By Rosemary Bruus
“That’s within tolerance.”
“Suppliers know every day represents lost production, so everything costs more.”
“We are the experts.”
“We have been doing business this way for 23 years!”
“We don’t understand – how did this happen??”
Sound familiar? These are some of the most common excuses boards hear when a capital construction project goes over budget. In reality, project cost overruns are a fact of life, caused by multiple factors. But where they were once an acceptable cost of doing business (and the industry seemingly had no end to revenues), high project costs are now coming back to bite companies, large and small. Turnaround costs have not escaped the financial microscope even historically being accepted by tight timelines and epic budgets.
Occasionally, costs offside of market expectations have proven calamitous. Executives and directors at several companies have recently encountered activist shareholders demanding more accountability from boards and management.
After somewhat of a hiatus, “we are seeing increased interest from U.S. activists, likely spurred by a weak Canadian dollar and a target-rich environment for funds from other countries looking for new investment opportunities,” said Walied Soliman, Norton Rose Fulbright Canada LLP (reported by Forbes Magazine January 26, 2017). “These targets are attractive as it is easier to accumulate a position in their stock and they likely have fewer resources to mount a defense against activists.”
Unfortunately, low commodity prices (with no light at the end of the tunnel) compound the issue when company performance is in question. According to Fred Pletcher, Borden Ladner Gervais LLP, Interestingly, “Canadian resource companies’ share prices have lagged commodity price increases in 2017, which suggests that there may be opportunities for activists to try and bridge this performance gap.”
Boards at SNC Lavalin, BHP, and Canadian Pacific, for example, have all been stunned by the upheaval within their companies.
“The board’s responsibility is to act in the best interest of the corporation,” says Michael Robinson, associate professor of finance at the University of Calgary’s Haskayne school of business. “Operations are management’s responsibility. Changes in projects must be explained to the board. Moreover, if a board member has knowledge and expertise in a project and finds that project change raises a red flag,” he adds. “you’re responsible for bringing that concern to the full board.”
Progressive boards focus on key ratios to fulfill their obligations. Running a company aptly parallels managing your own physical health. Management gets regular exercise, stays happy, and eats a healthy diet supplemented with vitamins. Forward-thinking directors monitor key ratios, just like they would their own body mass index (BMI), to measure ongoing progress and signal bellwether changes.
Synergy between management and its board can be a powerful combination. However, some boards are unable to respond to meaningful changes in ‘corporate BMI’ measurements. Fortunately for shareholders, times change, and so do the board’s legal responsibilities.
Today, board oversight has become a real and defined legal risk. Directors are responsible to ensure that their interests align with those of both management and shareholders. Unfortunately, however, activist shareholders sometimes arrive at this conclusion first. In the case of Sino-Forest’s bankruptcy, it was researchers at Muddy Waters LLC (neither the board or the shareholders) who first exposed possible fraud at the company. At some point, corporate BMI is confirmed when the facts become public.
At some companies, boards are reassessing the differentiators between strategic and operational decision-making in evaluating their corporate BMI as it relates projects with epic effect (with costs and lost production) of which plant turnarounds can be the elephant in the room.
A turnaround usually includes:
• Annual maintenance;
• Equipment repair and replacement;
• De-bottlenecking and system improvements; and
• Supplemental systems required to gradually increase production volume (units) to satisfy overall market demand (often known as ‘refinery creep’).
Turnaround costs (along with any other capital expenditures – CAPEX), produce risk. Managing project risk, in a nutshell, is about probability multiplied by possible effect. Proactive managers and directors consider the potential risks as well as define the stakeholders affected, creating a focused risk-mitigation strategy. They have a responsible eye in selecting the right leadership and then asking themselves some pertinent questions:
• What are the risks, and is there, or should there be a material effect on the financial statements (or social capital) of the organization?
• What level of investment or resources will come to bear on the project?
• What are the interdependencies (and possible risks) in terms of other projects, capital, leadership, suppliers and partners?
