EPC/ Turnkey Contracts in Highway Sector
Dr. Indrasen Singh, Dean, National Institute of Construction Management and Research, Goa
The EPC way of executing a project is gaining importance worldwide. But it is also a way that needs good understanding by the EPCC, for a profitable contract execution. In an EPC contract, coordination with various agencies is a demanding task, especially in item rate contracts. Often it happened that agencies try to put the reasons of delays etc. on others. The coordination is more difficult during commissioning and post commissioning times, because each agency tries to correlate its own performance with the others. It is very likely that, in an EPC contract the communication channels get overlapped, short circuted and confused. The EPCC is the prime functionary and so there has to be conscious effort for clear messages. Proponents of the PPP philosophy maintain that India’s infrastructure development hinges on private participation. The EPC route should be resorted to only when PPP is not feasible. Relegating national highway development to the EPC mode would be a retrograde step in India’s infrastructure development story, however compelling the case of EPC winning over PPP appears in the current economic conditions.
However, because of their flexibility, the value and the certainty, sponsors and lenders derive from EPC contracts, the author believe EPC contracts will continue to be the predominant form of construction contract and will be used on large scale infrastructure projects in most jurisdiction.
EPC contracts vary on the basis of the assignment of responsibility and related penalties.
Despite the general sluggishness that NHDP has been witnessing due to a variety of reasons like procedural delays and tardiness in land acquisition, private entrepreneurship is still forthcoming. However, matters are now getting a bit gloomy, thanks to the global slowdown whose potentially-threatening vibrations are now seen appearing on the Indian investment landscape. Private developers are getting increasingly circumspect of PPP projects, and national highways projects are not exception. Raising financial resources and managing business risks are both proving difficult.
It is estimated that as many as 60 national projects, involving can investment of around Rs, 50,000 crore, are not finding takers. Given that private antipathy to road projects persists in the medium term, India’s national highway development is most certainly headed for delay, something that the nation can ill-afford. It has been beautifully said about India: “We have to keep running fast just to be at the same place!” Any slowdown therefore implies that India’s movement can only be in one direction-backwards.
Take the case of NHDP-Phase V, perhaps the most lucrative project for both NHAI and private developers alike. The Rs. 42,410 crore project involves six laning or around 6,500km of four-lane highways. Out of the total length, 5,700 km (around 88%) would be stretches of the Golden Quadrilateral (NHDP-Phase I), which represent the country’s busiest national highways. For NHDP–V, NHAI had in place a new model concession agreement where the nodal agency has a share in toll collections (as opposed to an upfront fee known as negative grant) making it more lucrative for the government. Being the most profitable portfolio of national highways. NHDP-V started off triumphantly, eliciting tremendous response from Indian companies and even foreign developers.
Now, it s a disturbing contrast. Several developers with whom Project monitor interacted have said that financial closures are being delayed due to the liquidity crisis. Bank cannot “refuse” assistance as the projects are perfectly bankable but their hands are tied by the liquidity constraints. In some cases, projects are being restructured so as to reduce the debt component-typically from an 80:20 debt-equity ratios to 70:30. In this debilitating situation, a proposition of whether the EPC route would be a better alternative to PPP gains credibility. Although the Centre has briskly launched measures to improve liquidity-and it has indeed improved-the fear psychosis of the “slowdown” does not inspire confidence in developers to contend with business risk of national highway projects. Several developers, it is reliably learnt, have felt that the government should share the project risk, implying that the PP philosophy relegates to the EPC route.
One helpful step that the Centre is contemplating is the reduction of interest rates for road projects. This, if implemented, can inject confidence in private developers and increase their preparedness to embrace business risks and further the PPP culture. Another move that the Centre recently adopted is to allow private developers to annually raise toll fees for national highway projects. Hopefully, these measures along with an improvement in business confidence in the near future will result in a revival of entrepreneurship in national highway projects.
Proponents of PPP philosophy maintain that India’s infrastructure development hinges on private participation. The EPC route should be resorted to only when PPP is not feasible. Relegating national highway development to the EPC mode would be a retrograde step in India’s infrastructure story, however compelling the case of EPC winning over PPP appears in the current economic conditions.
Contracts as such can be classified into the followings:-
EPC, Lump Sum Turnkey, Engineered Packaged Route, Item Rate Contract etc.
The most modern variation is called EPCM that is engineering, procurement construction and management. On a global level, construction industry has completely adopted the EPC contracts and the EPC contractors have limited the otherwise predominant role of engineering consultants. These EPC firms are ready to take the risks associated with managing a project and posses procurement and project.
