Cost Insights
by PowerAdvocate

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

Focus on Labor: The 3 Tools You Need to Respond to the Midstream Labor Shortage Crisis (3/3)

February 4, 2015 at 1:52 PM / by PowerAdvocate

So you know that labor costs are rising sharply, that they’re one of the largest components of your projects, and that midstream companies have historically had low visibility into them. In this final installment of our Labor Deep Dive, we’ll arm you with the top 3 tools that you need to respond to the labor shortage. 

Pipeline Construction1 Properly Account for Labor Costs in Project Planning

Fast rising labor costs increase the difficulty of accurately estimating costs for projects that will begin months or years in the future. In order to account for those changes, midstream companies need to develop two internal capabilities:

First, they'll need to develop insight into the labor conditions of each region in which they operate. This process is critical to assessing and responding to risk in ongoing projects and to making strategic investment decisions about future ones. Midstream companies should collect data on the following indicators of the labor market in each relevant region:

  • What does the full labor pool look like? How many skilled workers are there? What percentage of them are new entrants? How many are expected to retire in the next decade?
  • What is the skill level of the labor pool in the region?
  • What is extent of regional competition for skilled labor in the Oil & Gas industry?
  • What are current and historical wages in the region? Have wages been volatile? What does the forecast look like for wages in the next few years?
  • To what extent does the region favor union vs. non-union labor?

With information on the labor market at hand, midstream companies should then develop standardized variables by which to assess each region (ex: Region A is high union, high wage, high skill). This process allows companies to compare regions along the same baseline and to make strategic decisions about where to invest in further growth.

Second, midstream companies must be able to predict and account for changes in labor costs over time. The most strategic companies will use project cost models alongside their cost forecasting to understand the extent to which an increase in wages affects the profitability of an entire project.

To do that, companies should maintain a central database of historical wage information and analyze average increases over time, supplementing those measures of inflation with market-specific predictions from internal experts or industry publications. Estimation teams should then agree upon standard labor escalation factors in order to ensure that all future project cost estimates are comparable to one another.

By accounting for changes in labor costs, midstream companies can use estimates to invest in areas that are less exposed to labor shocks, to evaluate projects with full cost visibility in order to prevent overruns, and to establish plans to mitigate expected price increases.

2 Develop Robust Recruiting and Skill Development Programs

Pipeline LaborYou can’t control the supply market, but you can respond to it in a way that eliminates the impact of the most severe price fluctuations. We recommend the following four strategies for creating a human resource pipeline equipped to handle a supply market in crisis:

First, the most successful midstream companies will act immediately to preserve the knowledge of their remaining veteran workers. That means making it a priority to invest in initiatives that record the insights of the longest-serving workers and ensuring that the results are disseminated to new entrants.

Second, companies should institute longer, more standardized training periods for both internal and external workers. Because midstream companies can rely less and less on knowledge transfer in field, it is a critical priority to ensure that workers have the skills and knowledge to complete their work safely and quickly. Companies with the best training programs will reap the dividends on multi-year contracts with workers that have been given the tools to work efficiently, safely, and quickly.

Third, the most strategic companies will reduce their reliance on outsourced labor by developing an internal labor pipeline that is able to flex to the needs of the market. When wages are low, midstream companies can afford to outsource more labor, but outsourcing also exposes midstream companies to price shocks when wages rise once more. Companies must have the ability to at least temporarily substitute their own workforce for outsourced labor in order to protect themselves from the most extreme spikes.

Finally, in a competitive market, independent workers will gravitate toward the companies with the best records for safety, training, development, and engagement. Midstream companies ought to begin thinking about creating broader human resource strategies and protocols that ensure that they’ll be able to attract enough workers to get their projects executed on time and on budget.

3 Implement Strategic Buying Strategies

Buying Scenarios Pipeline Labor

The most strategic supply chain and procurement organizations implement multi-year buying strategies that account for expected changes in their supply markets.

Midstream companies that hope to mitigate the impact of the labor shortage should lock in relatively lower labor prices today before they rise even higher. This chart summarizes our energy experts’ advice on executing labor contracts in the next 3 years.

When possible, long-term contracts with construction and engineering firms will ensure that the most strategic midstream companies will reap the benefits of their early sourcing efforts while more myopic companies will bear the brunt of cost pressures.

Click here to read our guide to the 6 most overlooked project cost drivers

Source: PowerAdvocate analysis, “Skills Shortages in a Booming Market” FMI Corporation

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