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EPC Industry in India: Issues and Challenges| 53 |
EPC Report 4 Cover pages.indd 53 2/20/2011 8:19:18 PM
EPC Industry in India: Issues and Challenges| 1 |
Chemtech Foreword 2
KPMG Foreword 3
Executive Summary 4
Acronyms Used 4
...
EPC Industry in India: Issues and Challenges | 2 |
CHEMTECH Foreword
S
trong infrastructure and industry are critical for ...
EPC Industry in India: Issues and Challenges| 3 |
KPMG Foreword
T
he Engineering Procurement and Construction (EPC) servic...
EPC Industry in India: Issues and Challenges | 4 |
EXECUTIVE
SUMMARY
The EPC industry as defined here is
different from the...
EPC Industry in India: Issues and Challenges| 5 |
Value Creation Strategies and
Routes to Growth
EPC companies can improve...
EPC Industry in India: Issues and Challenges | 6 |
Key Challenges
The key external challenges faced by the EPC industry ar...
EPC Industry in India: Issues and Challenges| 7 |
There are macro level learnings to be derived from Korea’s EPC
growth st...
EPC Industry in India: Issues and Challenges | 8 |
The report has been prepared by KPMG Advisory Services
Private Limited ...
EPC Industry in India: Issues and Challenges| 9 |
EPC or Engineering, Procurement and Construction industry
is referred to...
EPC Industry in India: Issues and Challenges | 10 |
Route 1
Expanding scope from being engineering companies to
EPC compan...
EPC Industry in India: Issues and Challenges| 11 |
Relevance of the EPC industry to the
India Growth Story
The 11th plan w...
EPC Industry in India: Issues and Challenges | 12 |
1
Source: Crisil “Construction-Opinion August 2010”
the next five years...
EPC Industry in India: Issues and Challenges| 13 |
2
TSR computation has been done for last 3 years data for companies whi...
EPC Industry in India: Issues and Challenges | 14 |
Total Shareholder Returns of Select Engineering and Construction
Compa...
EPC Industry in India: Issues and Challenges| 15 |
The value proposition offered by the EPC industry is based
on the conce...
EPC Industry in India: Issues and Challenges | 16 |
T h e p u r e
e n g i n e e r i n g ,
consulting or
PMC services
compa...
EPC Industry in India: Issues and Challenges| 17 |
Value Creation Strategies
The “project level” value creation driver in ...
EPC Industry in India: Issues and Challenges | 18 |
Scale and other Value Drivers for EPC companies
Performance improves f...
EPC Industry in India: Issues and Challenges| 19 |
D
iversification is a key element of
growth, and will be aggressively
pu...
EPC Industry in India: Issues and Challenges | 20 |
execution, and identify and manage their
risk exposure in a higher ris...
EPC Industry in India: Issues and Challenges| 21 |
EPC segments, with limited market size
in India, which has prompted Ind...
EPC Industry in India: Issues and Challenges | 22 |
Contracting Models
Model Role of EPC company Drivers / Highlights
Engi...
EPC Industry in India: Issues and Challenges| 23 |
The choice of the contracting models are
driven by multiple factors
Int...
EPC Industry in India: Issues and Challenges | 24 |
4
NSDC report on Human Resource and Skill Requirements in Building, Co...
EPC Industry in India: Issues and Challenges| 25 |
requirement at the Engineer and
Supervisor levels is a constraint as we...
EPC Industry in India: Issues and Challenges | 26 |
5
http://www.doingbusiness.org/rankings
Ease of Doing Business Ranking...
EPC Industry in India: Issues and Challenges| 27 |
We feel, the industry requires that nodal
agencies in various governmen...
EPC Industry in India: Issues and Challenges | 28 |
be taxed in India in addition to being
taxed in the country of residen...
EPC Industry in India: Issues and Challenges| 29 |
Key Internal Issues
The key internal challenge facing the
Indian EPC in...
EPC Industry in India: Issues and Challenges | 30 |
Organization Design & Management:
Building the Engineering
ORGANIZATIO...
EPC Industry in India: Issues and Challenges| 31 |
Source: PMI-KPMG Study on drivers for success in infrastructure project...
EPC Industry in India: Issues and Challenges | 32 |
Procurement
Procurement can be a vital element
influencing timely and p...
EPC Industry in India: Issues and Challenges| 33 |
6
And not necessarily poor planning
End-Use Industry Views
Power Genera...
EPC Industry in India: Issues and Challenges | 34 |
7
Source: http://www.sify.com/finance/ntpc-likely-to-float-rs-18-000-cr-...
EPC Industry in India: Issues and Challenges| 35 |
8
Economic Times, 23rd January 2011
Typical Outsourced Package Structur...
EPC Industry in India: Issues and Challenges | 36 |
9
Report of the Committee to study Design Features of Boilers and Auxi...
EPC Industry in India: Issues and Challenges| 37 |
10
Refers to opportunities for engineering and construction companies a...
EPC Industry in India: Issues and Challenges | 38 |
11
Including offshore engineering centers supporting global projects
1...
EPC Industry in India: Issues and Challenges| 39 |
It is a phenomenon very unlike the other
sectors discussed like Power G...
EPC Industry in India: Issues and Challenges | 40 |
as well as domestic investment, with
the feedstock being supplied by t...
EPC Industry in India: Issues and Challenges| 41 |
13
Techpetro Asia Newsletter (April 5,2010)
14
SAM group – Water - A Ma...
EPC Industry in India: Issues and Challenges | 42 |
Opportunity Drivers and Trends for EPC companies in Water Segment
Oppo...
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
Epc industry in india  report by jasubhai media & kpmg
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  1. 1. EPC Industry in India: Issues and Challenges| 53 | EPC Report 4 Cover pages.indd 53 2/20/2011 8:19:18 PM
  2. 2. EPC Industry in India: Issues and Challenges| 1 | Chemtech Foreword 2 KPMG Foreword 3 Executive Summary 4 Acronyms Used 4 Methodology 8 Coverage and Scope 8 Setting the Context 10 Value Creation Strategies 17 Key External Drivers and Issues 22 Key Internal Issues 29 End-Use Industry Views 33 EPC Industry in India Action Agenda for Sustained Growth 48 Acknowledgements 51 About Chemtech 52 About KPMG in India 52 Contents EPC Report New.indd 1EPC Report New.indd 1 2/20/2011 8:13:28 PM2/20/2011 8:13:28 PM
  3. 3. EPC Industry in India: Issues and Challenges | 2 | CHEMTECH Foreword S trong infrastructure and industry are critical for India as the country sees leapfrogging growth. As far as both these sectors are concerned, India is in a sweet spot, which has created multitude of opportunities in the fields of engineering, capital goods and construction. Though, India has witnessed significant investments in both industrial and infrastructure space, the growth has remained restricted due to various weaknesses of the Indian EPC industry and difficulties for the foreign players to ply in the market. At this juncture, it is an imperative to address the challenges, which restrict the growth of this sector in India and will continue to repress industrial development lest addressed. CHEMTECH has made an attempt to address the issues faced by the EPC industry through each edition of its international conference, EPC World Expo. Renowned speakers from world over have deliberated over the topical issues that must be resolved to accelerate the development of India’s EPC sector, which would eventually lead to country’s sustainable economic growth. As we reach another milestone year with 25th edition of CHEMTECH series of expositions and international conferences, Jasubhai Media and KPMG have come together and taken the initiative address these issues through this report. I wish to thank all the members of CHEMTECH Advisory Board for EPC who despite their busy schedules shared their opinions and guided the team to come up with the study report that aims to leverage the Indian industry. We sincerely hope that this report would be a useful information tool for both industry as well as statutory bodies to gear up for the challenges for the Indian EPC sector during this decade. Jasu Shah Founder & Chairman, CHEMTECH Foundation EPC Report New.indd 2EPC Report New.indd 2 2/20/2011 8:13:30 PM2/20/2011 8:13:30 PM
  4. 4. EPC Industry in India: Issues and Challenges| 3 | KPMG Foreword T he Engineering Procurement and Construction (EPC) services industry in India is faced with a large and unique opportunity due to galloping Indian economy, and investments in public and industrial infrastructure. The 11th five year plan has been an inflection point in Infrastructure investments, with them contributing upto 9 percent of India’s GDP. The 12th plan envisages a total investment in the region of USD 1 trillion, contributing upto 10 percent of India’s GDP. Similarly, there are large investments expected in industrial infrastructure, whether it be Oil and Gas, Metals and Mining and other industries. This large and fast build out of industrial and plant infrastructure requires a robust and growing engineering, procurement and construction services industry for spreading and management of risks, efficiency and productivity in engineering and construction and supplementing the management bandwidth of project developers. This report in line with the theme for Chemtech’s EPC conference, takes a forward looking view on the future of the EPC industry in India, based on current issues and challenges identified for the industry. We hope that the collective insights shared in this report contribute towards shaping future business strategies and government enablement that drive India’s long term growth in this sector. Arvind Mahajan Executive Director KPMG Advisory Services Pvt Ltd EPC Report New.indd 3EPC Report New.indd 3 2/20/2011 8:13:31 PM2/20/2011 8:13:31 PM
  5. 5. EPC Industry in India: Issues and Challenges | 4 | EXECUTIVE SUMMARY The EPC industry as defined here is different from the pure engineering or construction industry. We define the EPC industry as comprising of companies who are involved in executing projects involving multiple engineering disciplines with overall responsibility for the performance of a “unit” or the whole plant. The scope of work would include engineering, supplies, construction or construction management, erection and commissioning and providing performance guarantees. The EPC companies in India are evolving from multiple routes, with engineering companies, equipment suppliers, construction companies and project developers morphing in to EPC service providers by filling in the gaps. Expectations As a fallout of the USD 1 trillion investment expected in infrastructure and industrial growth keeping pace, there is heightened interest among the investor community from engineering and construction companies who stand to benefit from this wave. However, the expectations far exceed the historical performance delivered and the EPC service providers need to step up their ability to win and deliver business to meet these expectations. Similarly, customers now expect EPC service providers to ramp up their financial and execution capabilities to be able to execute larger projects, in time and with ever improving cost structures. EPC Engineering, Procurement & Construction GDP Gross Domestic Product PPP Public Private Partnership TSR Total Shareholder Returns EPCM Engineering,Procurement &Construction Management PMC Project Management Consultant FEED Front End Engineering Design O&M Operation & Maintenance JV Joint Venture BOP Balance of Plant BTG Boiler Turbine Generator BOT Build,Operate & Transfer BOOT Build,Own,Operate & Transfer DBO Design Build & Operate DBOOT Design,Build,Own,Operate & Transfer ITI Industrial Training Institute MRP Material Requirements Planning PNGRB Petroleum & Natural Gas Regulatory Board PCPIR Petroleum,Chemicals & Petrochemicals Investment Regions MENA Middle East & North Africa CGD City Gas Distribution ADB Asian Development Bank JNNURM Jawaharlal Nehru National Urban Renewal Mission JICA Japan International Cooperation Agency ULB Urban Local Body E&P Exploration & Production Acronyms Used EPC Report New.indd 4EPC Report New.indd 4 2/20/2011 8:13:31 PM2/20/2011 8:13:31 PM
  6. 6. EPC Industry in India: Issues and Challenges| 5 | Value Creation Strategies and Routes to Growth EPC companies can improve their wealth creation profile by focusing on performance, prospects and managing risks and financing costs. While performance is about improving margins by way of correct estimations, procurement and project management capabilities, and focusing on adding higher margin components to the services provided, prospects is about continuously adding newer avenues of revenue growth. The most likely route for diversification is through penetration in new end-use industries or taking the developer route, which in fact is an imperative for growth in sectors like Water, Roads involving BOT, BOOT contracts. International expansion by EPC companies is likely to be limited largely due to global competitive intensity and the large domestic demand. We expect increasing number of acquisitions in this industry, as companies look to enter new end-use industries by buying qualifications. Lastly,riskmanagementand“no-surprises”go a long way in improving investor perception, and materially bringing down financing costs for the EPC companies. EPC Report New.indd 5EPC Report New.indd 5 2/20/2011 8:13:32 PM2/20/2011 8:13:32 PM
