1/6/2017

All capital cost estimates of industrial process

plants can be classified as one of four types:
1. Rule of thumb estimates
2. Cost curve estimates
3. Major equipment factor estimates
4. Definitive estimates

1
 1/6/2017

The rule of thumb estimates are, in most

cases, only an approximation of the order of
magnitude of cost.
These estimates are simply a fixed cost per
unit of feed or product.

Complete coal fired electric power plant:

$2,500/kW
Complete synthetic ammonia plant:
$200,000/TPD
Complete petroleum refinery: $25,000/BPD
These rule of thumb factors are useful for
quick ballpark costs.
Many assumptions are implicit in these values
and the average deviation from actual
practice can often be more than 50%.

2
 1/6/2017

The cost curve method of estimating corrects

for the major deficiency illustrated above by
reecting the significant effect of size or
capacity on cost.
These curves indicate that costs of similar
process units or plants are related to capacity
by an equation of the following form:
Plant A cost = (Plant A capacity
Plant B cost Plant B capacity)X

This relationship was reported by Lang, who

suggested an average value of 0.6 for the
exponent (X).
Cost curves of this type have been presented for
petroleum refinery costs in the past.
The curves presented herein have been adjusted
to eliminate certain costs such as utilities,
storage, offsite facilities, and location cost
differentials. Separate data are given for
estimating the costs of these items.
The facilities included have been defined in an
attempt to improve accuracy.

3
 1/6/2017

It is important to note that most of the cost

plots have an exponent which differs
somewhat from the 0.6 value.
Some of the plots actually show a curvature in
the loglog slope which indicates that the
cost exponent for these process units varies
with capacity.
Variations in the loglog slope (cost
exponent) range from about 0.5 for small
capacity units up to almost 1.0 for very large
units.

This curvature, which is not indicated in the

previously published cost curves, is due to
paralleling equipment in large units and to
disproportionately higher costs of very large
equipment such as vessels, valves, pumps, etc.
The cost curve method of estimating, if carefully
used and properly adjusted for local construction
conditions, can predict actual costs within 25%.
Except in unusual circumstances, errors will
probably not exceed 50%.

4
 1/6/2017

Major equipment factor estimates are made

by applying multipliers to the costs of all
major equipment required for the plant or
process facility.
Different factors are applicable to different
types of equipment, such as pumps, heat
exchangers, pressure vessels, etc.
Equipment size also has an effect on the
factors.

It is obvious that prices of major equipment

must first be developed to use this method.
This requires that heat and material balances
be completed in order to develop the size and
basic specifications for the major equipment.

5
 1/6/2017

This method of estimating, if carefully

followed, can predict actual costs within 10 to
20%.
A shortcut modification of this method uses a
single factor for all equipment.
A commonly used factor for petroleum
refining facilities is 4.5.
The accuracy of this shortcut is of course less
than when using individual factors.

Definitive cost estimates are the most time

consuming and difficult to prepare but are
also the most accurate.
These estimates require preparation of plot
plans, detailed ow sheets and preliminary
construction drawings.
Scale models are sometimes used.

6
 1/6/2017

All material and equipment are listed and

priced.
The number of man hours for each
construction activity is estimated. Indirect
field costs, such as crane rentals, costs of
tools, supervision, etc., are also estimated.
This type of estimate usually results in an
accuracy of 5%.

The items to be considered when estimating

investment from cost curves are:
Process units
Storage facilities
Steam systems
Cooling water systems

7
 1/6/2017

Subtotal A
Offsites
Subtotal B
Special costs
Subtotal C
Location factor
Subtotal D
Contingency
Total

Economic evaluations are generally carried

out to determine if a proposed investment
meets the profitability criteria of the company
or to evaluate alternatives.
There are a number of methods of evaluation
and a good summary of the advantages and
disadvantages of each is given in Perrys
Chemical Engineers Hand book.
Most companies do not rely upon one
method alone but utilize several to obtain a
more objective viewpoint.

