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 1 Copyright © 2008 by ScottMadden. All rights reserved. The Construction Management Landscape The Construction Management Landscape Construction Costs Going Through the Roof 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. 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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 Construction Equipment Equipment Price Price Hikes Hikes 7% — China added 102 GW of capacity in 2006 and is expected to more 6.9% than double that capacity by 20204 6% — Many U.S. power generators are re-evaluating plans to build new 5% generation as a result of estimated construction cost increases — Limited resources worldwide to provide equipment for nuclear 4% construction programs 3.7% 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. 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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 2004 2005 2006 2004 Shop Load Current Shop Load Anticipated 2006 Shop Load 120 Equipment availability, e.g., cranes, limited to none 1.4 100 Longer lead times for materials and scheduling work 1.2 80 Higher fuel prices increase material extraction/production 1 s and transportation costs 60 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 0.2 ) Construction productivity is declining, in part due to the rs P rs ls rs 0 e H e tors so lves ol 00 nge mns c s LNG) a 5 u re scarcity of skilled labor Vess p ol V rs ls s s r Co (> Col Rea xcl. rs ors e p ve Ai rs Excha (e ntr le ot sse to Com s o M e Val o p C 1 Coo V Pum l um r tro P Contractors are experiencing: Ai Exchang on lumns/ C Large M o — Opportunity to focus on projects where expertise C is possessed, owners are reliable and a reasonable return can be expected NationalNational Utility Utility Infrastructure Infrastructure Cost CostIndices 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