‘Cost Engineering and Cost Control of Large and Medium Capital Projects’

– CONTINUED:
This important book was among the three books launched by Engr. Johnson
Awoyomi in February this year at Lagos. We intend to carry chapter four of the book here because of its significance to the topic, which is Cost Engineering and Cost Control, especially, in Medium and Large Projects.

CHAPTER 4: COST ESTIMATING

CHAPTER 4: COST ESTIMATING
4.1 Introduction
Estimating is the predictive process that quantifies either time or cost—it prices resources needed for the scope of an investment option, activity, or project. Budgeting is a sub-process within estimating, and it is used to allocate the estimated cost of resources into control accounts (time-phased approach).
Definition
AACE International defines Cost estimating as a compilation of all the probable costs of the elements of a project or efforts included within an agreed scope. During the AACE 2018 Annual Meeting at San Diego, CA, USA, a revised definition was offered by Larry Dysert a cost Estimator Guru. He defined cost estimation as a prediction of the probable costs of a project for a given and documented scope, to be completed at a defined location and at a point in time in the future. This recommended definition brings into the scene the perspectives of both location and future time. These dimensions of location and future bring into play the need for normalization when benchmarking an estimate.

Figure 4 1: Cost estimate is a range and not a figure
Cost estimates involve assumptions and uncertainty and, therefore, some level of error. In addition, it involves probabilities and cost ranges, as depicted in Figure 4 1. In cost estimating, contingency accounts for minor variabilities within the defined scope – not changes in the scope.
Accuracy of Cost Estimates and Scope Definition
Accuracy is the degree to which a measurement or calculation varies to its actual value, while precision is the degree to which a series of calculated values show similar results. Estimate accuracy indicates the degree to which the final actual cost outcome for a given project varies from its estimated costs. It must be noted that every estimate is a prediction of the expected final cost of a project for a given scope of work. Every estimate is associated with uncertainty and therefore is associated with a probability of underrunning or overrunning the predicted cost.
Individual projects should always have their accuracy ranges determined by a cost risk analysis study. From the resulting output of the risk analysis (the estimate probability distribution), the project budget should be derived based on the level of confidence (or risk) acceptable to management. Thus, the contingency on any estimate is the amount added to the point estimate to provide the desired level of confidence related to underrun or overrun.
Capital Project Estimate – Issues and Uncertainties
Figure 4 2 shows a list of issues in an NOC environment before setting up a Cost Engineering Unit. The challenges for the estimator is to evaluate the unique combination of required resources to provide a cost estimate for a project to be completed in the future.
Typical issues include but are not limited to the following:
• Record all sources of information, methods of calculation, pricing basis, and assumptions
• Base estimate on as much fact as possible
• Opinion, judgment, and assumptions are required because future events are being considered
• Some level of error must be accepted
• Basic estimating techniques are well established
• Experience of the estimator
• Processes and standards and historical database

Figure 4 2: Issues on Cost Estimating in an NOC environment before creating an Estimating Unit

Figure 4 3: Understanding uncertainties in Cost estimating: Source – AcostE

Figure 4-4 generically illustrates the accuracy range and variability associated with AACE Estimate Classes. During the 2018 AACE International Annual Conference in San Diego, USA, it was discussed that depending upon the maturity of project definition deliverables, the project’s technical complexity, the availability of appropriate cost reference information, the estimating techniques used, and other factors; a result, a specific estimate class may have a wider estimate accuracy range or a narrower range than other estimates of the same class (see Figure 4 5).
Figure 4 4 further illustrates that the estimating accuracy ranges overlap the estimate classes. There are cases where a Class 5 estimate for a particular project may be as accurate as a Class 3 estimate for a different project. For example, similar accuracy ranges may occur if the Class 5 Estimate is for a repeat design project, whereas the Class 3 estimate is for a project utilizing “first-of-a-kind” technology. It should be noted that the accuracy range should always be determined through risk analysis of the specific estimate and is never to be pre‐determined.

Figure 4 4: Generic accuracy range variability associated with AACE Cost Estimates

Figure 4 5: Estimate Accuracy with Project definition (Source: John Holman)
An estimate is never a single point number (or cost). Instead, it is a range of potential cost outcomes with associated probabilities of occurrence. Thus, the accuracy range of an estimate is a probabilistic assessment of how far a project’s final cost can be expected to vary from the estimate. The range is driven by the risks and uncertainties associated with the estimate. Some key points to note about estimate can be seen in Table 4 1
Table 4 1: Key points to note on Estimate and Accuracy
S/N Descriptions
1 All estimates involve uncertainty (as shown in Figure 4 1 – Potential for variability exists for all estimate elements.
2 All estimates should reflect a range of potential cost outcomes (Figure 4 1) values that need to be effectively communicated to management.
3 Risk Analysis (Monte Carlo) is needed to determine the estimate probability distribution associated with a specific estimate and determine the contingency required to select the single value for the project budget based on the level of confidence or risk acceptable to management.
4 When describing estimate accuracy, it is required to identify the confidence level (typically 80% or 90%) associated with the range between the indicated lower and upper values. If estimate accuracy is described as a +/- percentage, then the probability of the value upon which it is measured must be identified.
5 Estimates should be unbiased: The estimate should reliably predict the costs to deliver the project, given the scope and assumptions reflected in the estimate, and it should reflect uncertainty in the estimate range.
6 The estimate should provide sufficient accuracy to support the decision at hand effectively.
7 To improve estimate accuracy, you must improve the technical and project deliverables supporting the estimate, reduce risks and uncertainty.