8
 1/6/2017

As this is primarily concerned with cost

estimation procedures, there will be no
attempt to go into the theory of economics,
but equations will be presented which are
used for the economic evaluation
calculations.
There is a certain amount of basic
information needed to undertake the
calculations for an economic evaluation of a
project.

Depreciation arises from two causes:

deterioration and obsolescence.
These two causes do not necessarily operate
at the same rate, and the one having the
faster rate determines the economic life of
the project.
Depreciation is an expense and there are
several permissible ways of allocating it.

9
 1/6/2017

For engineering purposes depreciation is

usually calculated by the straight line method
for the economic life of the project.
Frequently economic lives of 10 years or less
are assumed for projects of less than
$250,000.

The working capital (WC) consists of feed and

product inventories, cash for wages and
materials, accounts receivable, and spare
parts.
A reasonable figure is the sum of the above
items for a 30 day period.

10
 1/6/2017

The annual cash ow (ACF) is the sum of the

earnings after taxes and the depreciation for
a one year period.

Uncertainties in the cost of equipment, labor,

operation, and raw materials as well as in
future prices received for products can have a
major effect on the evaluation of investments.
It is important in appraising the risks involved
to know how the outcome would be affected
by errors in estimation, and a sensitivity
analysis is made to show the changes in the
rate of return due to errors of estimation of
investment costs and raw material and
product prices.

11
 1/6/2017

These will be affected by the type of cost

analysis performed (rough estimate or
detailed analysis), stability of the raw material
and product markets, and the economic life
of the project.
Each company will have its own bases for
sensitivity analyses but when investment
costs are derived from the installed cost, the
following values are reasonable:

12
 1/6/2017

Set up an Excel spreadsheet

that will calculate your projects
NPV
Individually change your
assumptions to see how the
NPV changes with respect to
different variables
Helps to determine how much
to spend on additional
information

Suppose that you forecast the

following for an electric
scooter project:
Market Size of .9 (worst case) 1.1 million (best case) customers
Market Share of between 4% (wc)and 16% (bc) after the first year
Unit price between $3,500 (wc) and $3,800 (bc)
Unit cost (variable) between $3,600 (wc) and $2,750 (bc)
Fixed costs between $40 (wc) and 20 million (bc).
From Principles of Corporate Finance, (c) 1996 Brealey/Myers

13
 1/6/2017

Pessimistic Expected Optimistic

Market Size 900,000 1,000,000 1,100,000
Market Share 4% 10% 16%
Unit Price $ 3,500 $ 3,750 $ 3,800
Unit Cost (Variable) $ 3,600 $ 3,000 $ 2,750
Fixed Costs $ 40,000,000 $ 30,000,000 $ 20,000,000
Discount Rate 10%
Original Investment 150,000,000

Revenue: $ 375,000,000
Variable Cost $ 300,000,000
Fixed Cost: $ 30,000,000
Depreciation $ 15,000,000
Tax: $ 15,000,000
Net Profit (Pretax Profit - Tax): $ 15,000,000

Net Cash Flow (net profit + Depcn) $ 30,000,000

10 Year NPV $34,337,013.17

Changing each variable individually yields the following NPV:

Pessimistic Expected Optimistic
Market Size 11,000,000 34,337,013 57,000,000
Market Share -104,000,000 34,337,013 173,000,000
Unit Price -42,000,000 34,337,013 50,000,000
Unit Cost (Variable) -150,000,000 34,337,013 111,000,000
Fixed Costs 4,000,000 34,337,013 65,000,000

NPV is calculated by subtracting the initial

investment from the sum of yearly $30M net
cash flow.
NPV = - 150 + 30 [1 (1.1)10 / .1] = $34.3

Net Cash Flow is defined as net profit plus

the tax savings you get from depreciation

14
 1/6/2017

Pessimistic Expected Optimistic

Market Size 900,000 1,000,000 1,100,000
Market Share 4% 10% 16%
Unit Price $ 3,500 $ 3,750 $ 3,800
Unit Cost (Variable) $ 3,600 $ 3,000 $ 2,750
Fixed Costs $ 40,000,000 $ 30,000,000 $ 20,000,000
Discount Rate 10%
Original Investment 150,000,000