  7. 7. EPC Industry in India: Issues and Challenges | 6 | Key Challenges The key external challenges faced by the EPC industry are as follows:- Continuously evolving contracting models and relatively slower adoption of the EPC-LSTK concept, especially where customers are large public sector companies with in-house teams, and large private sector developers, who have significant in-house project management capabilities. Order book uncertainty brought about by purely price based procurement decision making of customers, which has led to the emergence of large number of hitherto unknown companies winning relatively large contracts. While this is essential for capacity building, it has led to uncertainty of order book for the incumbent service providers. It also makes making investment decisions more difficult for companies. Shortage of skilled manpower for managerial as well as site labour. The country has its task cut-out in terms of creating skill work force for the industry. However, the onus really lies on the private sector and the EPC companies to undertake initiatives to address this “supply-chain” issue. The perception on the sanctity of contracts remains divergent, especially between Indian companies and International entrants. There is a need to establish faith in our ability to enforce contracts by standardization, following international practices and setting right dispute resolution mechanisms. l l l l External Internal The key internal challenges are about managing scale and building capabilities to address issues emanating out of this:- Project Manager Empowerment, especially in Indian companies Balancing speed and cost control in the Procurement function Creating a robust engineering organization and balancing between efficiency and effectiveness Adoption of leading Risk Management practices The challenges are accentuated for two sets of companies a) International entrants and b) mid-size companies looking to scale up. Policy making can help mitigate some of the issues related to enabling private sector for building a skilled workforce, develoing speedier mechanisms for speedier resolution of contractual disputes, and clarifying taxation regulations related to the industry. l l l l EPC Report New.indd 6EPC Report New.indd 6 2/20/2011 8:13:32 PM2/20/2011 8:13:32 PM
  8. 8. EPC Industry in India: Issues and Challenges| 7 | There are macro level learnings to be derived from Korea’s EPC growth story, which may be replicated by the Indian industry Government support in terms of ministerial oversight for the industry, followed by active promotion of the industry overseas Capacity building initiatives in terms of institutions for developing construction industry talent Engineering firms working in collaboration with construction majors, facilitated by not-for-profit engineering industry associations Apart from the above, the report discusses specific end-use industry issues and demand outlook for Power, Oil and Gas and Water, bringing out nuances in terms of differences in contracting models, profile of service providers and key challenges. l l l Learnings from the Korean Construction Industry EPC Report New.indd 7EPC Report New.indd 7 2/20/2011 8:13:35 PM2/20/2011 8:13:35 PM
  9. 9. EPC Industry in India: Issues and Challenges | 8 | The report has been prepared by KPMG Advisory Services Private Limited in association with Chemtech. Leading executives from the industry were interviewed to seek inputs for the report. The representation included project developers, EPC companies, engineering consultants and construction companies. We have collected insights based on numerous engagements with nodal agencies, infrastructure companies, engineering and construction firms, and foreign players looking to enter India and equipment suppliers. Secondary research was conducted using published reports, news analysis and usage of standard financial databases subscribed to by KPMG. We have leveraged the expertise and relationships of our advisory teams in the area of Infrastructure and Government and Industrial Markets spread across the country. Taxation related inputs have been provided by our Tax team based on their working experience with clients in the area of infrastructure and engineering and construction. The report covers primarily the EPC services industry from the perspective of the following end-use industries - Power, Refining and Petrochemicals, Water and Water Treatment. These industries have large investments planned in the country for the next 5 to 10 years, and involve technological complexity apart from being complex from a project management perspective. Also, they are varied and bring out the nuances of the EPC sector across most aspects. Specific issues related to EPC services for other end use sectors like Roads, Railways, Metals and Mining etc are not detailed as part of this report, though many of the generic EPC industry issues identified in this report would also apply to EPC services for these other industries. Methodology Coverage & Scope EPC Report New.indd 8EPC Report New.indd 8 2/20/2011 8:13:36 PM2/20/2011 8:13:36 PM
  10. 10. EPC Industry in India: Issues and Challenges| 9 | EPC or Engineering, Procurement and Construction industry is referred to by various terms like Construction industry, Engineering and Construction, Contracting or just engineering industry. Here we define the EPC industry as consisting of service providers who are capable of executing projects on a turnkey basis, including detailed engineering, procurement, construction, commissioning and performance testing. We concern ourselves with players who are able to aggregate multiple engineering disciplines like process engineering, mechanical, structural, civil and electrical. Examples of such companies in India are Larsen and Toubro, Punj Lloyd, Tata Projects, Essar Projects etc. Players who only operate in the civil construction and structural engineering domain and would not undertake turnkey construction of a plant or packages within a plant are not considered as EPC companies by this definition. It is difficult to draw a strict boundary in terms of what constitutes an EPC firm vis-à-vis construction or engineering firms. One way to distinguish between a classical EPC company from a primarily civil construction company is the construction intensity of the end-use sector, defined by Crisil as the percent of construction spend in the overall investment towards creating an infrastructure or industrial asset. For example, Roads is estimated to be close to 100 percent, while a thermal power plant is 20 percent. The rest is towards equipment, mechanical fabrication, electrical and non-construction engineering spend. Defining EPC Industry EPC Report New.indd 9EPC Report New.indd 9 2/20/2011 8:13:38 PM2/20/2011 8:13:38 PM
  11. 11. EPC Industry in India: Issues and Challenges | 10 | Route 1 Expanding scope from being engineering companies to EPC companies. The most prominent example of this route Engineers India Limited, which is India’s leading engineering company, especially in the Hydrocarbons segment and now offers EPC services. However, successful instances of this route are limited. Route 2 Expanding scope from being construction companies to EPC companies. This is the more commonly followed route, wherein companies have added engineering and procurement capabilities to their existing expertise in mechanical and civil construction. The leading example of this route has been Larsen and Toubro, which moved from being a fabrication and construction company in to one of the largest and most respected EPC companies in India. Route 3 Expanding scope from equipment supply to EPC companies. Thisroutehasbeenmorecommonlyfollowedintheengineering and capital goods segment. Companies manufacturing major pieces of equipment for a particular manufacturing process have upgraded themselves to execute projects around their equipments. Examples are Elecon, TRF who are suppliers of material handling equipment and undertake projects in Power Balance of Plant packages supplying entire Coal handling systems or in industrial plants involving large material handling components. Route 4 A relatively new development has been of project developers backward integrating and setting up their own EPC divisions. This has been motivated by a desire to leverage their in-house project management capabilities, and to capture the margins typically belonging to contractors. Setting The CONTEXT EPC Report New.indd 10EPC Report New.indd 10 2/20/2011 8:13:39 PM2/20/2011 8:13:39 PM
  12. 12. EPC Industry in India: Issues and Challenges| 11 | Relevance of the EPC industry to the India Growth Story The 11th plan was an inflection point for the Indian infrastructure story. The 11th plan laid the foundation for large scale investments in infrastructure in India. Of the USD 500 billion planned to be invested in the infrastructure, at the current rate, it is expected that the plan will be met to 94 percent. This would amount to 9 percent of India’s GDP and is expected to go up to 10.25 percent of GDP. Mid-Term Appraisal of 11th Five Year Plan In order to achieve this plan, various pieces of the puzzle need to come together, and would require all stakeholders, the government, public sector undertakings, private sector to contribute their achievements in a co-ordinated manner. It is expected that the private sector would contribute 50 percent by way of financing to achieve this plan. The obvious policy focus has been on building financing capacity, formulation of PPP policies in various sectors, policies around creating investment clusters, land acquisition and environmental clearances. However, the chain is only as strong as the weakest link. Achieving this rate of infrastructure build-out calls for massive capacity building down the chain in terms of manufacturing capacities for equipments, raw material and commodity capacities (e.g. steel, cement, fuels etc) and human resources. Similarly, it calls for massive capacity building in the engineering and construction sector in terms of reasonable number of large to mid-size contracting or EPC companies available to be able to undertake Lump-Sum-Turn-Key (LSTK) and sub-contracting jobs in the country. Purely from a construction perspective, investment in construction is estimated to double to INR 16,809 billion over EPC Report New.indd 11EPC Report New.indd 11 2/20/2011 8:13:39 PM2/20/2011 8:13:39 PM
  13. 13. EPC Industry in India: Issues and Challenges | 12 | 1 Source: Crisil “Construction-Opinion August 2010” the next five years (2010-11-20114-15), from INR 8,895 billion recorded during the last five years1 . Within this the infrastructure segment, would comprise 85 per cent of the total construction investment. Within infrastructure segment, the roads, power, irrigation and urban infrastructure sectors would contribute around 73 percent of total construction investment. The opportunity for EPC players varies by industry given the contracting models and construction intensity of each class of infrastructure or industrial asset. CRISIL Resarch estimates that investments in the industrial sector would be 1.2 times in the next 5 years as compared to the previous five years while in infrastructure it would be 1.9 times, bringing the total growth to be 1.7 times. Projected Infrastructure Investments in 12th Plan Base Yr (2011-12) 2012-13 2013-14 2014-15 2015-16 2016-17 GDP (USD Billion) 1,595 1,738 1,895 2,065 2,251 2,454 GDP Growth (%) 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% Infrastructure Investment (% of GDP) 9.00% 9.25% 9.50% 9.75% 10.00% 10.25% Infrastructure Investment (USD Billion) 144 161 180 201 225 252 Total Investments (USD Billion) 1,019 Source: Planning Commission EPC Report New.indd 12EPC Report New.indd 12 2/20/2011 8:13:39 PM2/20/2011 8:13:39 PM
