Cost Overruns and Cost Estimation in the North Sea

Recently, a Norwegian government report on the cost overruns of projects in the North Sea was presented (NOU 1999:11). It concluded that there was a 25% increase in development costs from project sanction (POD, Plan for Operation and Development) to last CCE (Capital Cost Estimate) for the 11 oil field projects investigated. Many reasons like unclear project assumptions in early phase, optimistic interpolation of previous project assumptions, too optimistic estimates, and underestimation of uncertainty were given as reasons for overruns. In this article we highlight the possibility that the cost overruns are not necessarily all due to the reasons given, but also to an error in the estimation and reporting of the capital expenditure cost (CAPEX). Usually the CAPEX is given by a single cost figure, with some indication of its probability distribution. The oil companies report, and are required to do so by government authorities, the estimated 50/50 (median) cost estimate instead of the estimated expected value cost estimate. We demonstrate how the practice of using a 50/50 (median) CAPEX estimate for the 11 projects when the cost uncertainty distributions are asymmetric, may explain at least part of the “overruns”. Hence, we advocate changing the practise of using 50/50 cost estimates instead of expected value cost estimates for project management and decision purposes.