Strategy: Beyond EPC contracts

Engineering, procurement and construction contractors have been criticised for compromising innovation and squeezing suppliers on prices while maintaining their own margins. So what are the alternative options?

By Jason Deign in Barcelona

The engineering, procurement and construction (EPC) method of contracting is a mainstay of large-scale projects in the CSP sector. But as reported previously in CSP Today, the approach has come under fire from industry insiders.

Critics complain contractors are not passing on cost savings from their suppliers, leaving less cash in the pot for technical development and innovation.

In addition, since EPC contractors carry the risk for a project, it is argued that they tend to eschew risky innovation, opting instead for tried-and-tested approaches.

While acceptable in mature industries, the approach threatens to undermine development of the nascent CSP sector, where new technologies have the potential to greatly reduce costs and improve performance.

“The EPC approach sets up a conflict of interest and an ‘us’ and ‘them’ relationship between the engineer and the owner,” notes Dr Jeff Claflin, Principal Process Engineer at Lycopodium Minerals, a mining contractor which espouses a different method: EPCM.

He says once the contract is let, the EPC contractor minimises their work and quality in order to maximise their own profits. “If the contract is not comprehensively set up (which is a very expensive exercise), the owner will not get what they want or need, but what the EPC contractor can get away with,” he warns.

More power to the owner

EPCM stands for engineering, procurement and construction management, and effectively means the contractor does not build the facility itself, but acts as an agent of the owner in the design, procurement and management of construction of the project. In this way, the profit margin is fixed and the client has control of what they want done and the amount they pay.

“The emphasis on management is to highlight that the owner is in control,” says Claflin. “The owner’s interests are our interests. There is no conflict. The engineer does most of the work, but the client is completely involved at every step.”

Such attributes might seem to make EPCM highly attractive in safeguarding cost efficiency and innovation in CSP. However, the issue is not as clear-cut as it might at first appear.

To begin with, EPC contractors—as might be expected—strenuously deny the claims that they are working against owners’ best interests.

“You can look at any EPC publicly traded business and it’s not a high-margin business,” says Brad Friesen, Vice President of the Renewables Business Line at Fluor Corporation, which in February was awarded the contract for a 50MW CSP plant for Elecnor in Badajoz, Spain.

“We’re not going to be successful by adding margin to parts of the project where we’re not adding value. We only add margin where we bring value or take on risk.”

Nick Henchie, Construction and Engineering Partner at law firm Mayer Brown adds: “From an owner’s perspective, you have to weigh up that with ECPM comes uncertainty in time and cost. There are no guarantees.”

Less certainty

That might be acceptable to owners, but less so for investors - particularly in the current, risk-averse climate.

 

In fact, Henchie points out, in sectors where ECPM has been around for many years the trend is currently towards EPC-type arrangements because they offer greater certainty.

However, ECPM may not be the only alternative to EPC that is available to owners. Other approaches may offer a greater degree of cost transparency while retaining some level of guarantee over schedules and costs.

One option is to begin with an ECPM contract and convert it to EPC at a given point in the project.

In other words, the contractor and the owner work jointly to begin with. Then, once both parties have a reasonable handle on the project costs and schedule, the contractor offers a fixed price to finish the work on a turnkey basis.

 

If the price proves unpalatable, the EPC side of the work can be tendered. An analogous approach, favoured by a number of large contractors, is to operate EPC contracts on an open-book basis up to an agreed point.

Compromising innovation?

“One of our most successful business models is to use an open estimate book, where we fix the fees up front and show how we build up the estimates,” says Friesen of Fluor. “When the owner is satisfied that we’ve got the most competitive quotes then we close the books.

“The pricing gets more precise the further down the process you go, and that often results in the best possible price.”

Ian Copeland, president of Bechtel Renewable Power, which is building BrightSource’s Ivanpah Solar Electricity Generating System under an EPC arrangement, says his company “has used both models” but adds: “I really can’t think of any area where CM safeguards innovation.

“In Bechtel I am two phone calls away from a world-class expert in anything, and they all work for me.”

In an EPCM arrangement, Copeland suggests, because the main contractor is not fully in control much of this expertise may not be adequately used, to the detriment of a project. And open-book estimates and risk-sharing can be built into EPC to safeguard innovation.

It is also vital, he adds, to make sure that the interests of the owner and the contractor are fully aligned towards a successful outcome—which may ultimately be the best advice, irrespective of the acronym you want to use to describe the contract.

To respond to this article, please write to:

Jason Deign: mail@jasondeign.com

Or write to the editor:

Rikki Stancich: rstancich@gmail.com

 

 

 

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