  14. 14. EPC Industry in India: Issues and Challenges| 13 | 2 TSR computation has been done for last 3 years data for companies which have been publicly listed in the last 3 years and may be classified as engineering and construction companies 3 Source of data for analysis is Prowess, CMIE Expectations from the EPC Industry The EPC industry has gained prominent share of media, investor and entrepreneurial attention in the last 3-5 years. The stock markets have handsomely rewarded companies operating in the infrastructure, construction and EPC space, largely on account of future expectations. Similarly, the large investment plans have raised expectations of customers from this industry. Investor Expectations During the period of 2008-2010, theTotal Shareholders Return2 (TSR) by the EPC companies has been ~31 percent. TSR for the more broad-based Infrastructure index in the corresponding period has been only ~ 9 percent. KPMG analysis indicates that the expectations embedded in the current valuations indicate thatinvestorsareexpectingtheleadingEPCcompaniestogrow their order books and revenues at a rate of ~65 percent if they continue to maintain current profitability and capital turnover ratios, whereas the CAGR growth demonstrated in the last 3 years has been around 28 percent for the set of companies considered below3 . Hence the stock market expectation of growth of EPC companies appears to be very high. Private equity interest has also been high in the industry. RECENT EXAMPLES OF PRIVATE EQUITY DEALS CONCLUDED CONSORTIUM OF PRIVATE EQUITY FIRMS, INCLUDING BARING, SEQUOIACAPITAL, FIDELITYAND DEUTSCHE BANK,ACQUIREDA16 PERCENTSTAKE IN INFRASTRUCTURE-EPC COMPANYCOASTAL PROJECTS FOR $54.8 MILLION1 AVIGO INVESTED $14 MILLION IN DELHI-BASED NAFTOGAZ INDIA PVT LTD, AN EPC PLAYER IN THE O&G SECTOR. DELHI-BASED UEM GROUP, SPECIALISING IN WATER & WASTE WATER COLLECTION, TREATMENT AND DISPOSAL, MOPPED UP ` 90 CRORE FROM INDIA VALUE FUND CHENNAI-BASEDAQUADESIGNS INDIA,AWATER MANAGEMENTENGINEERING COMPANY, RAISED ` 55 CRORE FROM PEEPUL CAPITAL CONCORD ENVIRO SYSTEMS, A WATER MANAGEMENT ENGINEERING COMPANY, RAISED $10 MILLION FROM SAGE CAPITAL FUNDS IN DECEMBER 2009 A2Z MAINTENANCE & ENGINEERING SERVICES LTD (BACKED BY IEP, BEACON INDIA PRIVATE EQUITY FUND AND MR RAKESH JHUNJHUNWALA), IS PRESENT IN POWER DISTRIBUTION EPC BUSINESS. l l l l l EPC Report New.indd 13EPC Report New.indd 13 2/20/2011 8:13:40 PM2/20/2011 8:13:40 PM
  15. 15. EPC Industry in India: Issues and Challenges | 14 | Total Shareholder Returns of Select Engineering and Construction Companies 86.3% 74.5% 50.7% 38.9% 33.6% 32.3% 32.3% 31.5% 23.3% 23.2% 20.3% 17.1% 14.7% 14.1% 13.0% 12.4% 8.6% 8.5% 7.0% 4.5% 2.3% Ͳ3.7% Ͳ13.5% Ͳ20.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% Era Infra Engg. Ltd. Engineers India Ltd. SadbhavEngineering Ltd. JaiprakashAssociates Ltd. McnallyBharat Engg. Co. Ltd. Bharat HeavyElectricals Ltd. Larsen& Toubro Ltd. Ahluwalia Contracts (India) Ltd. Gayatri Projects Ltd. Thermax Ltd. HindustanConstruction Co. Ltd. Patel Engineering Ltd. Alstom Projects India Ltd. Madhucon Projects Ltd. Punj Lloyd Ltd. UnityInfraprojects Ltd. Nagarjuna Construction Co. Ltd. IonExchange (India) Ltd. I V R C L Infrastructures & Projects Ltd. J M C Projects (India) Ltd. GammonIndia Ltd. S P M L Infra Ltd. EleconEngineering Co. Ltd. Source: KPMG Analysis, financial data from Prowess, CMIE In summary, the expectations from the investors are much higher than the pace at which companies have delivered performance in the recent past. This is an indicator of the strongly positive expectations surrounding the sector, and hence the need for the industry to deliver a consolidated performance in line with what is expected of them. EPC Report New.indd 14EPC Report New.indd 14 2/20/2011 8:13:41 PM2/20/2011 8:13:41 PM
  16. 16. EPC Industry in India: Issues and Challenges| 15 | The value proposition offered by the EPC industry is based on the concept of risk sharing or risk transfer from the project developer to the EPC Company, at least to the tune of the capital cost of the project and to a limited extent to the initial operating performance of the plant / facility being built. In exchange for that, the project developers are willing to pay a premium for the integration services provided. Over a period of time, customers have come to expect a reduction in the total cost of putting up the plant and the time schedule through the EPC route, compared to exectution by the developer organization or the more traditional route of procuring equipment, services and engineering services separately and owning the integration and the project management. It is important to point out here that given the customer expectationsandtheconsequent EPC business model, an EPC company takes on a much higher level of real and perceived risks within a project, than other service providers in the pure engineering, consulting or Project Management space. Customer Expectations EPC company takes on a much higher level of real and perceived risks within a project, than other service providers in the pure Engineering, Consulting or Project Management space. EPC Report New.indd 15EPC Report New.indd 15 2/20/2011 8:13:41 PM2/20/2011 8:13:41 PM
  17. 17. EPC Industry in India: Issues and Challenges | 16 | T h e p u r e e n g i n e e r i n g , consulting or PMC services companies build their business models around p r o f i t a b l e c u s t o m e r relationships, and do not necessarily need profitability in each project that they undertake. However, the services of an EPC contractor are supposed to be based on comprehensive contracts with little room for interpretation and ambiguity, whereas pure engineering or EPCM service providers do not take on most of the project cost or time overrun risks which remain with the developer. Given its business model, an EPC Company hence has to target profitability from each contract, since the value at risk in the case of overruns is very high, in proportion to its expected margins. Further, the nature of the customer relationship continues to be “arms-length” over the period of the contract, as EPC companies look to protect themselves against time and effort overruns delays on account of the developer and a plethora of other risks that might take them off their initial estimates.At the same time, customers want to ensure that they get their plant or facility up and running, with the desired quality in time and with no extra claims raised by the contractor. APART FROM THIS BASIC CUSTOMER EXPECTATION, DURING OUR DISCUSSIONS WITH PROJECT DEVELOPERS SEVERAL OTHER EXPECTATIONS FROM EPC COMPANIES WERE COMMONLY MENTIONED EPC COMPANIES NEED TO IMPROVE THEIR FINANCIAL AND BALANCE SHEET STRENGTH TO BE ABLE TO TAKE ON LARGER JOBS,AND NOT DEPEND ONADVANCESAND FAST TRACK PAYMENTS FROM DEVELOPERS TO BE ABLE TO PROGRESS INDIAN EPC COMPANIES NEED TO SIGNIFICANTLY IMPROVE THEIR ENGINEERING CAPABILITIES, ESPECIALLY ON THE FRONT END SIDE. THIS IS ESPECIALLY TRUE FOR THE ENGINEERING COMPANIES WHICH ARE RESPONSIBLE FOR PREPARING THE FEED (FRONT END ENGINEERING DESIGN) PACKAGE SO THAT LSTK BIDDING CAN BE FACILITATED. DEPLOY LATEST CONSTRUCTION METHODOLOGIES AND TECHNIQUES, BOTH MANAGERIAL AS WELL AS TECHNICAL TO EXECUTE PROJECTS FASTER AND TO BETTER QUALITY. DEVELOP EMPOWERED PROJECT MANAGERS, SO THAT THEY CAN ACT AS MORE THAN JUST COORDINATORS, AND CAN INTERFACE WITH THE SENIOR MOST LEVELS IN THE CLIENT HIERARCHY AND TAKE DECISIONS TO RESOLVE PROJECT ISSUES. l l l l The EPCgame is competitive, while EPCMgame is about relationship& trust EPC Report New.indd 16EPC Report New.indd 16 2/20/2011 8:13:41 PM2/20/2011 8:13:41 PM
  18. 18. EPC Industry in India: Issues and Challenges| 17 | Value Creation Strategies The “project level” value creation driver in terms of profitability for an EPC company is its ability to a) Correctly estimate the detailed costs and time schedules of a project and b) Manage the entire ecosystem of customers, vendors, regulators, engineers and sub-contractors, to deliver within those estimates. Sources of Long Term Value Creation However, long term value creation requires EPC companies to improve in all three aspects that impact the market value of a company – performance, prospects, and financing. While performance is enhanced both through revenue and profit growth, future prospects are enhanced when the EPC company is positioned well to serve high growth segments and profitable customers. Financing component of value creation involves a reduction in the risk premium and discount rate associated with future cash flows of the company. This can be achieved by a combination of a reduction in actual cost of borrowing and the “expected” cost of equity through improved risk management practices and reduced volatility of revenue streams. EPC Report New.indd 17EPC Report New.indd 17 2/20/2011 8:13:42 PM2/20/2011 8:13:42 PM
  19. 19. EPC Industry in India: Issues and Challenges | 18 | Scale and other Value Drivers for EPC companies Performance improves for an EPC company with scale, as it is able to leverage efficiencies in procurement, overheads, relationship building with vendors and sub-contractors. Also, there are scale opportunities created when companies are able to invest in standardization of designs, value engineering and investment in world-class tools and techniques. The other two important aspects for value creation are “Growth to create future prospects” and Risk Management which are covered subsequently. EPC Report New.indd 18EPC Report New.indd 18 2/20/2011 8:13:42 PM2/20/2011 8:13:42 PM
  20. 20. EPC Industry in India: Issues and Challenges| 19 | D iversification is a key element of growth, and will be aggressively pursued in India. It is driven not only from the point of growth, but also from the perspective of managing volatility in order booking. Presently, the established EPC companies operating in a limited set of industries in India, are also perceiving a high risk to their order booking levels due to the large number of new entrants into the EPC space, as well as a perceived dilution in qualification criteria from many customers that appears to be providing a level playing field to the new entrants. Hence diversification has become a popular mode of seeking both growth and stability in revenue streams of EPC companies. Route 1 HORIZONTAL EXPANSION Existing EPC companies are diversifying in to new end-use industry sectors, inspired by the large investments coming up in these sectors. For example, Punj Lloyd, a player in the Oil and Gas space, expanded in to the Power Generation EPC market and has recently won orders in the Balance of Plant EPC space. Similarly, Tata Projects has entered in to a JV with EIL to form a TEIL, to address theinvestmentsintheOilandGasspace. The JV leverages EIL’s engineering know-how, client relationships in the Oil and Gas sector and the LSTK contract execution capabilities of Tata Projects. There are many other examples, of such strategies being followed by companies all over the country. Route 2 VERTICAL EXPANSION Some companies are expanding to control more of the investment value of the project, by becoming system integrators. A large proportion of these companies are equipment vendors, who believe that they have the ability to execute contracts onaturnkeybasis.Examplesofthisroute being followed being prevalent largely in the Power Generation equipment side. For example companies like Elecon, TRF which were earlier primarily material handling equipment vendors are now competing for turnkey material handling systems packages. Similarly, there are engineering companies like EIL, who are now offering EPC/ LSTK services to their clients. The vertical expansions have been driven by the desire to enhance the top line and to control a larger share of the investment pie. Engineering services contribute not more than 5-10 percent of the total plant investments, and while engineering services have higher margins and relatively lower risks, it doesn’t provide aggressive top line growth. Such vertical expansion into Construction and Project Execution by publicly listed manufacturing or engineering companies, is also driven by the higher earnings multiples currently associated with such “high potential” businesses. The market recognizes that construction and project management service providers will be in short supply and high demand in the short to medium term. As a note of caution, however, it is worth mentioning that companies who enter the Projects business from product manufacturing or engineering services backgrounds, need to carefully built the required capabilities for project Routes to Growth DIVERSIFICATION PROMISES GROWTH & STABILITY IN REVENUE STREAMS EXPANSION MODES Horizontal Vertical Backward Integration l l l EPC Report New.indd 19EPC Report New.indd 19 2/20/2011 8:13:42 PM2/20/2011 8:13:42 PM
