Why are the values of large capital projects routinely overestimated?
Stephen ReidDeloitte.
The APPEA Journal 56(2) 584-584 https://doi.org/10.1071/AJ15090
Published: 2016
Abstract
The values of resources projects are routinely overestimated and poorly understood when projects are sanctioned. The challenge with this is that shareholder funds can be squandered on projects that are less attractive than they are perceived to be. This extended abstract addresses how this happens.
-
Behavioural biases at the organisational, portfolio, and project level lead to the benefits of projects being overestimated.
-
Forecasts of capital expenditure and project timing are routinely optimistic. The author will survey the recent track record of the oil and gas industry in estimating project costs, showing that project costs and timelines are positively skewed; that is, costs and timelines have a greater tendency to be in excess of original estimates.
-
Project valuations are often presented as simple base case and anchored high/low cases. A poor understanding of the full spectrum of value outcomes can remove the chance for the project design to be enhanced and the benefits of flexibility are routinely ignored.
-
Small biases in commodity prices and demand projections can significantly improve the appearance of a project, particularly when these metrics move together.
-
Too much comfort is placed in the FEED processes.
There is a way to consider value to enable better decisions to be made when sanctioning resources projects. This approach combines tools and techniques from decision analysis, corporate finance and valuation, portfolio management, data analytics, and behavioural economics to provide tailored insights. The author will work through a case study on how to present value differently.
Stephen Reid is a Partner of Deloitte, with more than 25 years of corporate finance experience, and leads Deloitte’s national valuations team of 50 professionals. Stephen focuses on advising stakeholders of major corporates about value, from choosing between strategic options to maximising the value of a merged entity post-transaction. He has a special interest in advising corporations on how to make better decisions in relation to large capital projects, the value of which are often poorly understood. Clients choose to work with Stephen because of his pragmatic insights gained from over 25 years of experience, his commercial approach, his depth of industry knowledge, and his clear communication of the key issues—particularly in the valuation of shares, businesses and intangible assets. He focuses on major valuation projects, including advice on mergers and acquisitions, independent expert reports, and valuation advisory projects for other commercial purposes. During his career Stephen has provided clients with corporate finance advice, pre-acquisition due diligence reviews, valuations, structuring advice, and feasibility studies in respect of companies operating across a broad range of industries throughout Asia. He has a key interest in the energy and resources sector, and is particularly focused on the rapidly evolving energy sector, challenges facing the resources sector, and supply and demand pressures in eastern Australian energy markets. Stephen started his career in Sydney before moving to Hong Kong, Bangkok, and Melbourne. He is an Honorary Fellow of Macquarie University, and will be lecturing in Australia and China in the university's Masters of Applied Finance program from 2016. Member: Editorial Advisory Board of the Business Valuation Australia journal. |
References
Merrow, E.W., 2011—Industrial megaprojects: concepts, strategies, and practices for success. Hoboken, New Jersey: John Wiley & Sons.Merrow, E.W., 2011—Industrial megaprojects: concepts, strategies, and practices for success. Hoboken, New Jersey: John Wiley & Sons. and The Business Roundtable – Construction Cost Effectiveness Task Force, 1997—The business stake in effective project systems. September 1997. Washington, D.C.: The Business Roundtable.
In His Webinar, Carl Spetzler Estimated, ‘The Roi On Investing In Decision Quality [At A Major Oil And Gas Company] Was Astronomical—1000 to 1. Measurement is difficult but accuracy is not the issue.’ SPETZLER, C., 2011—Decision quality: the next wave. Society of Decision Professionals webinar, 14 December 2011.