Revenue: $ 375,000,000
Variable Cost $ 300,000,000
Fixed Cost: $ 30,000,000
Depreciation $ 15,000,000
Tax: $ 15,000,000
Net Profit: $ 15,000,000
Operating Cash Flow $ 30,000,000

10 Year NPV $34,337,013.17

Changing each variable individually yields the following NPV:

Pessimistic Expected Optimistic
Market Size 11,000,000 34,337,013 57,000,000
Market Share -104,000,000 34,337,013 173,000,000
Unit Price -42,000,000 34,337,013 50,000,000
Unit Cost (Variable) -150,000,000 34,337,013 111,000,000
Fixed Costs 4,000,000 34,337,013 65,000,000

It is very important that price estimation and

projections for raw materials and products be
as realistic as possible.
Current posted prices may not be
representative of future conditions, or even of
the present value to be received from an
addition to the quantities available on the
market.
A more realistic method is to use the average
of the published low over the past several
months.

15
 1/6/2017

This method is also known as the engineers

method, du Pont method, or the capitalized
earning rate.
It does not take into account the time value
of money, but, because of this, offers a more
realistic comparison of returns during the
latter years of the investment.
The return on original investment is defined
as:

The return on investment should be reported

to two significant figures.

16
 1/6/2017

The payout time is also referred to as the

cash recovery period or years to pay out. It is
calculated by the following formula and is
expressed to the nearest one tenth year:

If the annual cash ow varies, the payout time

can be calculated by adding the cash income
after income taxes for consecutive years until
the sum is equal to the total investment.
The results can be reported to a fractional
year by indicating at what point during the
year the cash ow will completely offset the
depreciable investment.

17
 1/6/2017

If the annual cash ow varies, the payout time

can be calculated by adding the cash income
after income taxes for consecutive years until
the sum is equal to the total investment.
The results can be reported to a fractional
year by indicating at what point during the
year the cash ow will completely offset the
depreciable investment.

This method is called the investors return on

investment, internal rate of return, profitability
index, and interest rate of return as well as
discounted cash ow.
A trial and error solution is necessary to calculate
the average rate of interest earned on the
companys outstanding investment in the project.
It can also be considered as the maximum
interest rate at which funds could be borrowed
for investment in the project with the project
breaking even at the end of its expected life.

18
 1/6/2017

The discounted cash ow is basically the ratio

of the average annual profit during
construction and earning life to the sum of
the average fixed investment, working
capital, and the interest charged on the fixed
and working capital that reects the time
value of money.
This ratio is expressed as a percentage rather
than a fraction.

In order to compare investments having

different lives or with variations in return
during their operating lives, it is necessary to
convert rates of return to a common time
basis for comparison.
While any time may be taken for this
comparison, the plant startup time is usually
taken as the most satisfactory.
Expenditures prior to startup and income and
expenditures after startup are converted to
their worth at startup.

19
 1/6/2017

Energy Costs > $ 500,000 / day at BPs

Cherry Point refinery in the US, when the
refinery is operating near design capacity.

2nd Newest Refinery in U.S.

Designed to run 100 kBD ANS Crude,
currently capable of 230+ kBD
Economies of scale in action large, single
train equipment so reliability is critical.
Industry leader in operating costs.

20
 1/6/2017

Conclusions

21
 1/6/2017

Financing large energy projects has become a

central feature of energy industry competition.
Large projects provide the best means to grow
production to meet the demands of a developing
world and offset declines from earlier ventures.
Only large projects provide the economies of
scale and other efficiencies to assure that their
sponsors can compete in the low-cost-producer-
wins energy business.

Yet large projects also bring outsized risks.

Energy companies who fail to solve the
challenge of undertaking many large projects
without suffering large setbacks eventually
find that they disappear as independent
entities.

22
 1/6/2017

Financing is a major challenge in this competitive

world. Large amounts of capital must be assured
over long planning horizons to succeed in a
world where projects can take three to six years
to develop and up to a decade to recover the
capital invested.
Successful energy players must find ways to
assure both a ready access to long-term capital
and ways to use their financing efforts to
mitigate large project risks.