  21. 21. EPC Industry in India: Issues and Challenges | 20 | execution, and identify and manage their risk exposure in a higher risk business in a calibrated manner. Several traditional manufacturing companies have faced financial difficulties in managing their project businesses in the recent past. Route 3 BACKWARD INTEGRATION Many Indian entrepreneurs have typically wanted to control as much of the value chain as possible.The story is being now repeated in the EPC industry - Reliance ADAG has Reliance Infrastructure, while Essar Group has Essar Projects. GMR has its own EPC division, while the Tata Group has Tata Projects. Many other business houses have established strong internal project execution teams. Moreover they believe they can derive substantial benefits on procurement activities through in-house procurement. Further, as an executive from one of the leadingplayersintheindustrypointedout large business houses making significant investments believe that there isn’t enough expertise and scale within the existing EPC companies for assuming and managing their project risks. In the Power Sector, for example, the only large full service EPC company that comes to mind is Larsen and Toubro, which can offer full EPC, BTG package, BoP package and also individual equipments and sub-systems. There are few others capable of simultaneously executinganumberoffullEPCprojectsin the Power Sector. One private developer mentioned that the available set of EPC companies does not inspire confidence in their being able to deliver projects on time and with the initial estimated cost. Typically in such scenarios, the risk of both schedule and cost is transferred back to the developer in forms of claims and counter claims on who is responsible for delays and escalations. As a result, the developer feels compelled to manage his projects on his own if he has the organization and resources to do so, and a large enough pipeline of projects to utilize these in-house resources efficiently. International expansion for growth has really not been a focus area for most Indian EPC companies given the growth in the domestic sector, and the stiff competition posed internationally by the global majors. However, there remain certain sectors where international expansion is likely. The Indian Oil and Gas plant engineering and construction market has all the global majors present in India. Hence, Indian companies competing with them have raised their game to the international level in this field. Hence companies like Larsen and Toubro, Punj Lloyd, Essar Projects have won business at the international level and should continue to do well in the hydrocarbons space. Similarly, sub- contractors in this space (e.g. Petron Engineering) may also be able to compete internationally, as they have been working as sub-contractors to global companies in India. On the other hand, there are niche International Expansion COMPANIES WHO ENTER THE PROJECTS BUSINESS FROM PRODUCT MANUFACTURING OR ENGINEERING SERVICES BACKGROUNDS, NEED TO CAREFULLY BUILD THE REQUIRED CAPABILITIES FOR PROJECT EXECUTION, AND IDENTIFY AND MANAGE THEIR RISK EXPOSURE IN A HIGHER RISK BUSINESS IN A CALIBRATED MANNER. EPC Report New.indd 20EPC Report New.indd 20 2/20/2011 8:13:42 PM2/20/2011 8:13:42 PM
  22. 22. EPC Industry in India: Issues and Challenges| 21 | EPC segments, with limited market size in India, which has prompted Indian companies in these domains to go global. Examples of this are to be found in Walchandnagar for sugar and biomass based power plants, KEC International for EPC in transmission and distribution space. Some of these expansions have been facilitated by global acquisitions as well – for example the acquisition of the mineral beneficiation equipment businessofcementmajorKHDHumboldt Wedag by McNally Bharat Engineering has provided them a foothold in the international market. Similarly, the acquisition of Sembawang and its subsidiarySimonCarveshassignificantly improved the international profile of the Punj Lloyd. KEC International acquired SAE Towers’ business, a leading manufacturer of steel lattice structures for transmission towers with subsidiaries in Brazil, Mexico and US.This is the most plausible route that Indian companies are likely to take acquiring companies in niche areas globally to create large multi-country EPC businesses. There are no large acquisitions of note in the main plant EPC market, other than Punj Lloyd’s acquisition of Sembawang. In the domestic market, diversification in to newer areas by EPC companies has been accompanied by acquisitions or JVs - particularly in the Hydrocarbons space, wherein the qualification criterion are quite stringent for entry. Tata Projects acquired Artson Engineering, while entering into a JV with EILfor its Oil and Gas foray. IVRCL acquired Hindustan Dorr-Oliver to strengthenitsWaterTreatmentbusiness and gain a foothold in the mineral beneficiation plant construction market. We expect the acquisitive activities of Indian EPC companies to intensify over the next 3-5 years. Opportunities for partnering or acquisition will arise as smaller, niche EPC companies find it difficult to compete against large companies.Additionally, the recent bout of aggressive bidding by Indian EPC companies is likely to throw up winners and losers in the next 3 to 5 years. This will likely lead to consolidation in the industry. GLOBAL ACQUISITIONS BY INDIAN COMPANIES Mineral beneficiation equipment business of cement major KHD Humboldt Wedag by McNally Bharat Engineering Sembawang and its subsidiary Simon Carves by Punj Lloyd SAE Towers’ business, a leading manufacturer of steel lattice structures for transmission towers with subsidiaries in Brazil, Mexico and US by KEC International l l l EPC Report New.indd 21EPC Report New.indd 21 2/20/2011 8:13:43 PM2/20/2011 8:13:43 PM
  23. 23. EPC Industry in India: Issues and Challenges | 22 | Contracting Models Model Role of EPC company Drivers / Highlights Engineering Procurement and Construction Management (EPCM) System engineering, optionally detailed engineering Detailed cost estimation Package and sub-contract structuring Managing bid / vendor selection process Quality management ( including drawing approvals of vendors, sub- contractors) Supervision of construction, erection, commissioning, performance testing Project Management ( sometimes an additional Project Management agency) l l l l l l l Commonly practiced in process industry Players like Engineers India Limited, Uhde, Foster Wheeler, Technip, Technimont ICB etc Contract values are small as compared to LSTK, however high margin Minimal risk for EPCM companies, however customers now insist on incentives based on project cost and schedule as compared to original estimates Places responsibility of managing risks, cost control and procurement on the project developer Preferred in the Indian context due to in-house capabilities of Indian entrepreneurs and willingness to take risks, and save margins l l l l l l EPC - Lump Sum Turn Key (LSTK) Engineering, procurement, construction, commissioning The extent of information provided varies, typically all the drawings and designs are provided to construction companies to bid, while in some cases only the conceptual design may be provided l l Complete risk transfer to EPC company Very large contract sizes, equal to the project investment HigheradoptioninIndiaofthismodelintheinfrastructure segments ( Roads, Water, Hydro Power etc) Limited adoption in the industrial segment l l l l Package EPC Engineering, procurement, construction and commissioning of a particular unit Most likely to involve mechanical, electrical, instrumentation, utilities civil and structural scope l l Project developer splits the project in “system” or unit packages Most commonly used method in Process plants, power plants – especially by the public sector. E.g. NTPC breaks the Power plant in to packages like BTG, Coal Handling, Ash Handling, Water Treatment etc Contract sizes can be as large as INR 2000 Crores l l l Contracting Models and their Drivers The demand for the EPC industry is driven by the contracting models adopted by customers. Theoretically, the EPC industry is driven by the need to reduce the risk for the developer, at the same time leveraging the expertise of the EPC player to reduce the overall execution period and cost. Some of the prevalent contracting models are mentioned below: Source: KPMG Research and Analysis, Industry inputs Key External Drivers and Issues EPC Report New.indd 22EPC Report New.indd 22 2/20/2011 8:13:43 PM2/20/2011 8:13:43 PM
  24. 24. EPC Industry in India: Issues and Challenges| 23 | The choice of the contracting models are driven by multiple factors Internal capabilities of the project developer Influence of financial institutions Availability of enough number of quality LSTK suppliers Prevailing market conditions, includingsupplierpower.Inacapacity constrained scenario, contracting models move towards shifting the risks on to the project developers. However, a few general trends can be drawn based on the above drivers, as follows: In the infrastructure segments, the contracting models are moving towards transferring more risk to contractors, including operating risks in the form of BOT, BOOT models. In the industrial segment, it is expected that the EPCM or even lesser risk models will continue to dominate. What will tilt the balance in favour of turnkey models in the industrial segment is the entry of new developers, especially in the mid-scale segments, who have limited internal capabilities to execute projects without LTSK type contracts. Order Book Uncertainty One significant trend in industry, l l l l l l l especially where projects are being awarded through the competitive bidding in the public sector, is the emergence of a large number of relatively small, unknown players bagging significantly large contracts. While it is important from a capacity building and competitive stand point, it has led to order book uncertainty for the incumbents. At the risk of sounding anti-competition, a senior management executive of a large EPC company suggested that it is not a healthy trend at all. “It is leading to contracts being bagged by companies with limited capabilities, which will affect projects in the medium to long run”. While the extent of truth in this prophecy can only be borne out over time, it is a fact that this phenomenon has increased the order book uncertainty for the incumbents. Strategic planning methods based on projected capital expenditure and historical market shares do not throw up reliable revenue projections, and there is scramble to hedge risks by diversifying and being present in as many sectors as possible. There are numerous examples around this; a look at the portfolio of the top 10 construction companies in India illustrates this point. Another ramification of this order book uncertainty is the appetite for investment in manufacturing or in-house value addition. The BTG manufacturing capacities of private sector companies in India like that of L&T, Bharat Forge, Thermax, BGR etc are faced with the prospects of being under utilized as most main plant equipment orders have been won by BHEL and the Chinese companies. This phenomenon was also seen in the Roadssector,wherethereisconsequently now a cap on how many orders can be placed on a single company, and also in the Balance of Plants in Power space, where multiple companies have sprung up to take advantage of the under- capacity scenario. CONTRACTS being bagged by COMPANIES with LIMITED CAPABILITIES will affect PROJECTSin the medium to long run EPC Report New.indd 23EPC Report New.indd 23 2/20/2011 8:13:43 PM2/20/2011 8:13:43 PM
  25. 25. EPC Industry in India: Issues and Challenges | 24 | 4 NSDC report on Human Resource and Skill Requirements in Building, Construction Industry and Real Estate Services Human Resources The shortage of skilled manpower is most acutely being felt in the construction industry. The construction industry currently employs 32 million people in the country. It is estimated that 1 percent increase in GDP translates to 1 percent increase in jobs for the construction industry. With the accelerated investment in infrastructure, this is only going to increase. If the 12th plan envisages doubling of infrastructure investment from the 11th plan, it calls for doubling of requirement for the construction industry, which indicates a large shortage of resources. While mobilization of unskilled labour at construction sites may be of relatively lesser concern, the need for doubling the skilled resources available in the country is being acutely felt. Anecdotal evidences indicate that construction managers with 15+ years of experience in building high quality roads are now drawing compensation in the same range as their peers in advanced countries, which was unheard of in the Indian context. Industry leaders are worried about the shortage of skilled workers like carpenters, fitters, welders, but what they lament the most is the lack of Project Managers with adequate experience and skill levels to execute the ever increasing size and complexity of projects. The11thplanenvisagesthedevelopment of a National plan for Human Resource development through training and certification of construction personnel. However, industry participants feels that this large capacity building will require significant private sector effort, for establishing training institutes, setting course material and reducing trainee career risks by providing absorption. While the need for upgrading the current setofITIsandvocationaltraininginstitutes is felt, more importantly, there is a need to establish training centers with private participation at major labour centers in the country, in the semi-urban and rural areasThe challenge is accentuated due to the demand centers and the supply centers being different. The supply is likely to be driven predominantly by states like Orissa, West Bengal and Bihar, especially at the minimally skilled levels4 . Centum Learning, a joint venture between Bharti Group’s Centum Learning and NSDC is one initiative, to skill and train 1.2 crore Indians on workskills in sectors like Telecom, Retail, Building and Construction. However, there is need for many more, especially from the Construction Industry itself. Hence there is an urgent imperative for collaborative action by the Engineering and Construction companies in investing in skill building at the supply centers, in a non-competitive environment. In the meantime, the government may have to refrain from disallowing the use of foreign labour for project execution, till such time as skilled labour shortages are addressed. While, the skilled resource “The existing public school infrastructure can be upgraded through private participation with minimal additional expenditure with after-school hours used for providing vocational skills” - Senior Executive at an EPC company IncrementalHumanResourceRequirement (including skilled workforce) in 000s Profile of People Incremental Requirement Project Managers and Engineers 473 Supervisors 473 Foremen 946 Crane Operators 7 Electricians 473 Weleder 473 Source: National Skill Development Corporation and IMaCs study on Human Resource skill gaps in Building, Construction and Real Estate EPC Report New.indd 24EPC Report New.indd 24 2/20/2011 8:13:43 PM2/20/2011 8:13:43 PM
