Cost Escalation in Alberta Oilsands

A great deal of engineering work is outsourced from Alberta oil sands projects but some oil companies feel they are not receiving value for money because of unpredictable performance and cost reimbursable billing practices.

Oilsands Cost Performance

At the moment the oil companies are assuming most of the risk in project and service delivery impacting their profitability. Rapid growth in Alberta has favoured the service sellers who pass most of the risk back to the buyers. Recent observations regarding massive cost escalation in the Alberta energy industry were made by oil sands leaders from Canadian Oil Sands, CNOOC, Sunshine Oil Sands, and Surmont Energy. Much has been done to coordinate major construction project start dates to smoothen peak demands so simply attributing high costs to the boom-bust cycle is no longer a strong argument.

Is the market shifting more in favour of buyers of engineering services? Demand side constraints from global demand, transportation constraints, and engineering labour shortages are moderating growth. The price split is continuing to place pressure on oil producer bottom lines. Eventually new capacity construction will decline and the industry emphasis will move to focus on maintenance which has much lower labour requirements. A tipping point may be approaching where the buyers of engineering services will expect more predictable performance, shared risk, and eventually firm fixed price service offerings from engineering suppliers.  These changes will bring about increased competition and greater attention to cost performance. Alberta’s engineering suppliers need to get control of their operational engineering costs and schedule performance in both design and maintenance processes. Engineering suppliers will need to find ways to remain competitive when this shift occurs.

Other Industry Experience

As the oil sands industry matures and construction pace becomes steady state industry participants should look to other industries to understand how they managed cost control and increased competition. The automotive and aerospace industries are both good case examples.

In the late 80s Canada’s automotive industry along with the US automotive industry experienced a major disruption from the entry of Japanese car makers into the North American market.  Increased competition placed significant pressure on automobile quality, cost and reliability standards. All North American automotive manufacturers and their supply chains were forced to redesign, retool, and radically improve their cost and quality delivery performance to compete and survive.  Some didn’t and further industry shake-outs continue as recently occurred after the financial crisis in 2008. Automotive engineering teams adopted new management practices such as Lean, Toyota Production System, and Total Quality Management with a focus on core process improvement.

A similar situation unfolded in Canada’s aerospace industry, ranking between fourth and sixth in the world in the 90s global manufacturing competition increased from new entrants
such as Embraer in Brazil as well as high competitive pressure on aircraft Maintenance
Repair & Overhaul (MRO) services created by low cost airlines, recessions, and military budget pressures.  The world leader in aerospace, the US also experienced similar competitive pressures from consolidation and the emergence of Airbus who was able to compete with Boeing head-to-head.  Aerospace engineering service suppliers of both design and repair services were also forced to adopt lean engineering practices to offer competitive and predictable services for aircraft manufacturers and MRO providers to remain profitable.  In both cases, engineering service suppliers adopted lean engineering successfully improving their delivery performance which enabled them to move to more predictable billing to meet their customer expectations and to compete internationally. Aircraft engineering services also provides a good example where strict cost and schedule performance must be met with no compromise on stringent air safety, regulatory, and reliability standards.

The impact of these massive changes were not felt in Alberta during the 80s-90s so the lessons of these competitive disruption experiences are being brought to Alberta by people who have relocated. Alberta did suffer from the NEP but the impact was due to very different reasons. To say the day will never come that the Alberta oilsands industry will not mature and competitive dynamics will not change is simply naïve so engineering service suppliers need to prepare.

Lean Engineering Process Improvement

How can Alberta Engineering Services Suppliers apply the experience from other industries to become more predictable, deliver better value, and reduce delivery risk for their customers? Proven lean engineering process improvements can deliver engineering productivity gains with cost and lead time reductions of 25% or more as demonstrated in the automotive and aerospace industries. Lean engineering process improvements could dramatically improve supplier profitability, competitiveness, and customer satisfaction in the Alberta oilsands. Lean engineering also offers the added benefit of solving engineering capacity shortfalls driven by the engineering talent shortages.

There are two varieties of lean engineering: lean engineering and engineering for lean. Engineering for lean involves designing for lean manufacturing applying principles such as design for manufacturability, design for assembly, mistake proofing, etc. Lean engineering involves streamlining engineering processes and removing waste in engineering processes to reduce delivery time, reduce engineering costs, and improve quality. Both are critical but engineering service suppliers need to have a program for lean engineering if they want to become more predictable, deliver better value, and reduce delivery risks for their customers.

Productivity Alberta is making a strong contribution to lean manufacturing awareness and training in the Alberta oilsands and construction supply chains. The reality is that lean requires a long term commitment and can take a few years to demonstrate sizeable improvements. Alberta engineering services suppliers need to be ready and ahead of the game as the shift takes place. North American automotive and aerospace suppliers waited until the crisis occurred before taking action and paid a heavy price. Adopting a new management paradigm on the back foot is not a path to success and many firms failed, were consolidated, or died slow deaths who could not change.

Can Alberta engineering service suppliers afford to wait for a crisis similar to what Canada’s automotive and aerospace industries? I would be interested to hear views on this issue.

4 thoughts on “Cost Escalation in Alberta Oilsands

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