Two approaches have proven successful at

performing these feats.
The Centralized Finance System is the
dominant approach. It combines strong
central credit with a sophisticated
intercompany financing system and selective
use of project financing to provide major
companies with a suite of advantages

23
 1/6/2017

Low-cost debt and equity, efficient use of

internal cash generation, global tax
optimization, and enhanced remittances of
affiliate cash are its most salient
accomplishments.

Project financing can economize a firms capital,

allowing it to do more projects than using only
its own resources would allow.
Through the use of leveraged economics, firms
also can harvest high returns on equity and
compete effectively in bidding situations.
These considerations are especially attractive for
start-up or weaker energy players who have
found that a Project Financing System can enable
them to commercialize their attractive
opportunities and compete with the majors in
specific situations.

24
 1/6/2017

Considerable discipline is required to practice

this system successfully.
Practitioners who fail to project-finance only
economically robust projects and preserve
nonrecourse loan terms, tend to overreach
over time.
Financial distress and even bankruptcy can
then result.

Ultimately, successful practitioners of both

systems end up developing hybrid solutions.
Project Finance players strive to build
consolidated financial strength and move
towards centralized financing.
Major firms end up incorporating project
finance as a component of their centralized
approach.

25
 1/6/2017

These results suggest that the best-practice

financing model for large energy projects
uses Centralized Finance for its core
investment program, while developing
disciplined guidelines for using Project
Finance on an exception basis (i.e., as
needed).

However, it is transparent from the foregoing

discussion that much work remains to be
done on a contract-theoretic analysis of
centralized versus project financing.
We believe we are among the first to indicate
the potential usefulness of the nexus-of-
contract approach to developing a more
rigorous but practicable framework for
comparing the relative benefits of the two
financing models.

26
 1/6/2017

Along with the considerations of tax

optimization, risk management, and transactions
costs minimization, this approach would
systematically and rigorously recognize the
strengths and weaknesses of the two financing
models with respect to the variety of agency
conflictsamong the project partners, between
lenders and borrowers, and along the internal
corporate hierarchythat are often sufficiently
important to change the sign of the realized rate
of returns.

27
 1/6/2017

1. Order of Magnitude Estimate (Feasibility)

+ 40%, - 20%
BFD , Process Modification
2. Study Estimate / Major Equipment
+ 30%, - 20%
PFD , Cost Chart
3. Preliminary Design (Scope) Estimate
+ 25%, - 15%
PFD , vessel sketches , equip. diagrams
4. Definitive (Project Control) Estimate
+ 15%, - 7%
PFD , P&ID, all vessel sketches, equip. diagrams, preliminary isometrics

5. Detailed (Firm or Contractors) Estimate

+ 6%, - 4%
Everything included ready to go to construction phase

Estimate low so actual cost will be high (+)

Estimate high so actual cost will be low (-)
Why is + # > - #.?

28
 1/6/2017

The first three types serve as a cost indicator

at a very early stage of the project design
stage.
They are developed with a minimum amount
of detailed engineering
Meant only as advise to the client or to
management as a first look at project cost.

Other types of estimates include:

Cost curve estimates
Major equipment factor estimates
Cost Indices

29
 1/6/2017

The cost curve method of estimating corrects for the

major deficiency illustrated above by reecting the
significant effect of size or capacity on cost.
These curves indicate that costs of similar process units or
plants are related to capacity by an equation of the
following form:

This relationship was reported by Lang, who

suggested an average value of 0.6 for the
exponent (X).
Cost curves of this type have been presented
for petroleum refinery costs in the past.

30
 1/6/2017

Major equipment factor estimates are made

by applying multipliers to the costs of all
major equipment required for the plant or
process facility.
Different factors are applicable to different
types of equipment, such as pumps, heat
exchangers, pressure vessels, etc.
Equipment size also has an effect on the
factors.