  26. 26. EPC Industry in India: Issues and Challenges| 25 | requirement at the Engineer and Supervisor levels is a constraint as well, we feel that it is easier addressed as over a period of time through private sector participation in engineering education, as this is financially rewarding even with limited or no government support. What may be needed though is more specialized curriculum development (for example Power Plant engineering). A second requirement is for cross- functional engineering skills and exposure. The EPC industry needs a set ofprofessionalstoactasintegrators,who can act as engineering coordinators and are comfortable with various engineering disciplines and not just one specific discipline. It is only with the availability of such talent, that companies can innovate, carry out value engineering to improve the overall productivity of a capital project. The second of critical challenges apart from technical and skilled labor, lies in developing managerial talent. There are few institutes focusing on teaching Project Management, especially for the construction industry in the country. In the absence of specialist finishing schools for Project Management, the industry relies on in-house training, and on-the-job training programs. While those are important, there is a need to go beyond the generic project management credits introduced in business schools or engineering institutions. It is strongly believed that the development mandate given to the Construction Industry Development Council and the National Institute of Construction Management and Research (NICMAR) needs to be supplemented by the establishment of some such high quality Project Management schools. “There is a need for building a high profile project management school along the lines of an IIT/ IIM, all we need is some land allocation and the industry can do the rest” – Senior Executive of an EPC company EPC Report New.indd 25EPC Report New.indd 25 2/20/2011 8:13:43 PM2/20/2011 8:13:43 PM
  27. 27. EPC Industry in India: Issues and Challenges | 26 | 5 http://www.doingbusiness.org/rankings Ease of Doing Business Ranking for India (i) Ease of doing business in India In the latest rankings5 for ease of doing business, India is ranked 134th in the world. Contracts Ease of Doing Business Starting a business Dealing with construction permits Registering property Getting Credit Protecting investors Paying taxes Trading across borders Enforcing contracts Closing a business 134 165 177 94 32 44 164 100 182 134 Source: World Bank Group, Ease of Doing Business Rankings, 2011 “Managing within a weakly enforced regulatory framework is a competitive advantage for Indian companies” - Senior Executive at an EPC company India scores particularly poorly in the establishment of new business and construction, closure of businesses, and enforcement of contracts. While, one may argue that these rankings mean little to investors and companies who see the immense potential of India, as also reflected in the FDI flowing in to the country. However, for many global companies contemplating entry into India, these are not encouraging indicators. One of the world’s leading design engineering and consultancy firms, while evolving it strategy for emerging markets recently, found these rankings to be particularly forbidding in its evaluation of India’s attractiveness as a business location. Risk Assessment of Typical Contracts DuringarecentengagementforanIndian EPC client, we studied the risk evaluation frameworks in use by international majors. We found that many international companies would rate typical Indian projects as “No-Go”. While the reasons would typically also include issues related to logistics constraints and overly aggressive delivery periods, the primary reason for such evaluations, we found, were the typical contractual clauses, including payment and retention terms which detract international companies from taking up large contracts in India. Moreover, many EPC companies find arbitration as a lengthy process in India, and hence the risk averse companies assume that in case of any disputes, they will have to accept terms from the customer. Interestingly, as a senior executive in in an EPC firm told us, the ability to manage within a weakly enforced regulatory framework is a competitive advantage for Indian EPC companies who have learnt to operate under these conditions. For example, these companies have realized that Liquidated Damages are rarely enforced by Public Sector clients. Further, new infrastructure developers, when dealing with large experienced EPC firms operating in India, find it difficult to prevent extra claims, and costs from escalating. EPC Report New.indd 26EPC Report New.indd 26 2/20/2011 8:13:43 PM2/20/2011 8:13:43 PM
  28. 28. EPC Industry in India: Issues and Challenges| 27 | We feel, the industry requires that nodal agencies in various government sectors, take up these issues, to align the project contractual clauses to international standards, particularly if they wish to receive enough number of bids in the International Competitive Bidding routes, reduce the number of disputes and raise the trust levels in the industry between project developers and engineering and construction companies. Taxation Direct tax A typical EPC contract will have the following scope of work in a single project: Supply of equipment (offshore and onshore); Installation / commissioning Services (offshore and onshore) Software / Technology transfer (offshore and onshore) Under a typical EPC contract, a non- resident contractor performs multitude of activities. The scope of work under EPC contract: Offshore: Offshore supplies and offshore services On-shore: Onshore supplies and onshore services (installation, commissioning, etc.) Taxability of payments received by foreign companies in respect of EPC l l l l l l contracts, especially in respect of off- shore supply of goods / services under a composite contract, has become a matter of great debate and litigation. Equally important is the issue in relation to withholding tax on such payments. The onshore supplies and services are normally taxable in India. There has been a lot of litigation in relation to taxability of offshore supply and offshore services. However, the controversy in relation to offshore servicesisnowrestedwithanamendment in the domestic law and accordingly offshore services are now taxable in India if they are utilised in India.Ageneral principle which was emerged out of the judicial precedents is that profit from offshore supplies would not be taxable in India provided following conditions are satisfied: Principal to principal transaction Title (i.e. risk and ownership) in the offshoresuppliespassedtothebuyer outside India Sale consideration is received outside India Sale is at arm’s length Although the above rulings suggest that offshore supply may not to be taxed in India, the taxability depends of facts of each case. Further, the revenue authorities have not accepted the above rulings and hence, it is still a matter of l l l l controversy and litigation. Hence, it is advisable to structure contracts in a tax-efficient manner after taking into account the peculiar facts of each case. Further, there as several provisions under the Proposed Direct Taxes Code, 2010 such as General Anti – Avoidance Rules, etc. that will have to be taken into consideration while entering into EPC contracts. Permanent Establishment (‘PE’) Issues Deputation of personnel for erection / installation / commissioning / designing / training activities is a common phenomenon in case of EPC contracts. The ambit of the domestic law of India is very wide and it tries to tax income from all the activities which give rise to some business connection in India. Based on the tax treaty, the business income of foreign companies would be subject to tax in India only if they have a PE in India.There are various types of PEs like fixed base PE, agency PE, service PE or construction / installation PE. Practically,inanEPCContracts,activities take a long duration to complete, and hence PE clause (especially fixed base, construction / installation PE and service PE) comes into play in this industry more often. This would imply that a foreign company rendering services in India for more than the specified period would EPC Report New.indd 27EPC Report New.indd 27 2/20/2011 8:13:44 PM2/20/2011 8:13:44 PM
  29. 29. EPC Industry in India: Issues and Challenges | 28 | be taxed in India in addition to being taxed in the country of residence only by virtue of the fact that services are being rendered in India for more than the specified number of days or they have a virtual presence in India. Hence, it is important for the EPC contractor to structure their operations and contracts to mitigate PE exposure. Association of Persons (AOP) Generally, two or more EPC contractors come together to bid for EPC contracts in the form of a consortium. In such a situation, an AOP exposure would arise. The term AOP is not specifically defined in theAct. One has to rely on the ordinary meaning and the law emerging out of the judicial decisions to determine what constitutes an AOP. Whether AOP exist or not is a very vexed issue and much depends upon the facts and circumstances of each case. Following are the consequences of constituting an AOP: Applicability of Maximum Marginal Rate; Issues in relation to carry forward of losses; Issues in relation to Foreign Tax Credit; Taxation at two level due to applicability of Minimum Alternate Tax on profit distribution from AOP l l l l BROAD PARAMETERS TO ANALYZE CONSTITUTION OF AOP TWO OR MORE PERSONS VOLUNTARY COMBINATIONS ACOMMONPURPOSEORCOMMON ACTIONWITHOBJECTTOPRODUCE PROFITS OR GAINS SHARING OF PROFITS AND LOSSES JOINT AND SEVERAL LIABILITY OF THE MEMBERS; AND SOME KIND OF SCHEME FOR COMMON MANAGEMENT l l l l l l EPC Report New.indd 28EPC Report New.indd 28 2/20/2011 8:13:44 PM2/20/2011 8:13:44 PM
