KPMG Global Energy Institute KPMG International

KPMGs Major Projects Advisory Project Leadership Series: Monitoring Capital Projects and Addressing Signs of Trouble
There are many historical examples of construction projects exceeding their budgetslike the Sydney Opera House, where the actual cost of completion was 15 times higher than the original budget.1 A story such as this, coupled with the fact that capital projects represent some of the most costly and risky endeavors a company will undertake, might make business owners hesitant to invest in large capital projects. While numerous factors contributed to the massive cost overrun on the Sydney Opera House, one of the root causes was the absence of an integrated framework of process controls for monitoring the project. Fortunately, there are tools and techniques that can be used by your project management teams to reduce the risks associated with capital projects. This white paper will first address some of the key project management control areas that will aid in the success of your capital project. Next, well discuss effective monitoring and how to identify red flags that may indicate potential risks. Finally, well discuss some steps you can take if you find that your project is heading in the wrong directionwhere the schedule is slipping, costs are rapidly increasing, and project performance is declining.

Using a Project Management Controls Framework

Most industry leading practices recognize that the selection and use of a project management controls framework helps to ensure project success and avoid major project issues or failure. The purpose of a project management controls framework is to put a system of key controls in place alongside an effective reporting system. Consistent use of a project management controls framework allows key performance indicators to be monitored frequently and unfavorable trends to be addressed early on. KPMGs Project Controls Framework (discussed in our white paper KPMGs Major Projects Advisory Project Leadership Series: Governance and Project Controls) is organized into five main project management processes. Within each of the main process categories are key project management controls, which, if properly implemented, can improve your capital project success. A brief summary of our Project Controls Framework and key controls follows.

Flybjerg, Bent (2005-12-01). Policy and Planning for Large Infrastructure Projects: Problems, causes, cures (Report). Policy Research Working Papers. 3781. World Bank Publications. pp. 45. WPS3781. http://go.worldbank.org/6G2FJ40OG0.

1 | Major Projects Advisory Project Leadership Series

2013 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. NDPPS 132555

PM Process 1 Program Strategy, Organization, and Administration

Key Controls: Project Strategy It is important to develop a delivery strategy for each major capital project and to get concurrence of key personnel and stakeholders. No two projects are identical, and similarly the strategies used to deliver each project should be unique. Projects should be subject to a formal authorization and approval process prior to entering into contracts and committing company funds. Policies and Procedures There should be a set of formal policies and procedures for all core and support process areas, and these should be regularly reviewed and updated. Personnel should have real-time access to the most current version of these documents and should receive training to promote compliance. Roles and Responsibilities In the same way that organizations define the roles and responsibilities of their employees for standard business operations, each capital project should have identified resources with specifically defined roles and responsibilities. Often, the simple identification of owner, consultant, and contractor personnelalong with their areas of responsibility will greatly enhance communication among project team members.

Energy construction projects can fail for many reasons. Poor risk management, scope creep, approval delays, inexperienced project team or support personnel, ineffective controls, and improper contract administration can all contribute to project failures. Another contributing factor is ineffective project monitoring systems. Implementing an effective project monitoring system is one of the most difficult project management challenges, as project reporting for energy projects requires coordinated information and integration from all project phases and construction activities, ranging from early strategy and planning to project closeout and commissioning. Given the size, scale, and complexity of many energy projects, organizations cannot afford to prepare and produce project reports in a reactive manner. Governing boards, shareholders, bondholders, and regulators are establishing high standards for project performance in order to help ensure that projects are delivered on time, within budget, and to the expectations established by the projects stakeholders or ratepayers. To accomplish these goals, energy construction projects should implement leading project monitoring systems tailored to meet the needs of project stakeholders, and regulatory requirements, and provide an accurate historical record of project information for future projects as well as operations and maintenance purposes.

PM Process 2 Cost Management

Key Controls: Budgeting The process for developing a budget should be formalized, so the budget baseline will be robust and appropriate for the needs of the project. A formal process also promotes consistency across projects and provides a framework for monitoring. Payment Processing and Administration It is critical to establish a formal payment review and approval process to control costs on a capital project. This process should be documented in the project-specific policies and procedures.

