equipment for nuclear 3.7% construction programs 3% 3.2% Construction Equipment Manufacturers 2% 2.3% 2.5% — Overseas heavy equipment sales by Caterpillar rose 35% in Europe, the Middle East and Africa and rose 23% in the Asia/Pacific region 1% 1.4% 1.5% 1.3% 0.9% 0.2% — Both Komatsu and Hitachi experienced a sales decline in North 0% Source: Statistics CPI DataBureau of Labor America and noted that demand grew in Europe & CIS, China, Asia & Oceania, and the Middle East & Africa 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Note: Year-to-year percent change for August

1. “Upgrade Plans Flow While Oil Prices Ebb,” ENR, October 2, 2006 by Thomas Armistead with Beth Evans 2. “Refineries’ Summer Break,” The Wall Street Journal Online, June 26, 2007 3. “New Realities Bring About a Construction Climate Change,” ENR, September 18, 2006 by Thomas Armistead with Peter Reina and Dan O’Reilly 4. “Costs Hit Coal Building Plans,” February 2007, Power Engineering by Amethyst Cavallaro 4 Copyright © 2008 by ScottMadden. All rights reserved. The Construction Management Landscape Competition for Key Construction Resources

Demand is not just raising prices, it is making projects harder to start and complete on-time with implications on budgets Current and future environment … DeliveryDelivery Schedules Schedules Growing backlog of project contracts at large EPCs Shop Capacity 120 2004 2005 2006 Equipment availability, e.g., cranes, limited to none 2004 Shop Load Current Shop Load Anticipated 2006 Shop Load 1.4 100 Longer lead times for materials and scheduling work 1.2 80 Higher fuel prices increase material extraction/production 1 s 60 and transportation costs 0.8 Week 40 More delays (start and ongoing) are due to labor and skill 0.6 availability constraints (management, engineers, craft 20 Group Brattle The Source: 0.4 levels) Group Brattle The Source: 0.2 0 Construction productivity is declining, in part due to the ) ers P 0 ol H rs scarcity of skilled labor 00 ge els s r Co 5 n mns rs rs rs ls s e u ctors so le ors e se p v Ai (> Vess s lves ot s rs Col re LNG) a M e Val to Excha Rea p 1 Coo V Pum l o xcl. ol V r tro (e Contractors are experiencing: Ai Exchang on Com s ontr C p C olumns/ Large M C Pum — Opportunity to focus on projects where expertise is possessed, owners are reliable and a reasonable return can be expected NationalNational Utility Utility Infrastructure Infrastructure Cost Indices Cost Indices

AnnualAnnual Backlog Backlog at Major at Major EPC EPC Firms Firms — Margins are on the rise with fewer “fly-by-night” Total Plant-All Steam Generation Gas Turbogenerators GDP Deflator Transmission Distribution 190 65000 contractors low-balling on bids 180 60000 — Freedom to turn down contracts with onerous 170 55000 terms or simply walk away ) 160 50000 — Difficulty in finding and retaining skilled and 150 45000 competent workers in trades and management 140 130

40000 100 (1991 = Index

Amount (Millions of $) of (Millions Amount Material and equipment cost estimates are higher than 120 35000 original project plans due to strong demand and low supply 110 Source: The Brattle Group Brattle The Source: 30000 Group Brattle The Source: 100 25000 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2002 2003 2004 2005 2006 Year Year

CompressedCompressed Project Project Schedules Schedules are are the the Result Result

1. “From The Top 400 Contractors, Prosperity Allows Firms to be More Selective,” ENR, September 24, 2007 by Gary Tulacz 5 Copyright © 2008 by ScottMadden. All rights reserved. Construction Management Tables Have Reversed Construction Management Tables Have Reversed Project Management Stages and Definitions

Development Design Scheduling Execution Commission Close-Out

Creation of Detailed Planning and Implementation/ Certification and System punch- scope-level engineering materials supply installation testing of list items closed- design for design equipment out Assessing Permitting planning and development operability (detailed Design drawings estimating Work estimate Long lead time performance Operations and updated with information Information materials monitoring maintenance field changes structure [for ordering inputted into documentation Documentation work work Work delivery Contract closed-out management, management management/ specifications Initial training scheduling and and scheduling schedule and cost development completion cost systems] systems) monitoring prepared Completion of Weekly progress Development work package status reporting of project PEP Short lead time Construction Contract materials check and testing strategy (make ordering versus buy) Development of development operations and maintenance documentation Outage planning interface