  30. 30. EPC Industry in India: Issues and Challenges| 29 | Key Internal Issues The key internal challenge facing the Indian EPC industry today is issue of being able to manage scale and diversity, with the rapid growth in business and diversification into new business areas. Other issues around improving the quality and value addition of engineering, implementing leading practices in project management, implementing modern construction methods are also specific challenges facing the industry players, but we believe these will get addressed in natural course as the EPC industry matures in India. However, the core challenge facing the mid-size, fast growing companies are around effective project management, management of growth and scalability without compromising on project and business risks, and developing systems and processes to make companies more scalable and less dependent on individuals. Project Management “E+P+C is not equal to EPC” said the director of one of India’s leading engineering and construction company. The glue that binds all these together is Project Management. Project Management is a science, with its own school of tools and techniques, both in the scientific and the behavioural domain. “In our company, project managers are GODs” is the common refrain in international EPC or engineering companies. However, this is not the case in Indian EPC companies, as is evident from various perspectives provided by Indian companies as well as developers. A leading Hydrocarbon major, in an industry forum, called upon the EPC companies in India to develop better project management talent, and especially requested the Indian offices of global firms to rotate local talent through global assignments to develop these skills. Most mid-size fast growing EPC companies in India are facing issues related to empowerment of Project Managers and the primacy of the Project Management function in an EPC firm. As a result, projects are de facto mana- ged by Business Unit Heads or other very senior professionals, reducing the designated project managers to co- ordination roles, and resulting in senior management being involved in day to day project issues. Further, with business growth, senior executive time available for a specific project becomes limited, resulting in loss of execution control. We suggest that fast growing mid-size companies relook at their organization structures and policies to ensure that their project managers are empowered. They should have accountability for project cost and time control, and adequate control over decisions related to the project. “E+P+C is not equal to EPC” RESPECT FOR SENIORITY IN INDIA LEADING TO PROJECT MANAGER EMPOWERMENT ISSUES THE OTHER DIMENSION OF THE CHALLENGE IS THE RESPECT FOR SENIORITY IN THE INDIAN CULTURE. WHILE PROJECTMANAGERSARE DE-FACTO CEOS OFAPROJECT,THEYMAYNOTALWAYS BE MOSTSENIOR INTHE PROJECTORGANIZATION’S HIERARCHY.THE PROJECTTEAM MAYCONSIST OF ENGINEERING COORDINATORS, CONSTRUCTION MANAGERS WITH MANY MORE YEARS OF EXPERIENCE – WHO WOULD BAULK AT REPORTING TO THE DESIGNATED PROJECT MANAGER DUE TO THEIR CULTURAL CONDITIONING. EPC Report New.indd 29EPC Report New.indd 29 2/20/2011 8:13:44 PM2/20/2011 8:13:44 PM
  31. 31. EPC Industry in India: Issues and Challenges | 30 | Organization Design & Management: Building the Engineering ORGANIZATION As we discussed earlier in evolution of EPC companies, most EPC companies are likely to evolve from the construction or the developer route. In both the cases, the key capability gaps would remain in the domain of engineering. While Project Management is the execution arm, engineering does and should function as the brain, adding competitive advantage in terms of standardization, value engineering and technology leadership. Engineering which being a knowledge based function requires careful design of organizationstructures,careerpathsand development strategies, and a different approach to performance assessment and management as compared to the other functions in the organization. Also, with rapid diversification, the centralization vs. decentralization question stares at managements of EPC companies, who would like to balance efficiency with effectiveness. For example, companies tend to centralize “end-use / process” independent engineering disciplines like civil, structural and electrical, while the other disciplines are de-centralized. However, there is no right answer, it needs to be carefully assessed in light of the company’s portfolio, strategy and culture. Source: PMI-KPMG Study on drivers for success in infrastructure projects 2010 - Managing for change Risk Management Less than one third of the survey respondents in KPMG-PMI Infrastructure report, had confidence in their risk management capabilities. The EPC business model revolves around taking ownership of project risks. Hence it is absolutely critical for EPC companies to establish robust processes for risk identification and risk management. Such a process would address risks identified at both the sales and execution stages of the project. While the ideal situation would be for EPC companies to be able to identify,mitigateorprovide forallrisksatthetendering stage, this is usually not practical, given the need to complete bids within a specified deadline, and to not rely indiscriminately on additional contingency margins that may impair EPC Report New.indd 30EPC Report New.indd 30 2/20/2011 8:13:44 PM2/20/2011 8:13:44 PM
  32. 32. EPC Industry in India: Issues and Challenges| 31 | Source: PMI-KPMG Study on drivers for success in infrastructure projects 2010 - Managing for change The KPMG-PMI study in 2010 also highlighted the some concerns on the comprehensiveness of risk identification by companies, given the high incidence of projects having suffered due to risks that were hitherto unidentified and hence not mitigated. Critical improvements are also required to acquire a robust level of sophistication and maturity in risk mitigation. Routinely used mitigation the competitiveness of the bids. Hence whilekeyrisksareidentifiedandmitigated during the bidding stage, a large number of additional or minor unmitigated risks may need to be addressed during ongoing project execution. Most leading international EPC companies, process all enquiries / tenders through a risk identification process based on which, go-No-go decisions are taken, and risk ratings are assigned to each project or proposal. The more sophisticated systems also have contingencies and margin policies based on risk ratings. Similarly, the portfolio of projects is weighted based on risk categories as strategic planning inputs. Another common element is Independent review of risks by personnel not directly involved in Project Sales or Execution. With the rapid growth in order books, and a senior management stretched for time, it is essential that Indian companies also rely less on individual or subjective experience and expertise, and more on agreed risk management tools and objective frameworks which can be used even by less experienced people with the help of knowledge and experience that is codified into these tools. These risk assessment frameworks, customized and developed with the inputs from senior management of the company, can flag off critical risks in the tenders, and ensure awareness and more informed decision making during bidding. Also, nuanced and differentiated processes of project execution, monitoring and control and staffing of projects based on the risk assessment will help in focusing the best and most careful decision making capacity towards the most risky of the projects in a company’s portfolio. strategies are either ‘reduce’, transfer or avoid. While “accept risk” type strategies are used infrequently, ‘exploit’strategies are rarely used. The industry thus is yet to reach maturity levels at which mitigation strategies are leveraged to exploit project risks and are used as means to maximize project income potential. Risk reporting and monitoring are the remaining links in the risk management process that are critical for its effectiveness. Evolving information systems can make timely and accurate project information for reporting purposes. The information reported should comprise early warning indicators and provide content that facilitates decision making. EPC Report New.indd 31EPC Report New.indd 31 2/20/2011 8:13:45 PM2/20/2011 8:13:45 PM
  33. 33. EPC Industry in India: Issues and Challenges | 32 | Procurement Procurement can be a vital element influencing timely and profitable project delivery in EPC projects. In projects with low construction intensity like Power projects, Refining and Petrochemical complexesandotherindustrialplants,just the standard “bought-out” components may comprise anywhere between 30-50 percent of the project value, apart from other procured items like construction materials and sub-contracted services. There are several reasons leading to complexity in the procurement function of an EPC company: Number of individual items to be procured for a large project, within specific and often varying deadlines. Cost targets for Procurement are usually set at individual component level, not at an overall Procurement budget level – since senior management usually does not l l disclose overall project cost budgets for confidentiality and flexibility purpose. The constant trade-offs between procurement time and procurement costs to meet the often conflicting goals of cost control vis-a-vis schedule control on a project. It requires companies to evolve strong sourcing teams, capable of vendor discovery and price discovery on a larger scale than would be required in a manufacturing set-up. In most manufacturingcompanies,ratecontracts, differentiated procurement processes for minor vs. major items, and MRP based procurement processes reduce the transactional overhead significantly. Moreover, most public sector units have made, depending on how one looks at it, the job easier or more difficult for contracting companies by providing vendor lists. This has resulted in vendor development take a backseat as the l burden of that job has been transferred to developer or the consultant. This is however, not the case with private sector clients, especially new entrants. EPC companies we believe, would benefit significantly from an increased focus on vendor development, including supportinghighqualityemergingvendors in getting themselves accredited with PSUs. Given this context, we feel Procurement capability can emerge as a strategic differentiator for improving performance and winning business in the EPC industry. It requires efforts on the part of engineering, procurement and client facing personnel to discover, qualify new suppliers and convince customers to include them in their approved lists or allow deviations on the projects. We feel however, in the emerging high growth but hyper competitive scenario for EPC companies, this would be a worthwhile investment to make. EFFICIENCY IMPROVEMENT INITIATIVES FOR PROCUREMENT FUNCTION REDUCE CYCLE TIME, BY DESIGNING THEIR PROCUREMENT PROCESSES FOR INCREASING DECISION MAKING SPEED REDUCING THE NUMBER OF TRANSACTIONS BY STANDARDIZATIONAND IDENTIFYING COMMON ITEMS ACROSS PROJECTS EXECUTED IN THE PAST IMPROVE THE COMPETITIVENESS OF THEIR SUPPLIER BASE BY CASTING THEIR NET WIDER, INCLUDING ELEMENTS OF GLOBAL SOURCING IN THEIR STRATEGY l l l EPC Report New.indd 32EPC Report New.indd 32 2/20/2011 8:13:45 PM2/20/2011 8:13:45 PM
  34. 34. EPC Industry in India: Issues and Challenges| 33 | 6 And not necessarily poor planning End-Use Industry Views Power Generation Units – especially thermal power plants are likely to be amongst the largest opportunities for EPC players in the short to medium term. The thermal power and nuclear power units both have relatively lower civil construction component and require superior capabilities in terms of equipment sourcing, engineering and integration management as compared to other infrastructure classes like Roads, Ports etc. Demand Outlook By 2015, India would need to increase its current generation capacity of 152 GW to 205 GW (an increase of 53 GW) till year 2014-15 for meeting the base load capacity requirement to support growth of economy at 8 percent and address unavailability of power in many parts of the country. To meet the peak load capacity requirement, the installed capacity requirement would need to be more than 270 GW. The generation capacity gap to meet baseload requirements varies significantly across regions and is estimated as 62 GW in Western Region, 62 GW in Northern Region, 54 in the Southern Region, 24 GW in the Eastern Region and 3 GW in the North Eastern Region of India in the year 2014-15. This projection implies an average annual generation capacity addition at the rate of 16 GW per year during the period 2007-08 to 2016-17 (covering two 5 Year Plan periods in India viz. XIth and XIIth). During the IXth (1997-2002) and Xth (2002-2007) 5 Year Plan periods, the average annual generation capacity addition in the country has been 3.6 GW and 4.2 GW respectively. The poor performance in the past is attributed to implementation delays6 by the public sector utilities coupledwithhitherto limitedprivatesector participation. Abottomupanalysis of expected plant additions was conducted based on a variety of sources such as the CEA database for upcoming additions, industry reports and KPMG’s internal assessment. Only those plants which have reached an appropriate state of readiness for commencement of commercial operations within the period FY 2010-15 have been considered for capacity addition. Effective supply addition for each year of the period (FY 2010-15) was calculated based on the total capacity addition. We expect a total capacity addition of 99 GW in this period. Assuming a similar rate, this translates in to an approximate opportunity size of INR 500,000 crore (i.e. over USD 100 Billion) towards capital expenditure for these plants. The majority of this investment will be towards thermal power plants, of which 80 GW are likely to be commissioned by 2015.The opportunities for EPC players, equipmentvendorsareforprojectswhich are likely to get commissioned beyond 2012-13 as they are the ones which are mostly likely yet to be tendered out - for balance of plant equipment if not main plant equipment.Source: KPMG Research and Analysis Expected Capacity Addition (GW) Power Generation EPC Report New.indd 33EPC Report New.indd 33 2/20/2011 8:13:45 PM2/20/2011 8:13:45 PM