It is obvious that prices of major equipment

must first be developed to use this method.
This requires that heat and material balances
be completed in order to develop the size and
basic specifications for the major equipment

31
 1/6/2017

This method of estimating, if carefully

followed, can predict actual costs within 10 to
20%.
A shortcut modification of this method uses a
single factor for all equipment.
A commonly used factor for petroleum
refining facilities is 4.5.
The accuracy of this shortcut is of course less
than when using individual factors.

Regardless of accuracy, capital cost estimates

are typically made-up of direct and indirect
costs.
Indirect costs consist of project services, such
as overhead and profit, and engineering and
administrative fees.
Direct costs are construction items for the
project and include property, equipment, and
materials

32
 1/6/2017

As mentioned previously capital cost

estimates of industrial process plants can be
made using previously obtained equipment
costs of similar size and then can be scaled
to reflect current costs using cost curves and
Adjusting for different sizes
Adjusting for different time periods

The preparation of a preliminary estimate is

based on
assessment of the design,
past cost estimates,
in-house estimating information,
and previous contracts and purchase orders.
It is not normal to obtain formal quotations from
equipment manufactures in support of a
preliminary estimate.
Informal telephone budget quotations on
identified major equipment such as vessels,
filters, etc. are acceptable.

33
 1/6/2017

However, even these types of expedient

quotations are time consuming.
Sophisticated estimating software are
available.
Definitive and detailed cost estimates are
full-blown exercises that are undertaken to
produce a competitive bid submission or
otherwise produce an accurate (plus or minus
10% or better) cost estimate, for
appropriation of funds.

12/2/2016

1. Rule Of Thumb Estimates

Produce only an approximation of the order of
magnitude of cost.
These are simply a fixed cost per unit of feed or
product.
Some examples are:
Complete coal fired electric power plant: $2,500/kW
Complete synthetic ammonia plant: $200,000/TPD
Complete petroleum refinery: $25,000/BPD

1384

These rule of thumb factors are useful for

quick ballpark costs.
Many assumptions are implicit in these values
and the average deviation from actual practice
can often be more than 50%.

1385

34
 1/6/2017

12/2/2016

The Rule of Six-tenths

Approximate costs can be obtained if the cost
of a similar item of different size or capacity is
known.
A rule of thumb developed over the years
known as the rule of six-tenths gives very
satisfactory results when only an approximate
cost within plus or minus 20% is required.

1386

The Rule of Six-tenths

1387

10

12/2/2016

The N exponent
An analysis of the cost of individual pieces of
equipment shows that the size factors
exponent will vary from 0.3 to unity, but the
average is very near to 0.6, thus the name for
the rule of thumb.
If a higher degree of sophistication is sought,
Table 1 below can be used.

1388

It lists the value of a size exponent for various

types of process equipment.
The Table 1 values have been condensed from
a vast, comprehensive tabulation of
estimating cost data

1389

11

35
 1/6/2017

12/2/2016

Using Table 1 size exponents transforms the

previously presented formula into,

1390

1391

12

12/2/2016

1392

1393

13

36
 1/6/2017

12/2/2016

Cost Indices
Cost indices are useful when basing the
approximated cost on other than current prices.
If the known cost of a piece of equipment is
based on, for instance 1998 prices, this cost
must be multiplied by the ratio of the present
day index to the 1998 base index in order to
proportion the value to present day dollars.

1394

Cost Indices

1395

14

12/2/2016

The following example illustrates a combined

use of both of these ratio and proportion
methods to produce an approximate cost.
Please note that the costs presented here are
purely hypothetical and should not be used as
a basis for anything other than an illustration.

1396

Let us assume that a rough estimate is being

prepared for a project in which a 5,000-gallon
capacity stainless steel pressure vessel is
involved.
Let us further assume that our past project
purchasing data shows that a 2,000-gallon
stainless steel pressure vessel, very similar to
that currently required, was purchased in
2001 for $15,000.

1397

15

37
 1/6/2017

12/2/2016

We now have all of the necessary components

to approximate the present day cost (CB ) of a
5,000-gallon vessel.
We have, two dates, past and of course
current; two known capacities (SB and SA ); and
one historical cost (CO ) (that of the 2001
purchased vessel).

