Download Improve the capital investment decision-making process

Apr. 2002 issue, pgs 47-50. Used with permission.
Improve the capital investment
decision-making process
A comprehensive workflow methodology and supporting
technology framework offer a solid approach to strategically
managing assets, before a company invests major resources
K. Loudermilk and R. L. Steinberger, Aspen Technology,
Inc., Rockville, Maryland
n the global process industries, the object of a project’s
economic analysis is to identify the most effective investment opportunities and strategies to pursue well in
advance of actually making an investment. The “best” engineering design does not necessarily ensure that a company
will achieve the desired return on investment capital or
achieve the targeted rate of return on invested capital.
Accomplishing a comprehensive investment decision
means blurring the lines between the traditional engineering
disciplines of process, mechanical and cost. Effective investment decision-making requires a workflow in which all
engineering disciplines work fluidly and in harmony to
make the various facets related to a project investment transparent to the organization. In this way, investment criteria may
be openly and thoroughly vetted by the organization, ensuring that these investments will achieve the greatest return for
the company and its shareholders.
I
Traditional vs. new paradigm. The object of economic analysis is to identify the most effective opportunities, threats and
strategies for investment. Rapidly reviewing investment criteria for the capital-intensive process industries is no simple
feat. Yet speed is crucial to take advantage of market opportunities when they exist. Traditional approaches to this project investment decision-making process are segmented into
various stages that are defined by functional groups:
• A business group assesses the market opportunity.
• Process engineering people develop heat and material
balances, process flow diagrams and a process equipment list.
• Cost engineering personnel develop key quantities
from the detailed equipment list, bulks and offsites.
• Scheduling experts develop engineering, procurement
and construction schedules to identify whether all resources
and activities can execute in time for startup and production.
• Finally, an investment committee of some type reviews
this data and approves or declines the capital investment.
In today’s global economy, however, this traditional
approach must rapidly evolve into a new paradigm for companies to achieve greater efficiency and maximize their
return on investment capital.
To achieve far greater benefits, traditional methods require
revisions in workflows that unite and compress the various
disciplines of an organization. A clearly defined workflow
spanning all of the engineering disciplines is required to
achieve a truly optimal investment decision.
The decision flow and options-analysis stages described
below represent a new approach that we anticipate most
organizations will evolve towards in the years to come.
Best process selection. The new approach for best process
selection involves defining the proper process technology
required to manufacture the desired product slate. Early in the
conceptual design stage, engineering functions including process, mechanical and cost engineering must work together to
review the chemistry of the process, define conceptually how
much the process will cost, how long it will take to build the
plant, and define the plant’s operating cost. Finally, at the
conceptual stage, these various criteria are summed to determine the investment payback period and rate of return.
Involving all of the engineering and business disciplines
in the conceptual design phase is essential to begin the
investment decision flow, as more than 80% of the ultimate
total installed cost (TIC) is locked up in the conceptual
design phase. For verification of this, one needs only to
look at the summary sheet for the direct and indirect costs
of a project.
The chain of costs indicated by a conceptual design
starts with the simple list of process equipment. This
implies costs for installation materials and associated construction labor. The chain continues with feed and product
storage facilities, utility requirements, site-specific items
including racks, utility piping, a control system and power
distribution network. The consequences of this chain have
induced workflow managers to gain maximum impact on
a project investment by focusing on the front end portion
of the workflow (FEED = front end engineering design)—
that is, during conceptual design. It is therefore imperative
that front end engineering disciplines and business managers
interact early and often.
Best plant configuration. Evaluating the costs and process
trade-offs of flexible plant configuration is an important
facet of investment decision-making. With grassroots plants
becoming increasingly rare, particularly in the U.S. and
Western Europe, plant lifetimes and durations now have
sunsets well beyond the 20 years typically appropriated
when an asset was first commissioned.
HYDROCARBON PROCESSING / APRIL 2002
Plant Design and Retrofitting
Reprinted from:
Fig. 1. Evaluate the cost of flexible plant configurations.
When new capital is spent, plants must be built for maximum flexibility—allowing for future revamps, expansions
and potentially even for change-of-service. Plant configurations
can be defined as having front end units (FEU) and back end
units (BEU). One strategy is to scope each FEU and BEU section at a certain capacity. Then combine the FEU and BEU one
or more times to achieve not only scale but also operational flexibility through various configuration strategies. Fig. 1 shows
an example.
