Navigant’s Tony Farrow describes how the particular risks of offshore oil and gas extraction present unique challenges for parties involved in construction projects
Onshore and offshore basics
In oil and gas extraction, both onshore and offshore-based facilities are dealing with the same process – namely the collection, initial processing, storage, and transfer of oil and gas. However, there are significant differences in the technical demands and risk profile of each approach.
One obvious difference is that everything is at ground level in an onshore set up, from drilling wells, to processing equipment, storage tanks and pipelines. In offshore facilities, floating vessels and fixed units extract hydrocarbons from reservoirs below the seabed. The capital sums involved in offshore assets are considerably larger and contractors take on greater financial risks than in equivalent onshore petrochemical projects.
Environmental, technical and logistical factors
Working in harsh and difficult conditions presents special challenges for developers of offshore facilities. At the surface, vessels are subject to extreme wind, wave and temperature changes. Subsea, work is restricted by massive hydrostatic pressures and variations in wave motions, and the logistical complexities of working in deep water.
Moving a vessel from the construction yard to the place where it will operate is a big-ticket cost item, especially for platforms that cannot float. Equipment capable of lifting and transporting these massive structures costs hundreds of thousands of dollars a day to hire, and is booked months or sometimes years in advance. If a hire slot for lifting and transporting equipment is missed, the knock-on costs for the project can be significant.
‘The logistics of construction work offshore mean it can be five times more expensive than performing the work in a construction yard.’
Tony Farrow, Navigant
Long lead times
An interesting feature of oil and gas exploration is that producers often lease assets built and owned by contractors and operators, rather than building their own. For instance, drilling rigs can be hired out at over $150,000 per day, and for a floating production storage and offloading unit the day rate might be $450,000.
At the start of this decade, there was a world shortage of offshore assets and orders of new vessels rose rapidly. However, it typically takes over three years to build these and the appetite for new capacity has waned in recent years, along with the oil price. Therefore, many producers, contractors and builders have been left with unwanted vessels.
Delays in construction
Construction of an offshore vessel has many stages, and typically involves several different suppliers and locations. If a project encounters delays, it might seem expedient to leave one stage of construction without completing the planned work, in anticipation of carrying the work over to the next stage. In practice, however, it is significantly more expensive to complete work during the next stage of construction and probably leads to more delays.
To illustrate how this works, let us look at a typical example. A yard in South Korea might be chosen as the location to build a fixed platform (used for the extraction and initial processing of oil or gas), ahead of transportation to Nova Scotia for installation offshore. When the platform leaves South Korea, it is assumed 10,000 man-hours of remaining work will be needed, but this is later corrected to 30,000 on arrival in Canada. However, productivity at the Canadian yard is lower than Korea and it takes twice as long to finish the carry-over work. Thus, the weather window for offshore installation is missed and it is not possible to take the platform to the operating location until after the winter months.
When the platform is eventually installed offshore, the commissioning process identifies that substantial changes are necessary. However, the logistics for undertaking construction work offshore are such that it can be five times more expensive than performing the work in a construction yard. Indeed, in North Atlantic winter conditions, it is unlikely that outdoor work offshore can even be performed, leading to more delays.
In the final analysis, an estimate of $1m for carry-over work when the platform left Korea turns into a bill of $50m in extra costs for the project.
Project risks drive dispute behaviours
In most construction projects, parties would normally examine contract terms to resolve any disputes. However, in offshore oil and gas construction projects, the day-to-day work is driven by the need to actively manage risk, which can mean making decisions by ignoring the contract. Contractors might settle an unreasonable subcontractor’s claim – should a yard not release its work – because it would be cheaper to pay an unjustified claim than hold up the project. This is different from onshore projects, which would typically process any dispute according to the contract terms.
The views expressed in this article are those of the author and do not necessarily represent the views of Navigant Consulting or any of our clients.