An engineering consultant is unable to sustain, reinforce and nourish such skills in his organization. Competitive forces are driving consolidation of construction in the EPC industry and leading to alliances among the large players.
In an EPC contract, the payments may even be made in a phased manner as per agreement between the parties, based on pre decided milestones, in short, other money finances a general construction where as an EPC project is financed by the contractor’s own funds or what he will raise upfront based on the contractor’s core competence and financial strength. Construction is a self-financed business with advances secured under various heads before the start of construction and during the course of project execution. An initial seed or venture capital along with bridge fiancé would be enough to keep it going. Construction business is an activity with low capital base and large volumes with low margins.
For an organization to survive in future, it would have to possess capability to mobilize/commit huge equipment resource at short notice. It must also have core competence and expertise to implement mega-multi disciplinary projects from start to finish/commission without any time or cost overruns. Leveraging the opportunities opening up in the construction industry would require crisis management skills and a readiness and ability to face eventualities as they unfold themselves. Hence, it is evident that the future is going to be in the value added sector of EPC business.
Based on these linkages constituents, various project delivery mechanisms have been devised. The size and nature of the project also influences the choice of the project delivery mechanism. The different types of contracts are as given here:
At the initial stage a strategic review is carried out of the works to be carried out. This is followed by the “offer kick off, which is in the form of proposals submitted by the EPC contractor, defining how and at what price the project should be undertaken. After the contract agreement is review is conducted to ascertain whether the engineering by the contractors conforms to the contractual obligation.
In this section, a short-key description of various phases in the execution of the EPC turnkey project is been discussed.
It is essential, therefore, that the contractor is clear about precisely where he takes over and what the Employer and his consultant have already done, i.e. what exactly are the Employers’ Requirements and what are the contractor’s obligations.
At the time of the bid submission contractors’ proposals will indicate how the employer’s proposal is to be achieved. So in accepting a contractor’s bid based on an incomplete design the intention is that the Employer accepts statements of intent about the residual or outstanding parts of the design upon which a “fixed and firm contract sum” is based. This fact is rendered all the more important when it is considered that at Contract execution stage whilst the design is still not fixed, the Contract Price certainly is. Once the Contract has been entered into, the contractor takes upon himself the responsibility for satisfying the Employers’ Requirements by, first of all. Verifying the incomplete Bid Package or basic design, and by expanding the same into a full and complete “description” of the required project in the form of residual and detailed design. Engineering, drawings, diagrams, specifications, purchase orders and other matters specified in the Contract documents.
Procurement becomes important because it is here that project management can be most effective in cutting time without compromising quality. For this, either the EPC contractor puts together a separate team or hires a project management.
Given below is an attempt to express the above phases is a simplified & figurative manner.
From here on, we will move on to some points very specific to EPC i.e. the sensitive issue of the completion of designs by the contractor from the point where they were handed over to him.
In any real EPC project, it is contended that whilst contractor’s proposals are to be a reasonable extension of the Employer’s Requirements, they ought, within the limits, to be able to be modified as to their detail in the design development. If, for example, the Employer’s consultant or, perhaps, a process licensor has closely determined a basic design, it will mean that certain constraints of payout, sizes, arrangements, etc. will have been given but the contractor should be left to interpret them so as to be able to evolve and develop the same to meet the Employer’s Requirements.
This will be all the more important if the Employer’s Requirements encompass many interconnecting parts of the project at varying stages of design, since it will not always be possible to freeze matters which may be subject to later modification depending upon what is finally agreed in other parts.
Consequently, as the design is incomplete and possibly fragmented at the outset then the contractor, unless clear mandatory stipulations are imposed, must be allowed some measure of discretion within whatever was actually agreed as to what he is to provide with regard to the detailed design.
This is, therefore, the contractor’s freedom to develop the optimum response whilst at the same time meeting the Employer’s Requirements, the whole exercise being a question of interpretation of what actually meets the Employer’s Requirements as the design is being developed. Unfortunately, many Employers and their consultants do not undertaid that the contractor cannot allow for drastic design revision major technical development, or more often than not personal evolve during the currency of the project and therein lies a obtaining Employer “approvals” following on form a highly subjective interpretation of the employers requirements. The period for development of the detailed design should, therefore, simply be used by the Employers and his consultant to ensure that the contractor in developing the design is not deviating too far from the requirements or that he is not lowering standards. This situation, in view of the problems of interpretation referred to above, obviously calls for a more detached attitude from both the Employer and his consultant with both of them stimulating ideas rather than just turning down what is simply not liked, albeit that it satisfies the Employer’s Requirements when considered from an objective point of view.