The new options-analysis method for best plant configuration requires a rigorous analysis and interaction of many engineering and business disciplines in an organization. This analysis should result in defining key project quantities, costs,
TICs, schedule, and the resulting internal rate of return (IRR)
and net present value (NPV) for each configuration option. Only
then is the best configuration decision made in a transparent and
easily understood fashion.
Project funding. Using this technique for project funding
involves analyzing the impact that, say, a 10%-variation in
TIC would have on the project’s viability. This is essentially a
method by which an organization can properly evaluate the risks
associated with investment options and prepare appropriate
contingency, ensuring there are no surprises during a project.
Fig. 2 lists the key investment selection metrics for a proposed greenfield alternate fuels project of $30 million in TIC.
Not surprisingly, the lower cost option represents a shorter payback period. Further, the lower cost project option shows a
higher IRR and NPV. Most notably, the NPV/TIC ratio between
the two projects is substantial, despite the relatively small
perturbation in TICs.
Such results, while self-evident here, should not be taken for
granted that they are, in fact, intuitive. Often, such results are
non-intuitive, and a simple summary such as that in Fig. 2
provides transparency for rapid and credible decision-making
at an early stage.
Least cost. Analysis for least cost involves the simultaneous
interaction of several engineering disciplines working together
to decide how best to handle a single object. Frequently, one discipline’s premises and results may impact another discipline’s
starting point.
When faced with alternatives, cross-functional teams involving process, mechanical, safety, maintenance, reliability and cost
engineering must review and determine the proper strategy
for alternatives such as the sparing strategy for pumps and
other rotating equipment. Does one go with a 100% pump
with a 100% spare or two 50% pumps with a 50% spare? For
heat exchangers, should we go with one shell to contain all of
the tube surface area or utilize two shells each with half the total
Fig. 2. Impact of total installed cost (TIC) on key drivers for business decisions.
surface? What is the cost advantage of the heat exchanger network utilizing seamless or welded tubes?
For that matter, what about choice of material of construction? Does it make sense to use lower cost A-515 steel for a pressure vessel or is the higher strength and higher cost A-516 steel
more appropriate? In each instance, process requirements,
design, cost, safety and reliability must be analyzed to define
which path to take. The new approach requires the simultaneous input, analysis of results and review by process, mechanical, safety and cost engineers.
Construction methodology. Construction methodology will
have a significant impact on TICs. Evaluating in detail which
sections of a plant should be stick-built and which modules and
skid-units should be shop-fabricated will determine the impact
on TICs very early in a project lifecycle.
For plants in operation with turnaround a major cost factor,
it may well be important to determine the cost of shop-built skid
units that would be installed quickly and tied-in rapidly during
a planned, short turnaround shutdown. The options-analysis
value is in its capability to identify cost-schedule benefits for
such circumstances.
Contract negotiation. An oft-overlooked aspect of project
work is anticipating and preparing for contractor negotiation.
For the initial bid on a project, owner operators (O/Os) must be
sure that their bidding contractors are providing quotes for
exactly what the O/Os are requesting.
Transparency of project requirements is not only a prerequisite when advancing project within an organization.
Rather, transparency is critical in ensuring that the bidding process is thoroughly understood by project engineering and
procurement contractors (EPCs). Business-to-business transparency ensures that O/Os and EPCs are in line with each
other’s expectations, ensuring rapid and accurate turnaround
of EPC bids.
Beyond the initial bid, corporations must prepare for change
orders that arise during the course of a project. Typical change
orders are: modifying to conform to a new P&ID; adding a service road, using gravel, asphalt or concrete; providing a spare
pump (or two at 50%); adding a security gate and/or guard
house; adding a run of pipe rack and piping; removing existing vessel and foundation; adding a relief valve and pipe run,
etc. A project team must quickly determine the impact of
change orders on a project, defining if they should revise the
design and—depending on the severity of the change order—
whether or not to stop forward-motion on the project.
Achieving the optimal business decision means that an O/O
HYDROCARBON PROCESSING / APRIL 2002
Fig. 3. General tiered structure of contractors. The contractor strategy must
include work breakdown and area assignments.
must prepare for change-order negotiation from a position of
strength. The only knowledgeable path forward for an organization is to approach this challenge through a united, interdisciplinary project team using a standard basis for decision-making. Such a team can define the impact on project
economics of each aforementioned example of a change
order; they can define the impact of asphalt versus gravel for
a road, of concrete versus standard security fencing, etc.
From a transparent framework in which all of the major
impacts on project economics are known, defined, and shared,
the project team can decide how best to negotiate a change order.