Estimate and Contingency
Contingency is a cost element of the estimate used to cover the uncertainty and variability associated with a cost estimate and unforeseeable cost elements within the defined project scope. Contingency covers inadequacies in project scope definitions, estimating methods, and estimating data. Contingency expressly excludes project scope changes, major unforeseen events such as earthquakes, and prolonged labor strikes. The funds are added to the point estimate to achieve a given probability of not overrunning the estimate (given the relative stability of the project scope and the assumptions upon which the estimate is based), as shown in Figure 4 6. In essence, contingency is an amount of funds to reduce the chances of overrunning the point estimate to an acceptable level of risk. The difference between the selected funding value and the point estimate is the amount of contingency. It is the role of the management to establish an acceptable level of risk. Usually, contingency should exclude escalation (a separate risk fund to account for costs over time). The Point Estimate is the estimated value before adding Contingency to account for estimated cost risks and uncertainty. Table 4 2 shows the list of what contingency includes and what it does not.

Figure 4 6: Contingency added to a point estimate (Source: AACE International)

Table 4 2: What is contingency is and what it is not?
S/N Contingency includes the following: Contingency does NOT include the following:
1 Risk events and conditions Changes in scope
2 Errors and omissions in estimating Major (unexpected) work stoppages
3 Minor design changes within the agreed scope Disasters (hurricanes, tornadoes)

4 Quantity variability
Escalation (price trends prevailing across entire cost categories)
5 Productivity variability –
6 Wage rate variability –
7 Pricing variability =

What is Estimate Quality?
Quality is conformance with requirements, and the key to a quality estimating process or product is to establish reasonable requirements and then measure their achievement. Unfortunately, too many owners leave contractors or other information providers to “do their thing,” which then falls well short of expectations. Owners should be careful. You get what you ask for (or do not get what you do not ask for).
A group asked an estimator guru to review a cost estimate. They complained that the contractor’s estimate quality was “terrible,” and they wanted him to castigate the contractor. He then asked, “what were your requirements?” They had none. So, he told them, “I can tell you right now that the contractor’s estimate is the highest quality because it meets all your requirements.” The moral of this story is that you should stop complaining and do your job.

Types of Estimate
There are two types of cost estimate:
• Service Cost Estimate
• Capital Cost Estimate
The Service Cost Estimate deals with rendering services to another party. The typical costs incurred include costs of man-hours, computer, printing, offices, and travels. An example is NETCO, an engineering design firm that provides design engineering services for Chevron Nigeria Limited. On the other hand, Capital Cost Estimate provides the capital cost of infrastructure, building a plant, refinery, a bridge, petrochemical plant, or FPSO, etc. It involves the following: end product required by project management, Capital cost of the plant, major equipment, bulk materials, construction labour, and other indirect costs. An example of a capital cost estimate is the cost of building a Gas-to-Liquid (GTL) plant, Refineries Rehabilitation, Construction AKK Pipelines, etc.
Another way to classify estimates is by the purpose they are to serve, as shown in Figure 4 7- Order of magnitude cost estimate for feasibility studies, preliminary estimates and definitive estimates.

Figure 4 7: Types of Cost Estimate by Use

Elements of Cost estimate
The components of any cost estimate are shown in Figure 4 8, covering both direct and indirect cost elements, which are fully addressed in the second chapter of this book.

Figure 4 8: Elements Cost Estimate – Source: AACE Int
4.2 WHO IS A COST ESTIMATOR AND WHY DO ESTIMATES MATTER?
A cost estimator is anyone that forecasts the future cost of an asset or project (or some sub-element of these) as used in investment decision making or project control (i.e., in a TCM process). Estimators can be owners, government, or contractors and can be in any industry – process, commercial, infrastructures, IT, aviation, agriculture, and transport; they apply to any life cycle phase. The breadth of this scope of work for an estimator is very challenging.
The outputs of estimating are used primarily as:
• inputs for budgeting
• cost or value analysis
• business decision making
• asset and project planning
• project cost and schedule control processes.
Cost estimating defines the scope of the project and establishes a target budget for the project. It also establishes the projection of cash flow and evaluation of the rate of return on investment. Therefore, cost estimating comes in handy for tendering by a Contractor bidding for a particular project and used as a basis for Cost Control during the project execution.
A Cost estimate is one of the primary elements in the decision-making process to sanction projects. Economics drives most project decisions throughout the project process (i.e., during all stages of project development). The cost estimate provides the indicated budget for the project and is also key to identifying the scope and execution strategies for the project. If the estimate does not reflect the full scope of the project, including procurement, contracting, and execution strategies, then project funding (based on the estimate) may not be adequate.
Owner and Contractor Cost Estimating Roles Contrasted
Table 4.3 differentiates the different roles of an owner organization from that of a contractor organization.
Table 4 3: Cost Estimating Roles of an owner and contractor compared

Estimating resources
A key role of Management is to support the development and maintenance of the estimating resources. The list of the resources includes the following:
• Competency – Roles and Responsibilities assigned, and training
• Estimating Guidelines and Procedure Manuals
• In-House Cost History / Final Job Reports (i.e., Closeout Reports)
• Labor Charts
• Material and Services Pricing Files
• Published Estimating Manuals
• Published Labor Productivity Surveys
• Design Engineering Manuals and Specifications
• Published Books, Magazines, Journals
• Estimating Software (commercial and in-house)
• Special Cost Studies
• AACE materials and participation