Neither the Employer more his consultants is responsible for checking that the contractor’s design is correct or even adequate but only that it conforms to the Employer’s Requirements set down in the Contract and as required by the Employer under the contracting scheme, being solely responsible for the design and its workability. The Employers and his consultant, on issues of design interpretation, must, therefore, stick to the framework of the Employer’s Requirements and the contractor’s proposals for the same, so that only departures from the framework can be disputed and not developments within it. Unless, of course, the Employer is prepared to pay for such changes. To ensure that the above is fulfilled the Employer and his consultant ought, of course, to have provided the contractor with all the information in their possession and which was used to prepare the Bid Package or basis design.
There are references in the majority of EPC Turnkey contracts whereby any information given by the Employer is for guidance only and that any comment or advice from the Employer on the contractor’s designs will not relieve the contractor of his responsibility for bringing the project to successful completion in accordance with such design. Therefore, the Employer or his consultant should be “reviewing and not approving”’ approval in the strict sense of the word being, inconsistent with any denial of responsibility, and merely noting the contractor’s proposals as apparently satisfying the Employer’s Requirements expressed in the Bid Package or basic design, by now incorporated in to the Contract.
Moreover, even where the Employer does have the light contractually to instruct design changes, it is contended that neither the Employer, nor his consultant, has power directly to introduce design of his own into the project design. The contractor in an EPC Turnkey scheme carries more than his fair share of commercial risks and should not have to bear Employer/consultant interference. In building up his bid price the contractor has, in the face of the incompleteness of the design, already had to cover all quantitative uncertainties as adequately as possible whilst trying to achieve an optimum economic result for both himself and the Employer.
Early decision, whilst they may seem logical, might, in the face of an overall review, be later seen to be leading to illogical or at least suboptimal results. Thus, any attempt on the part of the Employer or his consultant finalize or freeze a part of design without due consideration of this Employer created problem, will clearly lead to disruption and delay at some stage or other in the overall review.
Moreover, as the parties become concerned successively with more detailed matters the slightest delay in settling early problems can only lead to delays on the whore design and consequently the engineering procurement, fabrication and erection.
The fact that the design was not completed pre-contract means it overlaps with construction - this non-completion will impede both off-site and onsite progress if it is not allowed to proceed timely and efficiently.
The contractor is under a program obligation by the time schedule and the Employer, having the undertaken to respect the same, must simply within the limits of his obligations in a timely manner and abstain from interfering in the design process. Thus, if the Employer does make comments in accordance with rights under the contract then the contractor has to consider, depending upon the stage reached and if the proposals meet the Employer’s requirements, whether to take the same into consideration, it being remembered that the contractor is developing the design from the Bid package and basic design documents incorporated into the Contract without adjustment of the price but with absolute responsibility for results. In entering into EPC Turnkey contracts, scheduled for completion within restricted time and with a fixed price. Employers must afford the fullest cooperation and assistance to contractors by
The National Highway Development Programme, for which National Highways Authority of India is the nodal agency, is perhaps the biggest episode of India’s infrastructure development story. It is estimated that by 2012, an investment of Rs 2,20,000 crores would be required to upgrade India’s national highway network covering nearly 66,000 km. what is most encouraging is that what started off as a ministerial project, financed by the government and implemented through cash contracts, is now moving to be an inspiring example of the public-private partnership philosophy. While the first two phases of NHDP were largely implemented as EPC contracts, the subsequent phases have been envisaged to come up on BOT basis. This is the biggest salute to Indian entrepreneurship-contractors turning into entrepreneurs that not only construct the project but also raise finances and share the business risks.
For such projects, it is necessary for the Contractor to assume responsibility for a wider range of risks than under the traditional Red and Yellow Books (FIDIC). If the Contractor is to carry such risk, the Employer must also realize that asking responsible contractors to price such risk will increase the construction cost.
After studying the various aspects in detail, the following conclusions were drawn from the study:
Introduction
Engineering procurement and construction (EPC) contracts are the most common form of contracts used to undertake construction works by the private sector on large scale and complex infrastructure projects, such as power plants, petroleum and LNG terminals, steel mills, Roads etc. Under an EPC contract a contractor is oblised to deliver a complete facility to a developer who need only turnkey to start operating the facility, hence EPC contracts are sometimes called turnkey construction in contracts. In addition to delivering a complete facility, the contractor must deliver that facility for a guaranteed price by a guaranteed date and it must perform to the specified level. Failure to comply with any requirements will usually result in the contractor incurring monetary liabilities. A number of contractors have suffered heavy losses and, as a result, a number of contractors now refuse to enter into EPC contracts in certain jurisdictions. A substantial lighting in the insurance market has exacerbated this problem. Construction insurance has become more expensive due to significant losses suffered on many projects and the impact on the insurance market.However, because of their flexibility, the value and the certainty, sponsors and lenders derive from EPC contracts, the author believe EPC contracts will continue to be the predominant form of construction contract and will be used on large scale infrastructure projects in most jurisdiction.