Additionally, corporate management will be aware of every
important aspect of project change early in the change-order process, ensuring proper fiscal oversight and guidance.
Value of a tiered contractor strategy. Contractor strategy is also
an important aspect to project management and TIC impact. The
analysis of contractor tiering and its cost-schedule-economic
consequences is key to the project investment workflow. Either
a single contractor or several in a tiered responsibility structure
can execute a project. An example EPC tiered strategy is
defined in Fig. 3.
Whatever arrangement is decided on, identifying the associated costs and delivery schedule is important. To meet production startup, is it necessary to fast track the project or work
multiple shifts with overtime? During this approach’s evaluation process, an organization can make informed decisions
about workloads by discipline and how to incorporate internal
engineering staff for project work. Project teams must define
work breakdown structures and areas of assignment for each
EPC, and how they will interact as part of the overall project
with internal corporate teams.
Most effective use of investment capital. Business decisions
must be made regarding plant composition and project life
cycle. Through a concrete decision-making framework that
tracks the entire life cycle of a project, an organization can define
the impact on ROI of each of the following:
• TICs, utilities, feedstocks, operation costs
• Products sales in price and volume, and the trade-offs
between the two
• Impact of slowdowns due to construction delays, EPC
delays or delays incurred by decisions such as change orders.
It is important to quantify these aspects of an investment and
create a vector chart that illustrates the quantitative and qualitative impact each of these business criteria have on project ROI
(Fig. 4).
LK/qty/5-02
Fig. 4. An example vector graph describes the ROI influencers.
Outlook. The bottom-line investment answers and detailed supporting data are provided when an organization uses a comprehensive workflow and accompanying business practices.
These workflow and business practices must be parsed by decisions aligned with the natural decision flow of a project, instead
of by engineering discipline. Achieving this within an organization requires forward-thinking management to oversee the dramatic cultural changes required within an organization to
accomplish these tasks.
Additionally, an organization must have staff that is capable of
surging their performance, migrating quickly from extant work
practices to new workflows. These new workflows must incorporate the best elements of prior practices, such as engineering
excellence, for example, yet adopt new concepts and tool sets that
enable cross-functional communication and collaboration.
Finally, achieving dramatic efficiency improvements in capital investment decision-making is an operational necessity for
companies competing in the process industries. Capital expenditures are continuing to rise, and process industry organizations
are under intense pressure to handle this capital intensity with
their existing headcount—or with fewer headcount.
Kyle Loudermilk is the director, Icarus Business for
Aspen Technology, Inc. He has more than 14 years of
experience in the process industries, having begun his
career with Mobil Oil Corporation as a process engineer.
He has been with Aspen Technology, Inc. for over seven
years, and is now in charge of the Icarus business for
AspenTech. In this role, Mr. Loudermilk works with clients
to unify and compress the front end engineering and
design workflow by delivering technology solutions and
consulting services dedicated to this task. He earned
his BS and MS degrees in chemical engineering from Columbia University and
is an alumnus of Harvard Business School, having completed The General Management Program. He can be contacted by telephone: (301) 795-6820 or via email: [email protected].
Robert (Bob) L. Steinberger is business consultant,
Decision Engineering for Aspen Technology, Inc. He
has more than 30 years of experience with AspenIcarus technology and parented several key process and
project evaluation systems from concept to commercialization. The option engineering illustrations in this
paper and numerous others of greater detail were
derived from consults with thousands of engineers and
project evaluators over the years. Prior to joining Shell’s
head office engineering staff to develop Shell’s process
simulator, Dr. Steinberger earned three degrees in chemical engineering, was professor of chemical engineering at the Cooper Union School of Engineering for ten
years, consulted in VLE thermodynamics and edited a dozen engineering textbooks. He can be contacted by telephone: (301) 795-6853 or via e-mail: [email protected].
Article copyright © 2002 by Gulf Publishing Company. All rights reserved. Printed in USA.
Learn how you can improve your
capital investment decision-making process
Aspen Technology, Inc. provides asset lifecycle
solutions to the process industries. The integrated
tools in the Aspen Engineering Suite™ enable you
to focus on your business and accelerate your
decision making processes. Through it’s asset
lifecycle solutions, you can identify, evaluate and
optimize your assets. The benefits are clear and
measurable. You will improve key performance
indicators including: resource utilization and efficiency, return on capital employed and manufacturing efficiency.
For more information on the Aspen Engineering Suite, please contact one of
our regional offices listed below or visit our website at www.aspentech.com.
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