Valuing the Supply Chain – The Engineering & Construction Conundrum

Natural Gas Projects
August 1, 2017

The timely construction of pipelines is not only critical to the pipeline operator, its co-owners and shippers, but also to the 40 or so mainline contractors responsible for construction. Despite the differences in business models, contractors, especially the handful that are publicly traded corporations, rely on the timing of the start of construction to maintain and demonstrate financial projections. In this regard, whether a contractor is concerned with the construction of the mainline or facilities, keeping on construction schedule (and on budget) is critical for forecasting revenue and available resources. With a limited group of engineering and construction (E&C) companies qualified for large diameter pipeline work, developers, especially in constrained markets, can be left with few or less than ideal choices.  

Natural gas pipeline projects, especially those with relatively large geographic scope, are often divided into a number of segments, referred to as spreads. As a result, a contractor can be responsible for the construction of one or several spreads, or the entire project. Each pipeline developer has its own strategy regarding the timeline for soliciting bids for its spreads. Some choose to secure contractors early in the process, with increased risk due to potential regulatory timing issues, while other developers choose to wait until they have a clear view into the bevy of environmental impediments. Those who choose to secure contractors early may risk the cost of delays, while paying for labor that is waiting on the sidelines. Alternately, pipeline developers that wait until later in the project’s regulatory review may have limited supply of construction resources. 

Typically, pipeline construction spreads are not tied to a project’s phases and may be subject to different regulatory approvals. While most stakeholders are focused on project in-service dates, the beginning of project construction, or “turning dirt,” is another critical milestone to watch. A project’s Full Notice To Proceed With Construction (“FNTP” in regulatory parlance) is an important event for several stakeholders. The FNTP provides project developers federal regulatory approval, but not necessarily all required permitting approvals, to advance to construction. The construction phase is a major milestone, primarily because it limits the risk by transitioning a majority of the remaining uncertainty to factors within the developer’s control.

Expectations on market share and revenue forecasts for E&C companies are tied directly to the timing of project construction, which is ultimately tied to their ability to unlock revenue and realize cash flows from their backlog. In fact, highly regarded contractors can book credible and reliable business as project developers increasingly seek to mitigate execution risk early in a project’s lifecycle by reserving critical services for the future. While this trend is beneficial for the construction teams to increase sales backlog, transitioning that backlog to recognized revenue can be dependent on the same approval challenges faced by the project developers themselves.

 Contractors have traditionally relied on the project developer’s timeline to plan and schedule their key revenue-generating assets. Such reliance on the developer’s timelines can lead to a less than optimal deployment of a contractor’s equipment and manpower, which, in turn, can lead to cost consequences and underutilized resources if a project runs into unforeseen delays. Communication between regulators, developers, and contractors is not always seamless and uncertainty persists. LawIQ’s comparison of expected versus forecasted timing for a FNTP from the perspective of stranded project costs shows the potential magnitude of this challenge.

 Coming soon for customers of our platform will be data and analytics on the E&C companies responsible for building assets relevant to your business. To do so, we will harness our proprietary database of mainline contractors that are involved in constructing the pipeline that’s critical to our nation’s economy.

 

Distribution of Contractor Project Costs