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A VAR Model to Investigate the Volatility of Line-Pipe Steel Prices

Using Oil Price as a Referred Currency

FEATURED PAPER

By Trian Hendro Asmoro, ST. MM. MSc. CCP. PMP

PT Medco E&P Indonesia

Jakarta, Indonesia

 



Abstract

The volatility of steel prices and international currency is an element that affects actual project costs. This situation can be mitigated by considering risk contingency as a fixed percentage of the total budget and/or by inputting an inflation factor into the cost estimation. These methods have not overcome the root problem, however, which is the volatility and declining trend of US dollar purchasing power as base currency. As a result, an alternative currency with more reliable value as a cost reference is needed as a comparison of using gold equivalency as an alternative currency for cost estimation (Asmoro, 2013).

This paper will explore the potential for oil as a referred currency to be used in investigating the price volatility of selected steels, i.e. hot rolled coil (HRC) and billet as main material components in oil and gas pipeline projects. The reliability of oil in terms of purchasing power compared to the US dollar and inflation will be discussed along with how oil equivalency can be applied for selected steels to develop an oil-based forecasting model using a statistical VAR (Vector Auto-Regressive) model. VAR model is widely used to analyse multivariate time series data such as domestic product and oil price.

These methods might change the paradigm for estimating the material costs of pipeline projects and could be developed for and applied to other projects since steels are heavily used in all major construction projects.

Keywords: Line-pipe steel prices, oil price, VAR model, multivariate time series data, US dollar, purchasing power, oil equivalency, cost estimation, pipeline project

  1. Introduction

Project cost overruns have become a major issue for project management in recent years. The volatility of steel prices and international currencies are two of many elements that affect actual project costs. Project costs are also affected by the discrepancy between local currencies and the US dollar, the base currency. Furthermore, market volatility and quantitative actions by major governments have led to large fluctuations in the value of the US dollar in terms of purchasing power. Although the US dollar has been widely accepted and used as the international currency in most countries, using the US dollar as a basis for forecasting prices and cost estimation for future projects might be more risky now, thus it requires further evaluation.

1.1.Steel and Oil Prices

Steel is a cornerstone and key driver for the world’s economy and is used as an essential material for key equipment in most oil and gas projects. Hence, oil price is intuitively considered as one of key drivers in determining the steel prices. The volatility of the steel price could therefore be result in project cost overruns. Figure 1 shows that the oil and steel price has shown a similar pattern of movement during the last decades.

It is also broadly known that when oil price goes down, number of executing oil gas projects will decrease, so that demand of steel for oil gas projects will also be reduced (IHS, 2016). Consequently, the steel prices will adjust accordingly based on new equilibrium of steel’s supply and demand.

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About the Author


Hendro Asmoro

Jakarta, Indonesia

 

 

 Trian Hendro Asmoro, CCP, PMP is an oil and gas professional with more than 10 year experience in project and field development. Trian is currently senior project engineer at PT Medco E&P Indonesia. Trian holds a bachelor degree (ST) in Industrial Engineering from Institute of Technology Bandung (ITB), a Magister Management (MM) in Strategic Finance from University of Paramadina, Indonesia, and a Master of Science (MSc) in Petroleum Energy Economics and Finance from University of Aberdeen, UK. Trian is a Certified Cost Professional (CCP) and Project Management Professional (PMP). He has published several professional papers in journals covering topics of project management, cost engineering, business and petroleum economics.

Trian can be contacted at [email protected]

To view other works by Mr. Asmoro, visit his author showcase in the PM World Library at https://pmworldlibrary.net/authors/trian-hendro-asmoro/