Improving Contractor (Management) Capabilities to Reduce Project Risks

Improving Contract (Management) Capabilities
to Reduce Project Risks
Matthew Rae
Manager Networks Procurement
Oil & Gas Procurement and Supply
26-27 November 2013

APA Group, November 2013 2
Project Risk - what can go wrong?

Mexican President Felipe Calderon ordered an
investigation into the blast, yet 14 months on
the cause has still not been confirmed.
Contractual issues that arise from such an incident:
Consequential Loss
direct and indirect
Public & Product Liability Insurance claims
Workers Compensation claims
Warranties
Liquidated Damages
Defects Liability

The cause of the incident, a Columbia Gas worker, who
responding to a gas leak, came to the building and began using
a metal probe to make holes, as he tried to measure gas levels.
In the process, the worker punctured a gas line that was
improperly marked. Once the worker realized this, people in
the area were evacuated immediately.
It took Columbia Gas up to thirty minutes to shut off the gas,
but in that time, enough gas had already seeped into the
building, which then led to the explosion.

Agenda
About APA
Overcoming limitations and the need for flexibility
Building risk and reward into contracts
Your legal department and you drafting governance and dispute resolution
Challenging the pricing and terms
Questions

APA asset and investment portfolio

June 2000 June 2013
Infrastructure owner and manager Integrated operating business
Market
capital
$0.49 billion $5.1 billion
S&P/ASX 50
MSCI and FTSE World Indices
Assets
owned /
operated
$1.3 billion $12 billion
7,000 km gas transmission 14,120 km gas transmission
25,000 km gas distribution
Underground and LNG gas storage facilities
430 MW power generation (1)
239 km HV electricity transmission
Transporting 25%
of domestic natural gas
Transporting 50% of domestic natural gas,
70% in east Australia
Employees 6 More than 1,500
Operator External (Agility) Internal
… to Australia’s largest gas infrastructure business
(1) Includes the Diamantina and Leichhardt power stations under development
From IPO in June 2000…

Energy industry is among the most dispute-intensive industries in the world economy
Oil and gas contracts generate a high volume of disputes
Type of dispute and stakeholders involved vary
A contract is an agreement between two parties
The nature of oil and gas contractual disputes
Contract management is aimed
not at finding fault, but rather at
identifying problems and finding solutions together
with all contracting parties involved

In todays market….majority of companies have
standard form contracts
Drafted by the party with superior bargaining
power
Basic PO’s through to complex agreements
Market power may dictate a ‘take them or leave
them approach’
Intention is to improve efficiency
Standard form contracts

There is no one size fits all approach
Companies usually have a standard contractual position
End users should understand the acceptable changes
A starting point for contractual discussions as part of the sourcing process
Flexibility in terms and conditions
The focus when negotiating t’s and c’s should be on
reaching agreement with the other party,
this will require

Under or over specifying requirements
Contractor hitting a third party asset
Late project delivery and impacts
Major gas leak and potential gas outage
Environmental incident
Explosion
Fatality or serious injury
What risk?
Every risk has a “likelihood” and a “consequence”.
The higher likelihood and the worse the consequence, the higher the
risk rating
What is the appropriate allocation of project risks for a contract?

“Carrot and Stick”
Risk and reward can mean different things
Rewarding the contractor for over performing
The reward or carrot
Needs to be commensurate with value and risk
Performance based contracting
Reward types

To incentivise parties to the contract
For the appropriate allocation of risk
Contractors perspective….. more interest in the rewards and less in accepting
risk
To provide a framework for both contracting parties
“Back to back” any risks associated with penalties in third party agreements
with the contractor delivering the works
Why build risk and reward clauses into contracts?
Many contracting parties…..“enter into discussions about risk-reward to
reduce the chances of something going wrong, but get scared off the idea by
a sudden realisation about what might happen if something goes right.”
Source: Edward Height, a director at Source Information Services

Uncommon for standard form contracts to have them
A successful risk-reward mechanism is often based on predefined KPI’s or SLA’s
It’s not all about the bonus for exceeding milestones
Linking risk and reward mechanisms
Liquidated Damages (LD’s)
Consequential Loss & Limited Liability
Transferring too much risk can mean high contingency costs
Representing risk and reward clauses in contracts

Your legal department and you – drafting,
governance and dispute resolution

Engaging with legal from the outset and throughout
Majority of companies have standard form contracts
Talk to your Legal Department re customised or “off the shelf
agreement
Identify clarifications and/or exceptions to T’s and C’s
Post implementation reviews - feedback
Contract selection and drafting
Drafting, governance and dispute resolution

Governance and Dispute Resolution
Most contracts do not deal with the situation in which a dispute arises
Building these clauses in contracts provides a means of resolving commercial
disputes
Care needs to be taken in completing schedules that comprise dispute resolution so
that the provision has the effect intended by the parties.
Dispute resolution clauses should be drafted with clarity, precision and to ensure
they meet the intended purpose.
If contractual disputes do arise, it is important that these are managed in close
liaison with legal counsel to avoid any unnecessary litigation
Poorly drafted dispute resolution clauses may result in delay, expense
and inconvenience
Drafting, governance and dispute resolution
………. the very opposite of the desired result !!