Pressure to start later and end sooner affects every stage of large capital project development

Project Life Cycle

PressurePressure toto Pressure to ent D on C Pressure to lopm es duling utio omm e-Out evel ign Sched xec issi Clos FinishFinish StartStart Later Later D E ion SoonerSooner

Engineering Competitive markets design delays Cash flow Fabricator / Low reserve margins equipment supplier queues lengthening Acquisition of labor Underestimated costs Adverse impacts on Lack of commissioning and under funded other projects time and plans project Inadequate contract Delayed Delayed start-up specifications permitting Missing or incorrect Incomplete designs and documentation design documentation Risks

ScheduleSchedule Compression Compression Esca Escallatesates Every Every Project Project Risk Risk

Large capital projects have always been extremely complex and difficult to manage. Emerging conditions have increased the complexity through price escalations, lack of key construction management skills and schedule compression.

Construction management governance, through its eight key skills, provides the foundation for managing construction project risk well.

Project Management Regulatory Work Management Management

Workforce Financial Performance Performance Management Drivers Management

Stakeholder Process Management Management Quality Management

To address the challenges and mitigate risk exposure, companies should initially focus on rebuilding (or building) construction management skills in five areas Planning and scheduling Engineering and design Scope management Job estimating Project controls Work package development Permitting and licensing Decision making Sourcing Public accountability reporting Materials management and Regulatory filing management Project logistics Regulatory requirements Management management Regulatory Work Management Management Staffing Productivity management Project scoping Overtime management Project financing Workforce Financial Performance Contract management Budgeting Performance Management Drivers Work rule management Project financial reporting Management Skills training Project approval hold points Skills / job matching Safety Stakeholder Process Management Management Quality Equity partner interface Management Work continuity Intervener management Work method development Governmental relations Environmental management Standardization Community relations Project performance auditing Procedure management Schedule variance monitoring Process measurement Work quality monitoring Knowledge management

There are three broad approaches to construction management governance

Informal Style and Processes Limited Process Models Market-Based Approaches Description Relies heavily on consensus Relies on formal communication, Relies on formal management Includes few sub-processes to review and decision processes processes defined by Board and integrate enterprise considerations Incorporates multi business unit CEO Relies on perceptions, less process dimensions to integrate Addresses enterprise process empirically-driven enterprise considerations needs comprehensively Invites active and broad owner Uses project requirements to drive Uses business objectives to drive involvement fact-based decisions decision making Emphasizes project cost and schedule Focuses on owner key issues Implements rigorous processes to performance – project focus (i.e., Emphasizes overall project and increase owner comfort levels tactical) business management – program Emphasizes business, financial, Exhibits low to moderate capability of focus (i.e., tactical-strategic) human capital and operations decision tool infrastructure Exhibits moderate to high capability management – enterprise focus of decision tool infrastructure (i.e., strategic) Exhibits high-capability of decision tool infrastructure Key Practices Reliance by owners on third parties to Owners collaborate with suppliers to Owners define and drive define requirements define requirements and protocols decisions and reporting Group decision-making predominates Decisions reflect project economics Decisions grounded in enterprise Decisions driven by project needs and Decision-making based on selected value progress fundamentals Decision-making driven by Decision making is less factor- or Appearance of alliance and information over dialogue empirics-based partnership arrangements Sophisticated use of a full range Prevalence of bid-buy practices with of contracting options some incentive-based contracting Relevance When business scope is narrow When business scale is expanding When business complexity is With a small, tight management group With need to preserve owner demanding When strong buyer-power market interests With increased business conditions exist When buyer-supplier market management goal diversity conditions are balanced If balanced and strong buyer- supplier power market conditions exist

Preliminary planning enables downstream project activities Project spend lags initial planning and engineering The greatest impacts on project success are developed during project planning and detailed engineering phases

