EDITORIAL: Sasol overspent and overpromised
The market’s deep disappointment at Lake Charles overruns ought to be less about the price and more about how Sasol’s management continued to promise something they could not deliver
When Sasol said that its ambitious Lake Charles Chemicals Project in the US had run $1.1bn over budget, it took shareholders by surprise, causing the share to plunge as much as 15%.
But the market’s deep disappointment ought to be less about the price — even though it has now ballooned over 45% of its original cost estimate — and more about how management continued to promise something they could not deliver.
Sasol’s final investment decision in 2014 pegged the project cost at $8.9bn and said it would start operating in 2018.
In August 2016, the company announced that the price had, in fact, escalated by $2.1bn to $11bn. Beneficial operation was rescheduled for the first half of 2019. The company at the time said it had a high degree of certainty over the updated capital cost estimate, and former CEO David Constable said the number was the “worst-case scenario”.
If Sasol is to be believed, the project is 96% complete. So a whopping $1.1bn added to the bill at this late stage is indeed unexpected.
In late 2017, the effect of Hurricane Harvey saw Sasol add $130m to the bill. In October 2018, Sasol told the market the project was on track in terms of time and budget, but just four months later divulged the costs would rise to between $11.6bn and $11.8bn.
Shortly thereafter, joint CEO Bongani Nqwababa insisted Sasol was “very much in control” of the project.
Now, just three months on, it announced that the huge Louisiana chemicals project would cost between $12.6bn and $12.9bn, and one fund manager suggested there had been reckless mismanagement of shareholder capital.
But history has shown, time and time again, that most mega projects like these incur delays and significant cost overruns.
As The Economist notes, when George Stephenson built the world’s first steam-powered interurban railway, stretching from Liverpool to Manchester, in the 1820s, it cost 45% more than budget and was subject to several delays. Management of mega-build projects appears to have improved little since.
The Empire State Building cost double what it was meant to, and the cost of the International Space Station had ballooned by 186% at the time of completion. Brazil’s World Cup stadium costs escalated by 227%, and the Sydney Opera house was 1,357% higher than originally budgeted.
As noted in a 2014 study by Bent Flyvbjerg, a professor of Major Programme Management at Oxford University, performance data for megaprojects shows nine out of 10 such projects have cost overruns. “Overruns of up to 50% in real terms are common, over 50% not uncommon,” Flyvbjerg says.
He says that while delays are a separate issue, they quickly lead to cost overruns. Then there’s another factor to consider where the projects, once completed, don’t perform as anticipated.
If, as the evidence indicates, about one out of 10 megaprojects are on budget, on schedule and deliver the intended benefits, then about one in 1,000 projects is a success, Flyvbjerg finds.
To be fair, some of the risk associated with Sasol’s Louisiana project was factored into the share price in recent years. But before February’s announcement there was a great optimism among market watchers and Sasol alike that 2019 would be the year that the Lake Charles project would turn from a crucible to a cash cow for the synfuels and chemicals giant.
But the risks related to such a megaproject are well understood and certain fund managers have been wary of going all in. Certainly the market was not unreasonable to think the worst was over. If Sasol is to be believed, the project is 96% complete. So a whopping $1.1bn added to the bill at this late stage is indeed unexpected.
However, asset managers who were underweight on the stock, like PSG, believed that people had underestimated the risk associated with execution of the project and were also potentially overly optimistic on the economics.
But one thing seems clear when pursuing the track record of megabuilds: if Sasol wasn’t fooling shareholders, it was in the very least fooling itself.