  35. 35. EPC Industry in India: Issues and Challenges | 34 | 7 Source: http://www.sify.com/finance/ntpc-likely-to-float-rs-18-000-cr-tender-news-equity-km4bvDidjib.html End-Use Industry Specific Issues The thermal power industry has been one of the fastest to adopt the EPC model The Power Generation industry has seen one of the fastest adoption rates in terms of EPC contracting model. Prior to the reforms in the power sector and the policies around public private partnership models, power plants were being constructed by the state level generation companies and NTPC. The tariff regime and operating models of some these power generation entities at that time did not require utmost attention to projection completion on schedule and to cost budgets. However, with the competitive power pricing policy PPP bids, - wherein one can participate in developing power, only if you are the most efficient on capital cost as well as operating cost - has led to increased focus on executing projects on time and within budget. Most projects are being financed by project finance companies and financial institutions, who demand that developers manage the project budget escalation risks. Internal teams at even established generation companies are stretched, and at the same time, there have been a large number of new power sector entrants, some with limited background in executing large projects. Hence the entire sector is favourably inclined towards contracting project execution on a LSTK basis. The current landscape indicates that large public or private sector generation companies like NTPC, given their internal engineering and project management talent pool, will continue to buy individual packages, keeping the integration to themselves. However, they may combine multiple power plants in their portfolio, going for combined bids to get the best prices and reducing transactional bidding costs. NTPC floated a tender for different packages for 11 units of 666 MW each, the award of which is likely by first quarter of 2011. With this move, NTPC is expecting to bring down the cost/MW of setting up power plants, which many experts believe today is at about 5.5 crore/MW7 . State level generation companies, most of whom are currently on the twin package mode (BTG and BoP), may continue to procure in that manner. The trends in the private sector are interesting, where a distinction needs to be made between large business groups like Reliance ADAG, Essar Group, JSW Group, Sterlite Group, GMR Group, Lanco etc who are likely to build large portfolio of power projects in the future, vis-à-vis smaller players with fewer generation projects in their planned portfolio. While complete power plant as a single EPC/ LSTK package is still rare in the Indian scenario. Moreover, the trend of not awarding the entire EPC job (i.e. both BoP and BTG of a power plant) to one single service provider has been driven by: Distinct set of competencies required for the BTG and BoP packages. While BTG is technology, equipment and manufacturing intensive, BoP requires complex integration capabilities of sub-systems to be sourced, erected and commissioned from different sources. A single LSTK package would amo- unt to a range of around INR 6000 crores for a typical 2X660 MW project, requiring EPC companies with large balance sheet and risk bearing capability. It will be difficult to find enough number of such contractors to get a competitive bid. l l EPC Report New.indd 34EPC Report New.indd 34 2/20/2011 8:13:45 PM2/20/2011 8:13:45 PM
  36. 36. EPC Industry in India: Issues and Challenges| 35 | 8 Economic Times, 23rd January 2011 Typical Outsourced Package Structure by Thermal Power Plant Developer Segments The large business houses like Tata, Reliance, JSW, Adani have significant in-house capabilities as far as project execution goes. Moreover they have substantial leverage with equipment vendors and sub-contractors due to their large portfolios. (Reliance has demonstrated this by entering in to an agreement with Shanghai Electric Company for main plant equipment supply for all its thermal power plants, and in the process also getting access to cheap funds. Estimates put the savings on financing cost alone at INR 6500 Cr. for just the Sasan UMPP project being developed by Reliance Power8 . With that kind of leverage, it is hard to imagine, large private companies wanting to outsource setting up of power plants to EPC companies on a turnkey basis. If EPC companies are looking to capture this private sector market in utility power plants, we believe they will have to bring a value proposition which reduces power plant capital expenditure costs by at least 10 – 15 percent over the currently prevailing benchmarks, through efficient global procurement and strong project execution capability. “Do the EPC companies really deliver for us?” - Power Plant Developer Central Sector PSU State Sector PSUs Private Sector UMPPs EPC Contract for Entire Plant (BTG + BOP) · Not Applicable Rajasthan Rajya Vidyut Utpadan Nigam Ltd (RRVUNL) Projects · Companies like GMR, Jaypee, Essar, Indiabulls which have their own Project companies Not Applicable * Balance of Plant – EPC DVC projects to be tendered as single BOP package· NLC also expected to go for BOP in the NLC TPS – III · Some state generating c o m p a n i e s l i k e Maharashtra, Madhya Pradesh, Chattisgarh are going for the BOP route The new entrants and small-to-mid size players in the IPP market may go for BoP BOP route unlikely given the scale of orders and also due to the fact that most large power developers have EPC companies Coal Handling Plant (CHP) · N T P C , N L C – separate CHP package S t a t e g e n e r a t i n g companies going for split packages have CHP separate · Companies going for split packages have CHP separate Tata Power Mundra UMPP awarded CHP separately to Krupp: Reliance Infra undertaking Sasan UMPP on EPC basis Ash Handling Plant (AHP) · N T P C , N L C – separate AHP package Some state generating companies combineAHP with Main Plant but that is slated to change · Companies going for split packages have AHP separate S e p a r a t e p a c k a g e s expected from the UMPPs W a t e r Packages · NTPC and NLC – separate packages S t a t e g e n e r a t i n g companies of West Bengal, ie, WBPDCLand DPL will give complete water packages; rest will split · Water packages will be split Water packages will be split Source: KPMG Research, News Analysis EPC Report New.indd 35EPC Report New.indd 35 2/20/2011 8:13:45 PM2/20/2011 8:13:45 PM
  37. 37. EPC Industry in India: Issues and Challenges | 36 | 9 Report of the Committee to study Design Features of Boilers and Auxilaries being sourced from Chinese Manufacturers, September 2008 Hence in terms of contracting model, the following trends are likely to sustain / materialize Majority of the public sector projects or projects of new developers are likely to be on twin package route (BTG and BoP) Most large business houses in the Thermal Power business will manage their projects in-house to leverage their portfolio, faith in their internal project management and l l procurement capabilities, and hence will place smaller sub-contracting or equipment orders. In the BTG segment, the Chinese companies will likely continue to have the second largest market share, after BHEL. It may be difficult for Indian companies in JV with foreign partners to make inroads in to thismarketduetothecostadvantage offered by the Chinese players due to overcapacity in their domestic market. While quality concerns l regarding Chinese supplies have beenexpressed,weunderstandfrom our interview respondents that there is no conclusive evidence to this effect. In fact a CEA study9 in 2008 found no material reason to doubt the quality or the technology offered by the Chinese suppliers. On the other hand, BHEL is the most established player in Indian with ~60 percent market share and with recently augmented capacity should continue to protect its market share. EPC Report New.indd 36EPC Report New.indd 36 2/20/2011 8:13:45 PM2/20/2011 8:13:45 PM
  38. 38. EPC Industry in India: Issues and Challenges| 37 | 10 Refers to opportunities for engineering and construction companies as well as equipment suppliers, not restricted to those on offer through the EPC-LSTK model Refining and Petrochemicals Demand Outlook Oil and gas constitutes about 65 percent of the global and 40 percent of the Indian primary energy consumption. In the Indian context, the primary energy consumption over the last five years has increased by over 6.5 percent CAGR as compared to global increase of about 1.7 percent CAGR. The overall contribution and pace of growth of oil and gas provides a perspective on the importance of this segment to the Indian economy. Oilandgasisoneofthefewsectorswhich exceed the investment targets as laid out in the Government’s five year plans. For instance, in tenth five year plan, the actual expenditure was 112 percent of planned outlay at INR 1,08,003 crores. Similarly, during the midterm appraisal of eleventh plan, government has to revised its planned outlay to INR 2,69,461 crores from INR 2,29,278 crores, a 17 percent increase in planned expenditure. This is mainlybecauseofaggressiveinvestment plans by oil and gas companies in India. The actual expenditure during the first two years and 4 months of eleventh plan (up to August 2009) is INR 1,08,625.91 crores which is 47.38 per cent of the plan approved Outlay. The Oil and gas sector is poised for growth. Many public and private companies have announced their investment plans in the various streams of the oil and gas sector such as exploration and production, oil and gas pipelines, petroleum refineries, liquefied natural gas, city gas distribution and petrochemicals. All these investment plans would create a robust opportunity for EPC companies. The total value of the EPC10 opportunity in India for Oil and Gas sector can be pegged at USD 60 - 65 billion in the next five years. On the upstream side, an investment of about USD 18 - 20 billion has been envisaged in the next five years for development of offshore fields and laying pipelines. A substantial part of this investment is expected to be done by ONGC in developingtheeastcoastgasdiscoveries and maintaining production from existing discoveries. Moreover, the government is Five year plans Planned Expenditure vs Actual Expenditure 0 50 100 150 200 250 VII Plan VIII Plan IX Plan X Plan XI Plan* Planned Expenditure Actual Expenditure Actual expenditure as % of planned outlay 127 169 67 112 - *XI plan actual expenditure is only up to August 2009 Source: Planning Commission Investment(inINRthousandcrores) EPC Investment opportunity in Oil & Gas Sector 60-652 3-4 3 21-23 12 118-20 0 10 20 30 40 50 60 70 U pstream O ilPipelinesG as Pipelines RefineriesLN G Term inalsCG D N etw orkPetrochem icals Total Investment(inUSDBillion) Source: KPMG Analysis EPC Report New.indd 37EPC Report New.indd 37 2/20/2011 8:13:47 PM2/20/2011 8:13:47 PM