100% 100%

80% 80%

Costs committed by planning and design decisions

Spend % of Total Cost of Total %

0% Planning Detailed Procurement Construction Engineering Project Activities

Effective governance practices establish the foundation for realizing the benefits of project management best practices – namely cost leadership and process efficiency, according to the Construction Industry Institute Best PracticeBest Practice Use vs. Quartile Use versus Performance Quartile Performance Best Practice Value Best Practice Value High Impact

Design / Information Technology

Pre-Project Zero Accident Planning Project Technique Change Management Project Schedule Performance Reduction Medium Team Building Impact Planning for Startup

Constructability Materials Management

Low Impact 4th Quartile 3rd Quartile 2nd Quartile 1st Quartile Low Medium HighLow Impact Impact ImpactImpact Low Best Practice High Cost Savings Use Mean Performance Score 14 Source: Construction Industry Institute Copyright © 2008 by ScottMadden. All rights reserved. Building (or Rebuilding) Construction Management Skills Project Management Approaches

There are several broad project management approaches in use today

Project Management Body of Knowledge (PMBOK) Classic construction methodology, with centralized CPM scheduling and PMO-driven project management Production driven centrally through schedule adherence, tight work package preparation and strong “push” drivers for process efficiencies Speed of execution through efficient functional execution is the primary project throughput driver PMBOK methodology driven by optimizing performance along each element of the activity chain PMBOK is the most prevalent project management methodology in industry today Constructability Up-front decisions have the most significant impact on downstream activities All upstream events (e.g., design, engineering, etc.) must be executed around construction and commissioning requirements >15% overall project cost and schedule improvements common with constructability implementation Applications of constructability implementation typically include severe-duty projects such as oil pipelines, power plant construction, shale-oil refinery construction, etc. Stage Gating Stage gating is used to control major project segments – with approval to proceed to subsequent stages contingent on meeting each stage’s preset objectives Stage gating technique is being pursued in some regions as a regulatory management tool Large projects employing stage gating also have seen >15 % project improvements – with severe-duty construction efforts (e.g., Suncor at Alberta refinery construction) benefiting from this technique Lean Construction “Lean construction” is the adoption of the lean manufacturing technique pioneered by Toyota and Honda The key to “lean construction” is the decentralization of planning and decision making, managing for process, not speed, and the minimization of process waste through ruthless standardization Constructability concepts of feed-forward process input are also included in “lean construction” Elimination of process variance within this methodology has seen >15% cost and schedule improvements in large projects such as airport design and construction

Regardless of the project management approach selected, the success criteria and levers available to construction project managers remain the same

QUALITY

SAFETY

COST SCHEDULE

Decision Drivers

ContractContract ProcurementProcurement ProjectProject ProjectProject Risk Risk ManagementManagement ManagementManagement ExecutionExecution ManagementManagement

Each of the decision drivers has specific leading practices associated with it. Examples include:

Project Execution Procurement Management

Project management process is clearly defined Appropriate hedging tools used to minimize with procedures and communicated as the price volatility exposure expected process to complete project work Continuous evaluation of suppliers’ fabrication Projects are executed from start to finish by the queues and lead-times to ensure on-time same project manager deliveries Project controls are used to monitor the project Open, frequent communications with project continuously and hold project managers managers, “asset owners,” and finance accountable for results personnel regarding deadlines, resource Functional silos are not allowed to impede availability and delivery, and the corporate project structure and activities integrated construction and maintenance plan Construction and maintenance schedules are Supported by Supplier options expanded through appropriate integrated to optimize use of contractors and identification and qualification processes Organizational craft labor Organizational Process Tools Project Risk Management Contract Management Measurement Priorities and metrics for both the organization Contracts entered in a timely manner to and project are fully aligned minimize financial and project delivery risk During planning, likely project variances are Change order management process clearly identified and previous project actual activity defined and rigorously applied durations considered Web-based tools used to manage interactions Performance standards are clearly identified with contractors in near real-time and appropriate training provided before project Array of contracting approaches employed initiation depending upon project type, scale, and risk Planning and milestone development profile processes are evaluated after each project Significant time and effort are spent on stakeholder communications

