CEW Features
Recent Trends in EPC Project Contracting Models
When it comes to project design or construction, chemical industry
owners now prefer to make it simpler for themselves by handing
over such a huge responsibility to Engineering Procurement and
Construction (EPC) players. Swarup Mukherjee, President (Projects),
Walchandnagar Industries Ltd, discusses various types of EPC project
models implemented in recent times by EPC players and various risk
factors associated with them.
he genesis of Engineering
Procurement and Construction
(EPC) contract as a primary
form of project execution was
initiated by the project financiers for the
risk management considerations for the
project. Ever since infrastructure projects
funded by the World Bank & Other
multilateral agencies gained momentum in
India, the concept of Lump Sum Turn Key
(LSTK) contract has taken root as the best
possible or optimum solution for ensuring
achievement of project deliverables without
loss of focus and dependencies on external
elements like designers/consultants etc.,
who do not have a financial stake in the
project. This model ensured that the entire
fund is spent through its single agency that
is responsible for the ultimate outcome or
project deliverables and is also accountable
for any failures/delays.
Initially, there were few contractors (with
adequate financial and technological
muscle) who could take the overall
responsibility of large projects. Hence,
large projects used to be divided into
smaller EPC packages with a specific
focus on the area of execution (e.g., for
a power plant, separate packages like
gas pipeline, coal transport arrangement,
power house, balance of plants were used
to be the norm). Slowly with the passage
of time, the contractors became financially
54 January 2012
and technically competent. They gradually
expanded their presence across multiple
packages and the whole work started
being awarded as a single LSTK contract.
EPCM
In some such cases, concept of EPC
Management (EPCM) contracts emerged
wherein one single company having the
knowledge of integration requirement
of the entire project, takes the charge
for the complete execution and offers
separate EPC projects in package basis
to different EPC contractors. In such
cases, EPCM contractors take the onus
of the projects integration and have an
overall management control of the project;
though directly not responsible for the
project cost and schedule, which remains
with the project proponent. This method
had proven successful in various areas of
refinery, metallurgical and petrochemical
projects where it calls for high degree
of engineering coordination and single
vendors with complete capabilities are
normally not available.
In any case, the entire issues of
land acquisition, Rehabilitation And
Resettlement (R&R), Operations And
Maintenance (O&M) and sale of the goods
after project completion remain with the
project proponent. Accordingly, all issues
of statutory clearances, handling of all
Initially, there were few contractors
(with adequate financial and
technological muscle) who could
take the overall responsibility
of large projects. Slowly, the
contractors became financially
and technically competent.
local issues, as well as sensitivities for
various fluctuations in the sales proceeds,
continue to remain with the project
proponents management and their
effectiveness to ensure proper return on
the investments made.
EPC Project Models
Seeing this gap in ensuring proper returns
on investment, the concepts of Built,
Operate and Transfer (BOT), Built, Own,
Operate (BOO) and Built Own, Operate
and Transfer (BOOT) projects emerged
in early 1990s. This model became
particularly popular in the infrastructure
sectors like road, airport, etc. In the
BOOT projects, the EPC contractors not
only take up and complete the projects
but also earn revenue from the project
by operating the same for a specified
period of time and then handover to the
government or other project end owners.
One of the most successful models of such
type was the construction and operation of
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Mumbai-Pune expressway. Subsequently,
other major showpiece airport projects
like Delhi airport, Bengaluru airport,
Hyderabad airport, etc. were also handled
in the same manner.
The returns of such cases are always
back-ended but are a boon to the financiers
of the project, as the entire risk of returns
is covered by the single entity. But the
financiers need to have a proper evaluation
in such project before committing
themselves. Normally, project proponents
prefer to go for SPV route or float separate
company to control the risks of such large
size BOT/BOO/BOOT projects.
EPC contracting (EPC/LSTK project or
other infra projects on BOT/BOO/BOOT
basis) could not be contemplated in high
technology areas like nuclear power
plants where competencies were in short
supply as well as engineering risks were
severe. All the nuclear power projects are
practically operating under package wise
Procurement And Construction (P&C)
contracts with engineering remaining with
the project proponent.
This particular sphere of EPC contracts
in nuclear power plant is proving a major
concern in view of the Nuclear Liability Act
to all the contracting companies. This area
will see either substantial lack of interest
amongst the EPC players in future or
may even lead to further amendment of
regulatory framework.
While all these models of EPC/LSTK/BOT/
BOOT contracting methods had proven
to be a boon to the risk management
requirements at the project feasibility and
funding stage, they have impacted the
bottom line of the contracting companies
due to the inherent risk element, which
cannot be properly quantified at the
initial stage.
This matter of risk perception is shown
clearly in dismal valuation of the infra
companies across market cap levels in
the stock market. Though infrastructure
remained the key word for the Indias
growth story, the price to earnings ratio
(PE) enjoyed by these companies hovers
at the lowermost rungs in the stock
markets. All such EPC project companies,
who venture into the high value EPC
projects with very back-ended return
scenario, remain exposed to high debt
burden as well as uncertainties of the
overall economic scenario.
Risks in EPC Contract
While EPC contract was primarily
mooted for transfer of risk of investment
in a project, the contracting companies
have assumed the risk (knowingly/
unknowingly) in their balance sheets.
These risks become further complicated
when EPC companies work in foreign
countries. More and more infrastructure
projects are being taken up in the
African continent and in the Gulf
countries through EPC route. All these
projects, though come with higher
perceived margins, they inherently
carry the issues of legal risk, country
risk, currency risk, war risks, etc.
Many of these risks are generally not
covered by the EPC contracting
companies adequately.
The financiers have a role to play in
this risk mitigation process whenever
the route of EPC contracting is mooted.
The insurance scenario is also evolving
rapidly to cover these risks over the
years. While loss of profit policy and
terrorism risk cover is available at various
forms, issues like war risk is traditionally
never covered by the insurance agencies.
Insurance companies and reinsures are
more and more resorting to fine prints
in the insurance clause to insulate from
the various eventualities for which the
insurance is primarily meant.
Conclusion
As more and more project proponents
prefer the EPC route, in order to keep
their resources limited and focused to
their core competence, many construction
companies have jumped into the EPC
bandwagon to ensure growth. Many such
companies do not have full capability or
even knowledge of the entire gamut of
EPC works.
In many occasions, quite a few companies
fail to properly recognise the need of
proper risk management at right time,
which leads them into a very soft corner.
Such difficult occasions and realisations
among the EPC contracting companies
are likely to lead to consolidation among
the EPC players in years to come.
Email: smukherjee@[Link]
56 January 2012
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