1398

The first step is to determine the cost index for

our two dates.
Consulting a recent issue of Chemical
Engineering magazine, the M & S Equipment
Cost Index for 2001 is found to be 1093.9 (our
base index for this example).
In like fashion, the 2006 4th Quarter index is
found to be 1353.8 (the current index).

1399

16

12/2/2016

The student may be interested to know that

the M & S Cost Indexs base is 1926 = 100; this
provides an astonishing indication of the
amount of inflation that has taken place.

1400

This complicated data allows us to substitute,

1401

17

38
 1/6/2017

12/2/2016

Therefore, the 4th Quarter 2006 cost of the

2,000-gallon capacity vessel is estimated to be
$18,565.
Now, having determined the current
estimated cost of the smaller capacity vessel,
we need to adjust this amount to correspond
to the larger volume (5,000 gallons).

1402

Referring to Table 1, we find a size exponent

corresponding to stainless steel vessels equal
to 0.68.

1403

18

12/2/2016

Substituting in the equation presented earlier results in,

1404

The unit, ten, and hundred places in this figure

are irrelevant.
A rough estimate of $34,617 is ridiculous
and implies a degree of accuracy that has no
basis in this case;
$35,000 is more sensible and just as likely to
be correct in the context of a plus or minus
20% estimate.

1405

19

39
 1/6/2017

12/2/2016

Cost Indexes
Estimating Process Costs From Existing
Operations
No costs remain stable due to inflation and
deflation.
As a result, in our estimates we must adjust
any cost relative to some basis or index.

1406

A number of cost indexes exist

Data for two of the indexes for the period
1973 to 1984 are used for the example.
These years were selected because they
represent a period of rapidly rising inflation
followed by a leveling-off phase

1407

20

12/2/2016

Cost Indexes

1408

Data from Two Cost Indexes

1409

21

40
 1/6/2017

12/2/2016

Cost as a function of capacity for centrifuges for

inorganic service. These data are for solid bowl, screen
bowl, and pusher types

1410

Cost as a function of capacity for centrifuges for

organic service. These data are for solid bowl,
screen bowl, and pusher types.

1411

22

12/2/2016

4. Definitive Estimates
Definitive cost estimates are the most time consuming and
difficult to prepare but are also the most accurate.
These estimates require preparation of plot plans, detailed
ow sheets and preliminary construction drawings.
Scale models are sometimes used.
All material and equipment are listed and priced.
The number of man hours for each construction activity is
estimated.
Indirect field costs, such as crane rentals, costs of tools,
supervision, etc., are also estimated.
This type of estimate usually results in an accuracy of 5%.

1412

Summary Form For Cost Estimates

The items to be considered when estimating
investment from cost curves are:
Process units
Storage facilities
Steam systems
Cooling water systems
Subtotal A
Offsites
Subtotal B
Special costs
Subtotal C
Location factor
Subtotal D
Contingency
1413
Total

23

41
 1/6/2017

12/2/2016

1414

1415

24

12/2/2016

1416

1417

25

42
 1/6/2017

12/2/2016

1418

Intratec Plant Construction Cost Index (IC Index) comprises a series of specific and general price
indexes, evaluated by Intratec consultant's as fundamental for the construction of chemical
plants, which are combined to reasonably reflect generic chemical plants capital costs. Most of
the price indexes are obtained from Bureau of Labor Statistics (BLS) website and measures the
behavior of selling prices received by U.S. producers during time

1419

26

12/2/2016

1420

1421

27

43
 1/6/2017

12/2/2016

Lang Exponent
The exponent used in scaling the cost for different plant capacities.
Promoter calculates the cost of the project facilities from the reference
plant by applying the following formula:
C = Cb x [Qa / Qb] pow ( x)
where
Ca = Cost of the Plant,
Cb = Base Case Cost,
Qa = Capacity of the Plant,
Qb = Base Case Capacity, x = the Lang cost capacity exponent.
The Lang exponent is usually between 0.6 and 0.7 and can vary
from one process to another.

1422

28

44
1/6/2017

45