Possessing the skills and best practices sets the stage for achieving the project benefits

Best Practice Inter-Relations Defined

Half of the key best Maintainability & Operability – Designing equipment layout to ensure practices are executed that maintenance and operations tasks can be conducted efficiently during construction and effectively

Constructability – The optimum use of construction knowledge and experience in planning, design, procurement, and field operations to achieve overall project efficiencies and objectives

Front-End Loading – Defining and incorporating strategic information into the project planning phase to influence overall project capital costs, schedule reworks, construction turnover to operation, and steady state operations costs

Value Engineering – the systematic effort directed at analyzing functional requirements of systems, equipment, facilities, procedures, Impact on Project Costs on Project Impact and supplies for the purpose of achieving the essential functionality at the lowest life cycle cost, and consistent with meeting all performance requirements for reliability, quality, safety, etc. Low High Start-up and Commissioning – The process of ensuring that systems are designed, installed, functionally tested, and capable of being

TQM operated and maintained to perform within design specification

TQM – A strategy for continuous improvement performance in every Constructability level and in all areas of management Value Engineering Value Front-End Loading Front-End

Process Hazard Analysis Process Hazard Analysis – Ensuring safety of a facility by Start-up & Commissioning & Start-up

Maintainability & Operability & Maintainability identification of hazards or problem areas that result from deviations from normal design operations

Prefabrication Preassembly & Modularization – use off-site construction and assembly in controlled environments to minimize Prefabrication Preassembly & Modularization & Preassembly Prefabrication “stick-building” tasks

Construction Project ScottMadden Assessment Areas Performance Criteria Demonstrated Capabilities Project Management Project roles and responsibilities Hands on experience managing large Tools and measures for decision making and capital projects and fossil plant outages progress reporting Skill training and organization depth Major projects readiness assessment Scope definition and control processes ScottMadden proprietary best practices Work Management Project estimating procedures and data sources library Work package structures suitable for estimating and construction Outage planning and preparation Maximo and Passport management Construction organization design Workforce Work sampling and productivity estimates Documentation hierarchy (management Performance Overtime management processes model) Management Work rule management practices Skills sourcing and training activities Strategic sourcing and supplier Safety training materials and practices management Process Management Work schedule integration and optimization EPC contract management best practices Work methods Standardization and modularization Communication planning and execution Knowledge capture and transfer Outage management augmentation

Quality Management QA/QC program, process and procedure QA/QC program augmentation development and oversight support Project performance monitoring and performance Productivity sampling (wrench time improvement studies) Schedule and budget variance monitoring and remediation Post-project reviews, lessons learned, and knowledge transfer Supplier quality and queue management

Task Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8

1. Planning and Organization Finalize scope Identify data needs Schedule interviews and update meetings 2. Operations Assessment Conduct interviews Review available documentation Identify primary risks and exposure Review mitigation options and plans already in place Review existing metrics/monitoring mechanisms 3. Opportunity Identification Identify and prioritize gaps in risks and potential mitigation alternatives Identify and prioritize improvement opportunities Identify actions required to achieve improvements Prepare high-level project plan for next steps

Six to eight weeks in duration, depending on finalized scope Interviews with key internal stakeholders (typically 15 – 20 interviews) Review of internal strategy, commitments, requirements, plans, reporting and other internal documentation Small project team comprised of senior level consultants working collaboratively with key client personnel

Project Phase Task Planning Execution Lessons Learned Outage planning and preparation

Construction organization design

Documentation hierarchy (management model)

Strategic sourcing and supplier management

EPC contract management best practices

Outage management

QA/QC program

Productivity sampling (wrench time studies)

Post-project reviews, lessons learned and knowledge transfer

Communication planning and execution

Duration of consulting support varies depending on finalized scope Small project team comprised of senior level consultants working collaboratively with key client personnel

Phone: 404-814-0020 Mobile: 262-337-1352 [email protected]

Steve Sanders ScottMadden, Inc. Partner Ten Piedmont Center Suite 805 Atlanta, GA 30305

Phone: 404-814-0020 Mobile: 770-490-8684 [email protected]