Cost Insights
by PowerAdvocate

Intelligence for energy companies seeking a data-driven approach to cost management

The 3 Ways Project Misestimates Threaten Midstream Companies

February 4, 2015 at 1:46 PM / by PowerAdvocate

Wondering why accurate project estimates matter? In this installment of our project estimation deep dive series, we'll show you how bad estimates can have consequences that ripple through an organization and impact its highest level financial metrics. At the end, we’ll give you the tools you need to remedy the estimation problem and prevent the 3 scenarios below.

Accurate estimates are the best tool that midstream companies have to assess project feasibility and drive profitability, and they're the key to allocating your total available capital to the best possible mix of investments. So whether you overestimate and miss out on profitable investments or underestimate and execute unprofitable ones, bad estimates mean bad investments. Here's why:

1. Cost Overruns Have Enterprise-Wide Impact

Over and Under Estimates

Underestimates make unprofitable investments appear profitable. When midstream companies execute underestimated projects, costs end up exceeding expectations and threaten project profitability.

What's worse, the hit to profitability isn’t limited to underestimated projects: to make up cost overruns, you either have to take on more debt to finance the gap or take money from other projects, causing a ripple effect throughout your portfolio.

In just the last year, midstream companies have experienced project cost overruns of up to 40%. With numbers like those, missed estimates can threaten midstream companies at the enterprise level.

Whether in the form of destroyed quarterly earnings, ballooning debt, delayed projects across the investment portfolio, or diminishing rates of return, missed estimates endanger the highest-level financial success of any midstream company.

2. Overestimates Lose Profitable Investment Opportunities

It’s not just underestimates that threaten midstream companies: overestimates cause you to lose profitable investment opportunities in two ways:

  • Good investments appear to be bad ones, causing internal decision makers not to execute potentially profitable projects
  • High project bids are uncompetitive, so you lose projects to companies that have more visibility into actual project costs
With an average 12% return on pipeline projects, the decision not to execute a profitable project is a significant loss for any midstream company: on a $200M project, that means $24M in lost profits.

What's more, even when overestimated projects are executed, the result is that more capital has been allocated to a project than necessary, tying up precious resources and losing additional investment opportunities.

3. Misestimates Undermine Professional and Financial ReputationsMissed Estimate News

Whenever projects don’t go according to plan, reputations end up on the line. That’s true for individuals and for companies.

Misestimates embarrass executives in charge of project planning and ultimately lead to tough board discussions and changes in management.

But misestimates are also the swiftest way to cause public relations disasters and destroy investor confidence. That’s because misestimates indicate a fundamental inability to make strategic investment decisions, causing shareholders and investors to question the long-term stability of their investments.

The Bottom Line? Misestimates cause midstream companies to choose the wrong mix of investments and to suffer the financial and reputational consequences of doing so.

Wondering how to prevent those consequences?

Sources: Bloomberg, Natural Gas Supply Association Pipeline Cost Recovery Report

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