  39. 39. EPC Industry in India: Issues and Challenges | 38 | 11 Including offshore engineering centers supporting global projects 12 Not an exhaustive list of projects, examples provided only to demonstrate instances of work executed in India also planning to offer shale gas blocks in second half of 2011, which will create more opportunity over and above the aforesaid investments. The midstream segmentwouldseeaspurtininvestments given that the PNGRB is in the process of awarding four key pipelines segments more than 4,000 kms. Further there has been plan to launch additional pipeline such as Asansol-Howrah, Chennai- Nellore and other pipeline segments as part of national gas grid. This would mean an EPC opportunity of about USD 12 billion in natural gas pipelines. Additionally around USD 1 billion investment opportunity exists in crude oil and petroleum products pipelines. Further, to meet the domestic gas supply constraint, LNG regasification terminals have been planned at Kochi, Mundra and Ennore which would require the capex investments of about USD 3 billion by 2015. In the downstream segment, refinery sector has seen number of announcements by companies for expansion of existing plants and setting up of Greenfield refineries. The new refineries are expected to increase the India’srefinerycapacityby55mtpa.Given that refineries are highly capital intensive, the EPC opportunity can be pegged at about USD 21 - 23 billion. Besides this, some companies have announced firm additions in their petrochemical production capacity which would mean an EPC opportunity of USD 2 billion. In addition, the Ministry of Chemicals and Fertilisers has approved proposals of about USD 35 billion in three regions under its flagship Petroleum, Chemicals and Petrochemicals Investment Regions (PCPIR) policy. These three PCPIRs are — Visakhapatnam and East Godavari districts in Andhra Pradesh, Bharuch in Gujarat and East Midnapore in West Bengal. We have not included investments in PCPIR in our overall estimate. City Gas Distribution (CGD) is another downstream segment which is set to see a spurt in investment opportunities, due to new domestic gas discoveries and bidding by PNGRB. The regulator has already completed the bidding for 13 geographical areas in first two rounds and plans to have offer further 16 cities in next two rounds. Thus even if one were to assume a conservative spread per city, the EPC opportunity in CGD network is about USD 3-4 billion in the next 5 years. End-Use Industry Specific Issues The Hydrocarbons industry is unique in terms of player profiles as the very best in the world have a presence in India. Here is just a sample list of companies operating in India, not just by means of having offshore engineering centers, but having won & executed projects in India. Our discussions with these companies indicate that they have at least 20 percent of their India center manpower deployed on Indian projects. Source: Company Websites and News Reports Company India Offices11 Examples of India Projects12 Foster Wheeler Chennai, Kolkata and Gurgaon IOCL Paradip Refinery FEED package Uhde India Mumbai, Pune PMC for Refinery Units of BPCL, Mahul, Jacobs India Ahmedabad, Vadodara, Mumbai, Delhi PMC and EPCM for Manali Refinery Resid Upgradation Technip Chennai EPC for Ethylene Storage System of Chemplast Sanmar Tecnimont ICB Mumbai, New Delhi EPC for Polypropylene plants at IOCL Panipat Linde Vadodara Hydrogen Plant at IOCL Barauni Aker Solutions Mumbai Engineering, Procurement, Project Mana- gement and construction/commissioning assistance for Reliance Polypropylene plant Examples of International Engineering Companies Presence in India in Oil and Gas EPC Report New.indd 38EPC Report New.indd 38 2/20/2011 8:13:49 PM2/20/2011 8:13:49 PM
  40. 40. EPC Industry in India: Issues and Challenges| 39 | It is a phenomenon very unlike the other sectors discussed like Power Generation or other infrastructure segments. One of the differentiating factors is the engineering and equipment intensity, put together as the technological intensity of the projects. This is an area where the relative strengths of the international companies are believed to be superior. Moreover, the qualification criteria are stringent and past experience in a particular type of unit / package is demanded. As a result, it has been observed that international companies have established their niches. Amongst Indian companies, the key players include Larsen and Toubro, Punj Lloyd and recently Essar Projects, which has received large size orders in the recent IOCL refinery project. The industry is also unique in terms of the prevalent contracting models, with very little being given out as LSTK contracts. The various reasons cited for this phenomenon are as follows Limited set of LSTK contractors in the Oil and Gas sector, capable or willing to execute large turnkey contracts.WhiletheEPCcompanies believe that process plants are too complex and the quality of front end and basis engineering which will provide the solid ground for firm estimation is lacking, the l user industry feels that the EPC companies are just not willing to take large risks in this sector. While L&T and Punj Lloyd are among the few Indian companies capable of taking up large LSTK packages, the international companies do not have Indian balance sheets of the size wherein they can afford to take such large risks. The international parent companies hesitate taking up large projects in India on account of their internal risk assessment policies. Additionally, there is ambiguity related to various taxation issues, which results in limited number of bids being received in an international competitive bid route. One of the state-run refining and marketing company highlighted the lack of enough number of global bids received, when they did break their contracting pattern to attempt awarding large LSTK packages. KPMG’s tax experts believe there are ambiguities in Indian taxation laws related to importing of capital equipment for projects, and also in taxation on work performed in India for global companies, which force these companies to either not bid, or bid very conservatively. The complexity of the process industrymakesitdifficulttoprepare detailedandcomprehensivefixed- cost bids. The preparation of the l FEED, so that it is good enough to give it out for LSTK itself takes about a year, followed by bidding and contracting for another year. This process adds a good two years to the 3 odd years of project execution cycle. Moreover, Indian user companies seem reluctant to spend that kind of man-hours and cost towards front end engineering. Majority of the capital expenditure is being done by the state run oil marketing companies, ONGC or Reliance. While the state-run companies have their large in- house teams developed over the years to take on the integration challenge, companies like Reliance are well-equipped to assume the project risks on their own, given their entrepreneurialhistoryandesteemed project management capabilities. In that light, the LSTK model or larger packages would be possible only in the event that the internal teams of Petroleum companies are stretched on account of a large number of capital expenditure projects ( which it appears, is not the case), or there are mid-size refining and petrochemical companies setting up plants in India. The answer in terms of encouraging mid-sized players to invest in India seems to have been found in the form of PCPIRs being set up in the country which will encourage foreign l EPC Report New.indd 39EPC Report New.indd 39 2/20/2011 8:13:49 PM2/20/2011 8:13:49 PM
  41. 41. EPC Industry in India: Issues and Challenges | 40 | as well as domestic investment, with the feedstock being supplied by the anchor investor. Though not exactly falling in this bracket, ONGC’s petrochemicalsventure,OPaL,being set up in the Dahej PCPIR is a case in point. ONGC has limited in-house expertise in petrochemicals, and hence there is a clear difference in the way it has gone about its procurement. The EPC order for the ethylene cracker has been placed on a consortium of Linde and Samsung Engineering India. This is one of the largest EPC contracts awarded in India in the Oil & Gas sector. Also, it marks the entry of the famed Korean EPC companies to India. Contracting Models: Medium Term Outlook As far as the hydrocarbons and the process industry is concerned, it will likely continue to see the dominance of the EPCM model of contracting. However, to reduce the complexity of procurement and integration, the individual packages being procured for a Greenfield refinery or similar plant, are likely to come down from the current 20- 25 to may be 10-15 packages and even less going forward. IndianEPCcompanieslookingtoenterthe Hydrocarbons sector, have to overcome the challenge of qualification. The routes adopted by them to build their credentials have included a) acting as sub-contractors to international companies, b) bidding in consortiums or c) acquiring small companies which have partial qualifications. However, as compared to EPC in other industries or infrastructure segments, it is a more gradual process to establish oneself in the Oil & Gas sector in India. EPC Report New.indd 40EPC Report New.indd 40 2/20/2011 8:13:49 PM2/20/2011 8:13:49 PM
  42. 42. EPC Industry in India: Issues and Challenges| 41 | 13 Techpetro Asia Newsletter (April 5,2010) 14 SAM group – Water - A Market for the future (2010) 15 ADB: www.adb.org/India/main.asp; World Bank: go.worldbank.org/E9RO7F96W0; JICA: www.jica.go.jp/india/english/activities/ 16 Planning Commision of India 17 ‘India Infrastructure at crossroads’ Thomas Reuters. September 24, 2010 Water Demand Outlook Water Resource Management – A Critical Global Challenge and Burgeoning Opportunity The Worldwide Plant market for water treatment has been estimated at USD 380 Billion Dollars as of 200913 . Water demand is increasing due to growing levels of industrialization and the spurt in global population. However regions with high demand are not well connected with regions of high supply. Given the demand-supply mismatch and increasing emphasis on sustainability, water management is a sector expected to experience high growth. Structure of the Water market Nearly 50 percent of water use is for industrial purposes in developed countries as opposed to 80 percent for agricultural use in developing nations. Both public utilities and private players operate in this space with private players accounting for 44 percent of the serviced water in Europe as opposed to only 12 percent in South East Asia14 . Key Characteristics Description India Industry Structure Global move towards consolidation has led to the formation of multinational corporations like Veolia, Suez etc having presence in more than a number of nations and latest reported revenues of over 10 billion USD Growing opportunity in the Indian market has led to the growth of Indian firms in partnerships with global majors, intending to participate in the planned privatization of the water utilities market in India. Technology Patented In-house technologies possessed by most companies. No one technology dominates Procurement of technology through tie-ups with foreign majors End Use Consumers Industry consumes nearly 50 % of all water Agriculture consumes over 80 % of total water Domestic opportunity Historical infrastructural activity surrounding heavy industry development and emphasis on sustainability provided the necessary project management experience. Very little penetration of the Domestic market.Large opportunity going forward Typical Contract Mode DBO/BOT (Design Build Operate,Build Operate Transfer). Focus on both building and operation of the facility EPC (Engineering Procurement and Construction). Also DBO/BOT basis contracts. Source: KPMG Research and Analysis Comparison of Global Water EPC Market with India Indian Scenario: A growing market with a lot of opportunity Due to the multiplicity of issues plaguing the sector, the Central, State and Local governments are investing significant amounts of money in the sector. Add- itionally, funding to the water sector by development banks is increasing manifold. Investment in urban water supply and sanitation has increased during the first decade of the 21st century, driven by increased central government grants made available under Jawaharlal Nehru National Urban Renewal Mission (JNURM) and funding from development agencies such as ADB, World Bank and JICA15 . The 11th Five-year plan (2007–2012) foresees investments of INR 127,025 crore (USD 28.6 billion) for urban water supply and sanitation, including urban drainage and solid waste management16 . While private sector interest in the sector has increased, critical barriers such as poorlywrittencontractingdocumentation, large timelines to project award and sub-optimal risk sharing mechanisms continue to hinder the growth of private sector investment in the water sector in India17 . EPC Report New.indd 41EPC Report New.indd 41 2/20/2011 8:13:50 PM2/20/2011 8:13:50 PM
  43. 43. EPC Industry in India: Issues and Challenges | 42 | Opportunity Drivers and Trends for EPC companies in Water Segment Opportunity Area Drivers and Trends Wastewater Treatment Stringent enforcement of sewage disposal norms Shortage of Water for Industrial use Opportunity in building sewage collection infrastructure and Treatment plants l l l Water Treatment and Transimission Increasing Urbanization Opportunity in the form of EPC / BOOT model including metering and collections l l Industrial Water Infrastructure Large capacity additions in Power and Steel EPC is the preferred Contracting model l l Desalination Reducing cost of desalinated Water, couple with water shortage Medium term adoption in the industrial sector l l Water Management Leakage reduction programs by Municipal bodies Small projects, opportunity for engineering and equipment suppliers l l Agricultural Demand Irrigation projects and driving efficiency of water usage to agricultural consumers. Limited opportunity for EPC players l Source: KPMG Research and Analysis End-Use Industry Specific Issues Structure of the Indian Private Sector Asnapshotofsomecompaniesoperating in the sector along with their area of operations is mentioned below: Source: KPMG Research and Analysis EPC Report New.indd 42EPC Report New.indd 42 2/20/2011 8:13:51 PM2/20/2011 8:13:51 PM

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