Challenging the pricing decisions and terms

What is the pricing methodology to be used?
– Fixed Lump Sum Price
– Schedule of Rates
– Cost plus
– Management Fee
What are the major price drivers?
– Cost of Labour
– Raw Materials Pricing
– Manufacturing and Tooling Costs
– Freight and Logistic Costs
What is the rise and fall mechanism?
– CPI movements
– FOREX Movements
– Commodity price movements
Types of pricing decisions?
How can we challenge the contractor’s
pricing decisions?………………..in a word:
“transparency”

Understanding what makes up the cost of a finished product
Numerous sources of market indicators
Exploring rates for materials
Price of iron ore, directly
impacts the price of ERW
and Seamless Line Pipe
Oil is major component in
the production Pipe and
Fittings
The major raw material
input to meter set pipe
work, valves and fittings
Exchange rate also has an
impact on the imported
content component of
materials

An example of a typical Schedule of Rates
Exploring rates for labour
Item Trade UOM Normal Time Penalty Rate
1 Trade Assistant $/Hour $53.40 $72.00
2 Crew Hourly Rate $/Hour $1,306.00 $1,633.00
3 Team Leader $/Hour $80.00 $100.00
4
Field Operative /
Labourer
$/Hour $60.00 $75.00
5 Plant Operator $/Hour $65.00 $82.00
6 Welder $/Hour $160.00 $200.00
7 Gasfitter $/Hour $120.00 $150.00

Labour rates driven by Enterprise Bargaining Agreement (EBA’s)
EBA’s can be both union and non-unionised
Unionised EBA’s are available in the public domain, which allows us to see the
labour breakdown
Exploring rates for labour – rate buildups
Amount UOM Hrly Rate
Base Rate $30.00
Superannuation 9.50 % $0.38
Workers Compensation 4.00 % $0.16
Overtime Meal Allowance 20.00 $ $2.63
Travel Allowance $0.75 $/km $9.87
Leave Loading 17.50 % $0.69
Living Away from Home (Distant Work) $62.70 $/day $8.25
First Aid Allowance (min qualification) $2.61 $/day $0.34
Overhead 7.50 % $0.30
Profit 20.00 % $0.79
Income Tax 15.00 % $0.59
Actual Rate $53.40
Trade Assistant $53.40 per hour
Statutory
Requirements
Meal allowance
payable when required
to work Overtime, e.g.
by more than 1.5hrs
Annual leave payment
paid with Leave loading
of 17.5%
A payment made to a
worker where an
employment event
requires them to use
accommodation other
than their normal
place of residence
Statutory
Requirements
Understand labour cost……for cost avoidance and
to avoid double dipping !!Challenging the pricing decisions and terms

Total Cost of Ownership (TCO) of the life of an asset
Include: planning, design, construction and acquisition, maintenance, renewal,
depreciation and cost of finance
TCO expands the narrow confines of price to a vast field of opportunities
Price is not only different from cost, in fact it is merely one element of cost
Through life support/TCO
Anyone can get a lower price.
The object of good business is to
attain the lowest TCO.

Procurement set the pricing structure
Dependent on the type of good or service
Rates x Hours = Happiness
Lump Sum Contracts = high mark-up/contingency for allocation of risk
Understanding the impact on cost a change in on one or more components has
on total cost
Using mutually agreed rise and fall mechanisms
Challenging the contractor’s pricing/costing decisions

Be clear on the outcome you are driving to achieve
Focus should be on reaching agreement with the other party - stay
flexible
Own and understand your contract
Spend your companies money as if it were your own….seek
transparency, ask questions
Avoid Mexico….its far too dangerous there !!!
Some key takeaways…

Questions

For further information contact
Matthew Rae
Manager Networks Procurement, APA Group
Tel: +61 8 8113 9029
E-mail: matthew.rae@apa.com.au
or visit APA’s website
www.apa.com.au
Delivering Australia’s Energy

Improving Contractor (Management) Capabilities to Reduce Project Risks

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