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EPC CONTRACTS: RISKS IN MEGA EPC PROJECTS
Agenda for Presentation
EPC Contract Fundamentals:

Fixed Price Contract
Economic Benefits

1/7/2010
EPC Contract Fundamental: Some Questions
Contracting Strategy
Contract Performance Risks

Dr. Himadri Banerji CMD BASmS Pvt. Ltd.
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Presented at the World Engineering Congress Bangkok 4th
Graphs and Figures
Revenue Profile For a Typical EPC Contract
Execution Risk As EPC Contract Progresses
Execution Risk As Cost Plus Contract Progresses
Relative Risk Reward Profiles of Different Contract Strategies

EPC Contract Execution Risks: Owner Contractor
Interactions
Owner Demands and Oversights
Contractor Pressures
Disputes: Causes and Possible Reasons
Summary Research Findings: Risk Management

1 Case Study in Risk Management:
“EPC Contract Risk Assessment and Mitigation During
Economic Meltdown”

EPC Contract: Advantages
Fixed Price Contract, Negligible Escalation

Design-build/engineer, procure, construct EPC
contracting can potentially save millions of

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dollars up front, as well as dollars paid in
change orders while construction proceeds.

Hardly any escalation in costs occur

Contractor brings to fore the best practices in
project management

Timely Execution and Project earnings Start
2 Faster

Life Cycle Cost of Project Diminishes.

EPC Contract Fundamental: Some Questions

Owners often question whether the
checks and balances are in place and
question who really pays for alterations
in design.

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Owners look toward the design-
build/EPC contractor to be the one stop
shop and the last stop for all the costs to
be incurred for a project—from inception
to project closeout.

Thus, change becomes an issue that may
not be well defined in today’s design
3 build/ EPC construction environment.

EPC Contract Fundamentals: Some Questions

In a changing world, what does uncertainty mean
for the design-build/EPC industry?

What do the current world economic conditions, as
well as the current U.S. economic conditions mean

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to a design-build/EPC contractor wanting to play in
the construction industry today?

How do factors such as labor supply restrictions,
loss of intellectual knowledge, and gap in fund
availability for the infrastructure projects pose
challenges to a design-build/EPC contractor
wanting to play in say E&P or Power Sector.

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EPC Contract Fundamentals: Contracting Strategy

Contracting Strategies

The design-build/EPC process merely establishes the
roles and relationships among the key members of the

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project team.

To achieve the specific project goals, however, the
delivery system must be compatible with the owner’s
contracting methodology and procurement process.

One of the single most important decisions that any
design-build/EPC contractor will make is on the type of
5 contract that it enters into with an owner.

The contract strategy represents the way in which the
delivery


Systems are packaged and paid for by the owner.

Owner will insist via the contract provisions that the
contractor, in return for being paid to execute those

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functions,

-also accepts the risks of performing
-those functions according to the standards
-and conditions laid down in the contract

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Typically, in fixed-price contracting, any unforeseen cost is
not strictly underwritten within the original contract and
likely to be assumed by the contractor.

The fixed price that envelops the contract should
accommodate a worst-case scenario if execution risks
become a reality.

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This buffer is calculated in the form of a contingency and
can represent up to 15% of the asking price.

The best case scenario is that these are not exercised, in
which situation they are released and materialize as
additional “cream” on top of the base price/margin.

7 In the worst-case scenario, these risks exceed the
contingencies put in place and erode the base margin to an
extent that the contractor loses money on the project


When the contractor provides a price for the design build/
EPC scope, it is obligating itself to provide the

project scope and quality that meets the owner’s
requirements functionality,

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affirms can be accomplished within the time
required timeliness, and thus

affirms that its costs are sufficient to meet both
requirements in terms of resources labor,
equipment, and so on—all for a fixed cost.

8


Contractors initially welcomed the lion’s share of risk on EPC
projects in return for the significant profit potential that could be
derived from having simultaneous control over

design,

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procurement, and
construction and
any resulting efficiencies in cost and schedule.

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Revenue Profile Rebased to 1 for a Typical EPC Contract

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Typical Amplification of Execution Risk As EPC Contract Progresses

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Typical Amplification of Execution Risk With Cost Plus Contract

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Relative Risk Reward Profiles of Different Contract Strategies

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EPC Contract Execution
Owner Contractor Interactions: Owner Demands

However many owners demand

Increased role in the design process,
Heightened fast-track completion requirements,

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Enhanced performance guaranties
Owner supplied equipment

With no corresponding assumption of risk, and without a
proper change management process defined in the EPC
Contract for such interventions.

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Owner Contractor Interactions: Contractor Pressures

Risks associated with third-party technology and
equipment supplied by owner equipment
manufacturers (OEMs) increasingly shifted to the
contractor.

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Contractors bid on EPC projects where they were

Unable to adequately utilize value engineering

Unable to Innovate to Balance

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Forced to swallow increase in risk.

Owner Contractor Interactions: Consequences

Profit margins declined,
Owner penalties increased,
EPC contractors were caught in the squeeze.

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Not surprisingly, contractors met the increase in risk
with higher pricing, thereby depriving owners of the
cost savings EPC projects were intended to provide.

Even worse, the incidence of disputes soared, often
followed by protracted and costly litigation.