PM Process 3 Procurement Management

Key Controls: Sourcing To form strong business relationships with reputable firms, the solicitation process must be formalized. This formalized process promotes consistency among projects and will establish a reputation of fairness for your company. Contracting Contracts are legally binding agreements, so it is essential that the language of these contracts be carefully considered and standard contract templates developed for consistent use across all capital projects. Involve your legal department or external counsel in this process.

PM Process 4 Project Controls and Risk Management

Key Controls: Change Management Capital projects are constantly changing, and in order to effectively manage these changes, it is important to develop a formal process including standard documentation and review and approval procedures. Risk Management As previously mentioned, capital projects are risky endeavors, so it is important to have a process in place for addressing these risks. Risk management involves assessing risks prior to engaging in a project and continuously developing and reacting to those risks throughout the project life cycle.

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2013 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. NDPPS 132555

PM Process 5 Schedule Management

Key Controls: Schedule Development Standards Developing formal schedule development standards results in project schedules that include the necessary components for effective monitoring. IT also promotes comparability among projects. Schedule Change Management Schedule change management is in a category of its own due to the frequency with which schedule adjustments are made. It is not uncommon for the schedule to change daily based on factors such as weather, materials delivery, staff availability, actual versus budgeted progress, etc.

Effective Techniques for Monitoring Capital Projects

Entities with a robust project management framework can still run into trouble if they do not apply thorough monitoring techniques. Monitoring techniques set up feedback loops to assess whether control processes are operating effectively, and if they are not, monitoring techniques help to reset control processes tailored to the specific project environment. Monitoring techniques also ensure that unfavorable project trends are identified and mitigated by the project management team. Based on our experience with troubled projects, the following monitoring techniques may help you to keep your project on the right track.

Preparing summary cost reports is one of the most challenging project reporting activities for most large energy projects due to the focus on tracking and reporting according to FERC accounting requirements. FERC accounting requirements often make it more difficult for the project team to reconcile and summarize data from several sources and present accurate project financial information in a well organized and consistent manner. Payment information and procurement/contract information often reside in separate systems, and budget information, if not approved at a detailed level, may require redistribution over many cost categories. Key components of an effective reporting system for energy projects include: Transparency and accuracy Ability to drill down by layer Limited redundant information in different systems Limited # of manual adjustments Limited large variances between original submission and actuals For utility projects that will be subject to a prudence review, it is important that project cost reporting is timely, and accurate, and provides the level of detailed required to support any requests for additional costs or justify any cost overruns.

Project Management Reporting

To monitor a project at a big-picture level, management and key stakeholders must receive status reports that include agreedupon information, in an agreed-upon format, and at a frequency that allows for real-time monitoring and reaction to potential issues. The most common project failures result from schedule slippage and cost growth. Examples of trend monitoring that management may be interested in include: Actual percent complete (cost basis) compared to schedule percent completedocument any differences Original budget compared to adjusted budgetbudget changes and transfers should be appropriately tracked and approved by project management Pending change orders and commitments that may be approved, but which are not yet priced or included in the project budget Other cost risks that are not included in the project budget Cost-to-Complete (CTC) based on established cost estimating techniques (this should not just be a subtraction of original budget less costs to date) Total cost forecast variance from adjusted budget.

Assessment of Roles and Responsibilities

As the project progresses, observe and gather feedback about the project management team to help ensure that roles and responsibilities that were initially developed remain effective. Continually assess whether the project team members assigned to each role demonstrate the appropriate competenciesboth internally, within the owners organization, and externally, among contractor and consultant personnel.

Project Cost Reporting

In addition to higher level cost reporting in a project status report, be sure to include standardized reporting of detailed project costs. Key elements of such reporting include original budget, budget transfers, approved change orders, current budget, commitments, pending change orders, payments to date, and forecast.

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2013 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. NDPPS 132555

Contract Administration and Compliance

Once formal contracting processes and contracts are in place, monitor activities performed under the contracts for compliance with contract terms, and formally track all contract changes. Key contracting practices also include a process to select appropriately qualified contractors and consultants.