• What are the opportunities with technology in terms of accomplishing more with fewer resources and what processes can we build up through constant measurement and leveraging that (measurement) data? This is where logistics can act like a third-party audit of processes as well as accumulate data for analysis.
• At what point does it become negligent to ignore the leverage easily available through studying the data from your own plant prior to a turnaround?
• At what point do you decide to transcend the deterrents and simply use the data to increase efficiencies and productivity?
Logistics is a key area for leveraging the CAPEX dollars, specifically an area defined as third-party logistics (3PL) which is not limited to shipping, receiving, coordinating, cross-docking, packing and unpacking — 3PL collects data on a regular basis to streamline efficiencies. And the beautiful part is that 3PL can be outsourced usually producing savings (due to the short-term nature of a turnaround) as well as the utility of the data used for long term planning.
Parts, equipment, suppliers and supplies can be inspected for identification, integrity, catalogued for timely and cost-efficient arrival (and departure) at plant turnaround site independent of the complexity, size or weight of the variable. Unforeseen complications can be measured and logged along with their solutions so that again the desired part, equipment, supplies or supplier is on hand avoiding the creation of a costly delay (further extending plant production downtime).
Consider the example of BP’s disaster-remediation efforts in the Gulf of Mexico. Although it is not a carbon copy of a plant turnaround, it does present urgency and many unknowns to be tamed with a limited capital budget. Given several important considerations: finite qualified resources, a looming (growing) environmental crisis, and a huge need for supplies (parts, equipment and expertise), as well as emergency preparedness (being able to leverage data and processes from previous disasters). That said, would the use of logistical data have been likely to have benefited BP’s efforts (in terms of lost production, human lives and environmental cleanup as well as future litigation)?
Leveraging logistics data means having what you need, when you need it and knowing it works just like having a running car with a full tank of gas when a woman needs to get to the hospital to deliver a baby. Preparedness when faced with situations where anything can go wrong is a responsibility at all corporate levels. Plant turnarounds are no different.
Proactive boards ensure corporate vitality by being aware of corporate BMI indicators with respect to plant turnarounds. Logistical data can assist in measuring this vitality showing the productivity of plant turnaround efforts by pinpointing potential problems before they become fodder for outsiders/activists. This logistical data can provide high-level intelligence beyond budgetary variances in areas of business relationships and social capital. Such information can provide a confidential opportunity to confirm diligence, and gives the board additional comfort in its ability to act with the greatest number of choices should a situation arise.
A careful consideration of logistical data can provide insights approaching that of an audit. Audits are usually initiated to assist in reaffirming optimal controls, environmental responsibility, cost recovery, accurate asset valuation or bottom-line EBITDA – but not fixing blame.
Companies in the energy industry face a long awaited (and doubtful) recovery in commodity prices that has led to asset sales and increasing budget scrutiny. A closer inspection of processes, logistics, and costs sponsored by directors and seen through from start to finish, can reduce losses that might originate from outdated controls, non-compliance with contracts, overcharges, duplications, or fraud – to cite just a few examples.
Cost recovery, highlighted by logistical data, may be the mechanism that saves employees their jobs and preserves share price. Directors will typically find this specialized expertise available in an outsourced logistics firm, which may identify areas where the organization experiences pressure, delays, missing documentation, or abruptly concluded searches for information. This information can serve as a beacon to assist the board in revealing situations where corporate BMI could improve remarkably, as if by magic.
Attention to corporate BMI indicators builds resilience and sustainability well-ahead of activist’s initiatives. Corporate responsibility is a choice at every minute by all interested parties.
Rosemary Bruus is director of Fairstone Group of Companies (plus another audit consultancy which she recently resigned from). A hallmark strength of Rosemary’s is creatively leveraging cost awareness to gain new revenue streams. She gets a kick out of nurturing the entrepreneurial community and has sat on a number of advisory boards, including several at the University of Calgary and Mount Royal University. She studied geology and accounting at the University of Saskatchewan and Psychology at the University of Santa Monica, plus various classes with both the Institute of Corporate Directors and Certified General Accountants.
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