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Owner Contractor Interactions: Disputes

A recent survey of construction trends in Power
Plants in US, Europe and Asia and Middle East

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By BASmS Business Intelligence Group
found that there has been a significant

Increase in construction related disputes over
the past few months

The survey also found that the disputes were
much more prevalent on complex projects
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costing more than $500 million


Thus the major causes of disputes and claims:

1.Architect/engineer error and omission,

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2.Excessive change orders and owner/contractor
interference.

Less frequent causes mentioned were

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differing site conditions,

acceleration issues and

non-performance of subcontractors.

Possible Reasons

Tighter current global economic environment…
fight harder for every dollar

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leads to hard-line negotiations,

tough contract terms and

strict enforcement of contract language.
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Summary of Research Findings

Recent project experience and recent
trends within the construction industry
indicate that executing projects is going
to be more difficult and more risky in the

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future.
Understanding these risks and their legal
implications will be critical so that both
the owners and the design-build/EPC
contractors can be successful.
EPC Contracting with negotiated alliance
and change management processes built
in may be more viable alternatives.
20 Rigorous Use of Risk Management
Techniques will become a necessity for
EPC Contractors while Bidding, Planning
and Executing.

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Managing Risks

As an integral part of sound project
management practices,

Risk management is a systematic and
proactive approach to reduce uncertainties
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Risk Assessment and Mitigation During Economic
Case Study in Risk Management: EPC Contract

Meltdown.

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EPC Contract Risk Assessment and Mitigation During Economic
Meltdown.

1..EPC Risk Dynamics
Measures of Economic Downturn and Macro Impacts
Six Macro Economic Factors
GDP
Global Equities
Exchange Rates, Capital Flows and Chinese Yuan
Manufacturing and Industrial Production

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Oil Price Volatility and E&P Spending
Oil Price Volatility and E&P Cost Dynamics

2.EPC Risk Analysis and Mitigation :
Risk Allocation
Insurance and Hedging

3.EPC Projects Data : Value at Risk
Projects Affected
Research Findings
4.World’s Largest EPC Contractors
25 Backlog and Impact on Global Forward Manufacturing

5. Thank You

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Economic Downturn and Macro Impacts: The Six Factors

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Economic Downturn and Macro Impacts on GDP Growth

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Economic Downturn and Macro Impacts on Global Equities

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Economic Downturn and Macro Impacts on
Exchange Rates and Capital Inflows

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Chinese Yuan: Government Manipulated Exchange Rates

Economic Downturn and Macro Impacts

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Economic Downturn and Macro Impacts on Manufacturing

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Economic Downturn and Macro Impacts on Industrial Production

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Economic Downturn and Macro Impacts:
E&P Costs Escalate and Fall In Meltdown

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Dynamics
Of Risks

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E&P IHS/CERA Upstream Capital Costs Index

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Economic Downturn and Macro Impacts:

Exploration and Production Spending
Oil Price Volatility and

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Risk Analysis Mitigation Insurance

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Risk Analysis Mitigation Risk Transfer Instruments

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MANAGING EPC RISKS IN MEGA EPC PROJECTS
RECOVERY FROM THE DOWNTURN

The Projects Affected During Transition

1.Ras Tanura Integrated Project (RTIP)
2.Pearl GTL
3.Petro Rabigh Refinery Upgrade

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4.Shah Sour Gas Field Development
5.Khurais Oilfield
6.Manifa Offshore Oilfield
7.Saudi Kayan Petrochemicals Complex
8.Hassyan Power & Desalination Plant
9.Ras Girtas Power Project
10.Shaybah Phase 2 Expansion

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Total cost: $114.5 billion
The countries behind our project list are Saudi Arabia,
Qatar and the UAE, where energy and infrastructure projects
on a world-leading scale continue to progress.
With almost US$120 billion worth of critical energy and infrastructure projects
up for grabs

EPC Companies Who Matter
1. Bechtel (USA)
2. Technip (France)
3. Aker Solutions (Norway)
4. Chiyoda Corporation (Japan)

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5. SNC-Lavalin Group (Canada)
6. J. Ray McDermott (USA)
7. JGC Corporation (Japan)
8. Hyundai Heavy Industries (South Korea)
9. Foster Wheeler (USA)
10. Daelim Industrial Company (South
Korea)

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EPC Companies Who Matter..Contd

Fluor, Foster Wheeler, Shaw Group, Jacobs,

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Technip, Toyo, JGC, Toyota, and GS
Engineering in Korea, they typically win the
majority of the work. As their backlogs
increase that’s a clear barometer that
equipment will be ordered going forward and
are signals for the manufacturers to start
forward Planning.

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Projects Today
1. Nassiriya Oilfield (Iraq)
2. Integrated Gas Development Project
(UAE)
3. South Pars Gas Field (Iran)

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4. Jubail Export Refinery (Saudi Arabia)
5. Tianjin Petrochemicals Complex
(China)
6. Touat Gas Field (Algeria)
7. Gassi Touil Gas Field (Algeria)
8. Skikda Refinery Upgrade (Algeria)
44 9. Sipchem Polyvinyl Plants (Saudi
Arabia)
10. Borouge (UAE)

Projects Today
1. Trans Sahara Pipeline
2. Al-Shaheen Refinery
3. Nabucco Pipeline

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4. Yanbu Export Refinery
5. Khalifa Point & Fujairah
Refineries
6. Jubail Export Refinery
7. Integrated Gas Development
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8. Abu Dhabi Crude Oil Pipeline
9. Kuwait Oil Co drilling platforms
10. Oman oilfield services contract

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Thank You

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