While many industries are postponing major capital projects in the current economic climate, the power and utilities sector does not have this luxury.
It stands on the verge of a massive capital deployment that cannot wait. Developed countries need to urgently upgrade aging infrastructure, while developing countries need better access to power, gas and water to sustain economic growth.
The International Energy Agency (IEA) projects that at least US$13.7 trillion1 must be invested between now and 2030 to cover the basic demand for power, with trillions more required to support the industry’s low-carbon transformation.
Success, therefore, will come down to deploying capital efficiently — keeping the cost of capital as low as possible and keeping construction costs and schedules under control.
This is no small feat.
A 2002 study revealed that 9 out of 10 transport infrastructure projects across the world exceeded their initial cost expectations.2
Smart meters, large offshore wind farms and next-generation nuclear power plants are just a few examples of the new types of projects power and utilities are undertaking.
Many of these projects have never been done before and therefore contain the risk of “first of its kind” costs and delays.
So what can be done? To improve their ability to bring projects in on time and on budget, power and utilities must address three key areas: funding; contract risk and construction risk.
Capital markets have improved since the worst of the credit crunch, but securing funding at a reasonable cost for the scale of investment required can still be an issue.
To address this, rigorous value-for-money criteria must be adopted to develop robust business plans that reflect the risks of scenarios such as changing regulatory environments, volatile commodity prices and an uncertain cost of carbon.
Contingency funds must be re-assessed. Too high a contingency and the project may fail to meet the value-for-money threshold required by investors, regulators and consumers, but too low and you run the risk of runaway costs.
Partnering can be an effective way to share risk and reduce the cost of capital — especially in the power and utilities industry, where government support mechanisms exist to support the transition to a green economy.
The importance of structuring contracts so that risk is allocated to the party best able to manage it cannot be overstated.
Power and utilities companies typically use a complex network of contractors on major projects, and there is significant potential to release value locked up in underperforming contracts. Contractors’ incentives should be aligned to the project owners’ objectives, and benchmarking can be used to identify underperforming contracts as well as to negotiate regulatory settlements.
Some of the most common risks during construction result from a lack of flexibility.
Delays will occur, but they matter less when they have been expected and planned for. Experienced project managers will understand their contractors and anticipate where bottlenecks are likely to occur. People risks are also an issue.
With so many major projects in the power and utilities sector, there is a real risk of utilities competing for a limited supply of qualified engineers.
Controlling costs on major infrastructure projects will be critical to the success of power and utilities companies. The immense scale of the capital outlays they must undertake means that capital efficiencies will take on a new importance.
Those who adopt leading practices to address financing, contract and construction risk will be more able to deliver projects successfully.
1 World Energy Outlook, International Energy Agency, November 2009.
2 Flyvbjerg et al, “Underestimating Costs in Public Works Projects,” Journal of the American Planning Association, Vol. 68, No. 3, Summer 2002 (available here).