Dashboard reports and risk reports are can be effective ways to help identify warning signs for utility projects. A good project dashboard includes the important project metrics presented on a single page. If a project dashboard takes more than a few minutes to comprehend or requires a lot of explanation and other supporting information, it has not served its purpose to provide quick, meaningful, and actionable information to management and other key stakeholders. Dashboard reports are especially useful for large programs with repeatable projects such as wood-to-steel pole replacement, pipeline replacement, pipeline inspection and hydrotesting, and major gas or electric transmission or distribution projects. Status of permits, right-of-ways, transmission tower construction, etc., are all easily communicated via simple dashboard reports. Formalized risk reporting has been around for a while, but it has recently emerged as a standard and valuable tool in identifying, analyzing, tracking, and responding to project risks for major energy construction projects. Risk reporting may take the form of a simple risk register updated on a routine basis or a combination of risk dashboards, risk analysis, and meeting minutes discussing risk trends and other important risk management information. As the success of energy projects becomes more and more focused on the ability to effectively manage and mitigate risk, especially environmental and regulatory risks, the greater the importance of an effective risk reporting function.

Project Reviews and Compliance Auditing

Perform periodic project reviews to monitor risk and to assess compliance with carefully developed project policies and procedures. These reviews can be performed internally or by a third party. The project review methodology should be standardized to provide for comparability across multiple reviews. Issues identified should be tracked and reported on a frequent and ongoing basis and verified for compliance during subsequent project reviews. For compliance auditing, be skeptical, especially in your invoice review process. For example, do not release retention amounts prior to a contractor finishing its work. Also, during the invoicing process, be sure to obtain and track unconditional lien releases to reduce exposure to costly and time-consuming claims.

Red Flags and Potential Project Issues

What do you do if you have great tools for monitoring capital projects, but you are unsure about how to interpret the results? How do you know if project trends are favorable or unfavorable? Capital projects generate huge amounts of data. Here are some red flags and potential issues common to the construction industry: Project reports that do not change significantly over time may indicate that their content is not being updated regularly to represent true project status Project reports that summarize overall progress at a very high level with little or no supporting documentation of the percentage of completion or the cost forecast may indicate a lack of competence or unreasonable optimism on the part of the contractor Project estimates or changes without a detailed breakdown of costs including labor, equipment, materials, and subcontractors may indicate poorly developed estimates Lack of appropriate reviews and approvals or signatures on contracts and change orders may indicate ineffective controls or intentional circumvention Inability to produce supporting documents in a timely manner may indicate that project management team members are skipping steps in your defined processes Schedule changes presented without documentation of potential cost impacts may indicate lack of integrated cost and schedule reporting systems Risk items that do not indicate responsible parties, status, mitigation plan, etc., may indicate poor monitoring and risk response.

Reacting to a Troubled Project

Despite your best efforts, sometimes a capital project fails to meet its performance expectations. The schedule may continue to slip, costs may be increasing rapidly, and, perhaps, contractor change order requests and potential claims are piling up. If this happens, here are some steps you can take to lessen the risks and costs of a troubled project: Increase the frequency of project status reportingengage stakeholders more often

4 | Major Projects Advisory Project Leadership Series

2013 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. NDPPS 132555

 Get out of your office and into the fieldobserve contractors and subs as they perform their procedures to assure yourself that the project status is what they are reporting Consult legal counsel to make sure you have a clear understanding of the remedies available in the contract exercise any remedies that are beneficial

Assess project documentation practices and address any deficiencies Consider hiring a third-party subject matter professional to perform a project assessment.

Conclusion The costs and risks associated with major capital projects are here to stay. What you can do is to avoid excessive risks and failed projects by using a consistent project management framework paired with effective project monitoring techniques. Using the tips in this white paper, your business can make well-informed, proactive decisions that will help

to lead your project down the road to success. And if your project still experiences some unexpected challenges, dont throw in the towel. By reacting expeditiously to a troubled project, you may help lessen the damage and get your project back on track.

Contact us Geno Armstrong Principal, Advisory KPMG LLP (U.S.) T: 415-963-7301 E: garmstrong@kpmg.com Clay L. Gilge Principal, Advisory KPMG LLP (U.S.) T: 206-913-4670 E: cgilge@kpmg.com Erika Alvord Director, Advisory KPMG LLP (U.S.) T: 503-820-6603 E: ealvord@kpmg.com

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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. 2013 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and cutting through complexityare registered trademarks or trademarks of KPMG International. NDPPS 132555 KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 152 countries and have 145,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. Each KPMG firm is a legally distinct and separate entity and describes itself as such.