12/09/2006 - 22:00

Budget blow-outs put pressure on projects

12/09/2006 - 22:00

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BHP Billiton’s Ravensthorpe nickel project is in line for the invidious honour of having the biggest cost blow-out of all the major projects in Western Australia in recent years.

Budget blow-outs put pressure on projects

BHP Billiton’s Ravensthorpe nickel project is in line for the invidious honour of having the biggest cost blow-out of all the major projects in Western Australia in recent years.

With more than 1,700 workers on site, Ravensthorpe is a huge project operating in a part of the state that has never experienced anything like it.

When the project was approved in March 2004, its budget was $1.35 billion.

BHP announced a 32 per cent cost increase in August 2005 and in July this year announced another blow-out, with costs “more than 30 per cent in excess of the currently approved budget”.

The company said tight labour markets and shortages of equipment and skills had driven up costs and in some instances affected project schedules.

Currency strength against the US dollar had added further cost pressure.

BHP is not alone in suffering from big cost blow-outs, which have hit companies large and small.

Multinational aluminium producer Alcoa and mid-cap iron ore miner Portman both suffered one-third cost increases on recent expansion projects.

Alcoa’s Pinjarra alumina refinery upgrade was affected not just by skills shortages and rising costs, but also industrial relations problems.

As well as adding to the cost of the project, these factors delayed its completion.

“We managed this by fitting the work to the people available,” Alcoa executive Kim Horne told a skills conference in June.

“This resulted in a longer, flatter construction period rather than a short, peak period of activity.”

The difficulties experienced by Alcoa are highlighted by comparing its project with BHP Billiton’s $250 million upgrade of its Worsley alumina refinery.

They are two similar projects in essentially the same market at the same time, yet BHP completed its project close to budget.

While most of the commentary on skills shortages and cost increases has focused on Australia’s overheated market, Woodside has indicated that the problem extends wider.

Announcing a 21 per cent cost increase on the North West Shelf venture’s phase 5 expansion, Woodside said it was “largely due to higher labour costs in construction contracts awarded during a period of extraordinary international construction market inflation”.

The cost increases on some projects are even more dramatic if the starting point is their feasibility study.

For instance, Roc Oil’s Cliff Head oil field development was originally budgeted to cost $156 million, in April 2004.

By the time the project was approved, the budget was $227 million. When the project was completed in May, the cost had risen to $285 million.

Similarly, the expansion of CSBP’s ammonium nitrate plant at Kwinana was originally estimated to cost $150 million.

The budget had increased to $200 million when the project was approved last November.

The company announced last month that the budget had subsequently increased to $260 million, after finalising “design and regulatory requirements together with updated estimates”.

For most of the projects discussed above, higher revenue flowing from increased commodity prices is expected to outweigh the higher costs.

The danger for the WA economy is that other projects, not just in mining but across all industry sectors, will be aborted because of the higher costs.

BHP Billiton has already announced that a $1.1 billion expansion of its Worsley alumina refinery has been deferred because of higher costs, and there is speculation Alcoa may defer the proposed $1.5 billion expansion of its Wagerup refinery for the same reason.

The budget for Chevron’s giant Gorgon gas project will have increased substantially from the $11 billion estimate produced three years ago, and it remains to be seen whether this will affect the viability of the project.

In the iron ore sector, current and aspiring producers point to the near-90 per cent price increase achieved over the past two years to indicate their ability to cope with higher costs.

Nonetheless, rising costs will increasingly start to affect the viability of some of the proposed projects. Rising costs will also have an impact on taxpayers, though the widely publicised cost increases on the New MetroRail project are modest compared with other projects.

The rail project’s current $1.6 billion budget, which may be affected by legal claims, is 6.2 per cent above the December 2003 estimate and 13.8 per cent above the original 2002 budget.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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