W21_TRI_ Developing a Negotiation Model on EPCI Price & Schedule

1.      Problem recognition, definition and evaluation

After conducted EPCI cost analysis and schedule analysis, the negotiation process is required in tender stage. Since the economics of a gas project was so marginal, negotiation would become a critical process to make such a tender whether it’s failed or success. The good negotiation should be prepared with some adequate materials, such as a negotiation model. Therefore, a negotiation model is required to be built prior to negotiating with bidder(s). 

2.      Development of the feasible alternative

Principally, any successful negotiation must have a fundamental framework as follows:

·         The alternative to negotiation

·         The minimum threshold for negotiated deal

·         How flexible a party is willing to be, and what trade-offs it is willing to make

Three concepts for establishing negotiation framework: BATNA (Best Alternative To Negotiated Agreement), Reservation Price and ZOPA (Zone Of Possible Agreement). And expanded to the fourth concept: value creation through trade.

Developed by Roger Fisher and William Ury, BATNA is one’s preferred course of action in the absence of a deal. Always know the BATNA before entering into a negotiation. Otherwise the negotiator won’t whether a deal makes sense or when to walk away.

The reservation price (also referred to as the walk-away) is the least favorable point at which one will accept a deal.

ZOPA is the area range in which a deal that satisfies both parties can take place. Each party’s reservation price determines one end of the ZOPA. Each party had a reservation price, and they bargained within the ZOPA. In doing so, each got a better price than his/her walk-away.

Figure 1. Reservation Price & ZOPA

3.      Development of the outcome

According to Figure 2 and Figure 3, the 75% confidence level of EPCI schedule and cost fall in duration 28 months and cost USD 200 Million. Meanwhile, input for cost simulation is shown in Table 1.

Figure 2. Summary Statistic of Simulated EPCI Schedule

Figure 3. Simulated EPCI Cost (Cummulative)

Table 1. Breakdown Project Head Cost

 

4.      Selection of criteria

Based on above figures and table, company as buyer is able to build reservation price and ZOPA as a negotiation model to bidder(s) as seller.

5.      Analysis and Comparison

The negotiation model is shown in Figure 4. The maximum company’s settlement of EPCI duration might be started from 27 months which has 40% confidence level. However, the company has ZOPA from 28 months (75% confidence level) to 30 months.

Meanwhile, the company has ZOPA from USD 202 Mn to USD 222 Mn. The minimum ZOPA became OE is set at 80% confidence level. The maximum ZOPA for the company is set sligthly above 100% confidence level in order to expand the probability of success and to incorporate 10% allowance of OE. However, the maximum ZOPA is still below the maximum EPCI price USD 251 Mn.

 

Figure 4. EPCI Negotiation Model

6.      Selection of alternative

What is company’s BATNA? If the deal is failed, then the company shall propose another project scenario, either to deliver gas to other buyers to leverage economics or to conduct re-engineering to create value engineering and reduce cost to balance the opportunity loss.

7.      Performance monitoring and post-evaluation of results

The negotiation is most likely needed after bid price opening, thus a negotiation model is required. The negotiation model is built according to project economics, what maximum EPCI price is allowed to generate a certain level of economic indicators (company’s MARR). In addition, the maximum EPCI duration in the model is based on the gas sales agreement. If negotiation is failed, company shall have strong BATNA in this project since conducting re-tender with current scope will be totally wasting time.

References:

·         Asmoro, Trian H. (2012, Nov 16). Negotiation: Your Starting Points. Retrieved from: http://3an.blogspot.com/2012/11/negotiation-your-starting-points.html

·         Asmoro, Trian H. (2012, Nov 16). W18_TRI_ Cost Analysis using Simulation Approach. Retrieved from: http://aacemahakam.blogspot.com/2012/11/w18tri-cost-analysis-using-simulation.html

·         Asmoro, Trian H. (2012, Nov 22). W19_TRI_ EPCI Schedule Analysis using Simulation Approach. Retrieved from: http://aacemahakam.blogspot.com/2012/11/w19tri-epci-schedule-analysis-using.html

W20_TRI_ Economic Evaluation on Gas Development Project

1.      Problem recognition, definition and evaluation

Two scenarios of gas development project needs to be analyzed using main economic indicators, i.e. IRR and NPV. The two scenarios are as follows:

- Case 1: Delivering 55 BBTUD sales gas to buyer A and 5 BBTUD to buyer B for about 9 years, then delivering 15 BBTUD to buyer B for next 7 years.

- Case 2: Delivering 60 BBTUD sales gas to buyer B for about 9 years, then delivering 15 BBTUD to buyer B for next 7 years.

The production facilities will be built using EPCI contract with total duration 3 years, including 1 year for tender and budget approval process.

2.      Development of the feasible alternative

The economic model of gas development project using Production Sharing Contract (PSC) terms was built for resulting economic indicators.

3.      Development of the outcome

Net cash flow of each scenario is shown in Figure 1 and Figure 2. As shown, the project basically has negative cash flow in early years of investment that generates high positive cash flow in early years of operation.

Figure 1. Case 1 Cash Flow

Figure 1. Case 2 Cash Flow

4.      Selection of criteria

According to above cash flow, the economic indicators of each scenario is as follows (MARR=10%):
- Case 1: IRR 14.08%, NPV@10% USD 65.339 Million
- Case 2: IRR 13.44%, NPV@10% USD 59.644 Million

5.      Analysis

Based on economic indicators, case 1 had slighlt higher of IRR and NPV compared to case 2. In this analysis, case 1 could be selected for Plan of Development (POD).