EPC contracts vary on the basis of the assignment of responsibility and related penalties.
Importance of the Study
The EPC project requires complex design and engineering works, procurement of specified equipment and machineries and a single entity for contract execution. For the development of any project, it is necessary to identify the suitable design source and how it is suitable in contracting scheme. Especially all the three elements cost, time and quality is to be strictly maintained. This study will help to expand the knowledge in contract management in EPC/Turnkey packages advances secure under various heads before the start of construction and during the course of project execution.EPC in National Highways
The National Highway Development Programme, for which National Highways Authority of India is the nodal agency, is perhaps the biggest episode of India’s infrastructure development story. It is estimated that upto 2012, an investment of Rs. 2,20,000 crore would be required to upgrade India’s national highway network covering nearly 66,000 km. what is most encouraging is that what started off as a ministerial project, financed by the government and implemented through cash contacts, is now moving to be an inspiring example of the public-private partnership philosophy. While the first two phases of NHDP were largely to come up in BoT basis. This is the biggest salute to Indian entrepreneurship-contractors turning into entrepreneurs that not only construct the project but also raise finances and share the business risks.Despite the general sluggishness that NHDP has been witnessing due to a variety of reasons like procedural delays and tardiness in land acquisition, private entrepreneurship is still forthcoming. However, matters are now getting a bit gloomy, thanks to the global slowdown whose potentially-threatening vibrations are now seen appearing on the Indian investment landscape. Private developers are getting increasingly circumspect of PPP projects, and national highways projects are not exception. Raising financial resources and managing business risks are both proving difficult.
It is estimated that as many as 60 national projects, involving can investment of around Rs, 50,000 crore, are not finding takers. Given that private antipathy to road projects persists in the medium term, India’s national highway development is most certainly headed for delay, something that the nation can ill-afford. It has been beautifully said about India: “We have to keep running fast just to be at the same place!” Any slowdown therefore implies that India’s movement can only be in one direction-backwards.
Take the case of NHDP-Phase V, perhaps the most lucrative project for both NHAI and private developers alike. The Rs. 42,410 crore project involves six laning or around 6,500km of four-lane highways. Out of the total length, 5,700 km (around 88%) would be stretches of the Golden Quadrilateral (NHDP-Phase I), which represent the country’s busiest national highways. For NHDP–V, NHAI had in place a new model concession agreement where the nodal agency has a share in toll collections (as opposed to an upfront fee known as negative grant) making it more lucrative for the government. Being the most profitable portfolio of national highways. NHDP-V started off triumphantly, eliciting tremendous response from Indian companies and even foreign developers.
Now, it s a disturbing contrast. Several developers with whom Project monitor interacted have said that financial closures are being delayed due to the liquidity crisis. Bank cannot “refuse” assistance as the projects are perfectly bankable but their hands are tied by the liquidity constraints. In some cases, projects are being restructured so as to reduce the debt component-typically from an 80:20 debt-equity ratios to 70:30. In this debilitating situation, a proposition of whether the EPC route would be a better alternative to PPP gains credibility. Although the Centre has briskly launched measures to improve liquidity-and it has indeed improved-the fear psychosis of the “slowdown” does not inspire confidence in developers to contend with business risk of national highway projects. Several developers, it is reliably learnt, have felt that the government should share the project risk, implying that the PP philosophy relegates to the EPC route.
One helpful step that the Centre is contemplating is the reduction of interest rates for road projects. This, if implemented, can inject confidence in private developers and increase their preparedness to embrace business risks and further the PPP culture. Another move that the Centre recently adopted is to allow private developers to annually raise toll fees for national highway projects. Hopefully, these measures along with an improvement in business confidence in the near future will result in a revival of entrepreneurship in national highway projects.
Proponents of PPP philosophy maintain that India’s infrastructure development hinges on private participation. The EPC route should be resorted to only when PPP is not feasible. Relegating national highway development to the EPC mode would be a retrograde step in India’s infrastructure story, however compelling the case of EPC winning over PPP appears in the current economic conditions.