6.      Selection of alternative

Furthermore, a new economic indicator, i.e. ERR (External Rate of Return) shall be applied in order to comprehend the nature of such cash flow. ERR directly takes into account the interest rate (Ɛ) external to a project at which net cash flows generated (or required) by the project over its life can be reinvested (or borrowed). ERR also describes a macro-economic measurement that looks at the overall impact of a financial move on your entire financial life. It involves the “big picture.’

Formula of ERR is as follows:

R_k = excess of receipts over expenses in period k,

E_k = excess of expenses over receipts in period k,

N = project life or number of periods, and

Ɛ = external reinvestment rate per period

Therefore, the ERR of each case generated by Goal Seek of Ms Excel (Ɛ=MARR) will be:

7.      Performance monitoring and post-evaluation of results

To summarize, the indicators of each case is shown in Table 1.

  Table 1.Economic Indicators of Gas Project

	CASE 1	CASE 2
IRR	14.08%	13.44%
NPV@10% (MUSD)	65,339	59,644
ERR	-0.82%	-0.57%

Using Table 1, case 1 has higher negative ERR compared to case 2. In this analysis, case 2 is preferable rather than case 1 since case 2 will generate more FV revenue per PV cost.  Then, case 2 will be proposed to management to be selected for POD. However, all two cases have negative ERR show that this gas development project is non-profitable project since ERR < MARR, regardless this project has IRR > MARR and NPV > 0.

Finally, when making financial decisions, it’s important to always think about not only what we expect to happen within the confines of the investment we are looking at (IRR), but also to look at what the consequences of this decision will be versus others we could make (ERR).

References:

·         Bridel, Wes. (2009). Rate of Return: Beyond the Basics. Retrieved from : http://www.kingdomcalling.com/2009/10/14/rate-of-return-beyond-the-basics/
·         How to calculate your Return on Investment. Retrieved from : http://www.fatpitchfinancials.com/392/how-to-calculate-your-return-on-investment/
·         Sullivan, G. William, Wicks, Elin M & Koelling, C. Patrick. (2012). Engineering Economic 15^th Edition: Chapter 5 Evaluation a Single Project, pp. 205-208
 

W9_BUD_ Estimate of Capital Investment

1.    Problem Definition

Based on equipment list and specification, we already done doing cost estimate for every single equipment with result as follow:

Equipment	Total Equipment Cost
Heat Exchanger	$                      200,000
Pressure Vessel	$                      600,000
Pump	$                      120,000
Total	$                      920,000

Next step, to make feasibility study of the project we must estimate the capital investment based on equipment cost.

2.    Feasible Alternatives

There are 2 alternatives method to estimate capital investment, as follows:

a. Using Lang Factor

b. Using Capital Cost Breakdown

3.    Develop the Outcomes for each Alternative

a. Lang Factor

This method used to approximate the capital investment by multiplying the basic equipment cost by some factor.

Type of Plant	Lang Factor for Fixed Capital Investment
Solid processing plant	3.9
Solid-fluid processing plant	4.1
Fluid processing plant	4.8

Fixed Capital Investment         = Equipment Cost x Lang Factor

                                                  = $ 920,000 x 4.8

                                                  = $ 4,416,000;

Note:  Fixed Capital Investment also called as Total Plant Cost in AACE Recommended Practice which consists of: process capital, general facilities, overhead & fee, and contingencies.

b. Capital Cost Breakdown

Plant costs are built up by first establishing the cost of each equipment item delivered to the plant site. Material and labor costs to set and install equipment are next estimated using recommended factors.  Total plant costs are established by adding field indirect engineering costs, overhead and administration based on recommended factors.

4.    Selection Criteria

Selection of preferable alternatives would be based on:

1. Accuracy

2. Flexibility

2. Verifiability

5.    Analysis and Comparison of the Alternatives

Attributes	Lang Factor	Capital Cost Breakdown
Accuracy	+50% to -50%	+30% to -15%
Flexibility	Lang factor available only for three types of plant: (1) solid, (2) solid-fluid, and (3) fluid processing plant	- Installation cost available for various types of equipment - Distributive percentage factors available for six specific types of installations and for four different generic plant types:  (1) solids, (2) solids-gas, (3) gas processes, (4) liquid and liquid-solids.
Verifiability	Unknown contingency	The contingency factors used documented in the report and based on clear assumption.

Attribute	Rank	Alternative Rank
Accuracy	1	Capital Cost Breakdown > Lang Factor
Verifiability	2	Capital Cost Breakdown > Lang Factor
Flexibility	3	Capital Cost Breakdown > Lang Factor

All the three attributes shown that Capital Cost Breakdown better than Fang Factor.

6.    Select the Preferred Alternative

Based on comparison, the preferred method to estimate capital investment is Capital Cost Breakdown.

7.    Performance Monitoring & Post Evaluation of Result

Both methods applied only for Class 5 AACE Cost Estimate Classification System for feasibility study purpose. To ensure the accuracy of cost estimate, the result will be compared with Class 3 Cost Estimate after we get higher percentage of project definition.

References:

1.    AACE International (2003). Recommended Practice No. 16R-90: Conducting Technical and Economic Evaluations – As Applied for the Process and Utility Industries.

2.    AACE International (2003). Recommended Practice No. 19R-97: Estimate Preparation Costs – As Applied for the Process Industries.

3.    Peter, M.S., Timmerhaus, K.D. (1991). Plant Design and Economics for Chemical Engineer 4^th Edition: Chapter 6, p. 150-215