From Construction Contracts to EPC–WHY
In recent years, the construction industry is making a very vital and visible shift from “owner managed construction projects” to EPC projects with independent but coordination disciplines of construction. The EPC contractor takes the responsibility of completing the project at a given cost and time frame and acts as a single point of interface between the promoter and all other agencies connected with the project. EPC contracts vary on the basis of the assignment of responsibility and related penalties.Contracts as such can be classified into the followings:-
EPC, Lump Sum Turnkey, Engineered Packaged Route, Item Rate Contract etc.
The most modern variation is called EPCM that is engineering, procurement construction and management. On a global level, construction industry has completely adopted the EPC contracts and the EPC contractors have limited the otherwise predominant role of engineering consultants. These EPC firms are ready to take the risks associated with managing a project and posses procurement and project.
An engineering consultant is unable to sustain, reinforce and nourish such skills in his organization. Competitive forces are driving consolidation of construction in the EPC industry and leading to alliances among the large players.
Construction and EPC
Construction is a business sustained by money advanced by clients and progress payments made during the course of the project. Compared to this system, EPC is governed by project finance, deferred payments and equity stakes, organized up front by the contractor until the completion of the work and commissioning to the satisfaction of the client.In an EPC contract, the payments may even be made in a phased manner as per agreement between the parties, based on pre decided milestones, in short, other money finances a general construction where as an EPC project is financed by the contractor’s own funds or what he will raise upfront based on the contractor’s core competence and financial strength. Construction is a self-financed business with advances secured under various heads before the start of construction and during the course of project execution. An initial seed or venture capital along with bridge fiancé would be enough to keep it going. Construction business is an activity with low capital base and large volumes with low margins.
For an organization to survive in future, it would have to possess capability to mobilize/commit huge equipment resource at short notice. It must also have core competence and expertise to implement mega-multi disciplinary projects from start to finish/commission without any time or cost overruns. Leveraging the opportunities opening up in the construction industry would require crisis management skills and a readiness and ability to face eventualities as they unfold themselves. Hence, it is evident that the future is going to be in the value added sector of EPC business.
Types of EPC Contracts
EPC contracts may vary in the basis of assignment of responsibility and related penalties. The relationship between different constituents of the industry is very flexible as shown in the diagram below.Based on these linkages constituents, various project delivery mechanisms have been devised. The size and nature of the project also influences the choice of the project delivery mechanism. The different types of contracts are as given here:
- Engineering, Procurement and Construction (EPC)
- Complete single point responsibility
- Fixed time fixed price contracts, heavy penalties for non-performance
- Escalation possible by mutual consent
- Most popular for power projects in the range of USD 0.5 to 1bn
- Lump-sum Turnkey (LSTK)
- EPC with no scope
- Preferred for power and industrial with projects in the range of USD 0.5-1bn.
- Engineering Procurement Construction Management (EPCM)
- Responsibility for placement of order for equipment and payment lies with the promoters.
- Fixed time–fixed price contracts
- Lower penalties relative to EPC for non-performance
- Preferred for very large projects (>USD 1 bn) in sectors such as petrochemicals, oil and gas and steel
- Turnkey
- Responsibility to implement complete project
- Fixed price as well as cost plus contracts are possible
- Contractor need not have financial capability
- Preferred for medium and small projects (USD 0.5 bn)
- Engineered Packages Route
- Promoter breaks up the project into packages
- Turnkey supply of packages
- Promoter is responsible for project co-ordination
- Item Rate Contract
This is the most prevalent contractual mechanism in which:-- The owner through an appointed consultancy organization does the Engineering.
- Bill of qualities is furnished and tenderer is required to quote the price item-Wise.
- The contractor need not have large financial capability in this case.
Project Management Scope
All over the world, there are contractor’s expert in all types of engineering and construction works and Employers should seek to profit from a potentially important contribution in both expertise and experience regarding design from such contractors with a view to promoting both the speed and economics of their own projects. By doing so not only the cost and time factor are controlled but some other factors are also positively, like:- Employers can and do confidently rely upon contractors’ skills, not only for construction but also for design. This input of expertise and experience is a major advantage to Employers and can allow the chosen contractors influence the practicalities of projects from early stage.
- Contractors can also help to highlight potential problems associated with the design obligations, the responsibility for which such contractors will ultimately bear on EPC Turnkey projects. Furthermore, contractors’ input into EPC turnkey systems means a single team both to design and to construct projects bringing normally distinct specialists into a cooperative relationship, it being the intention of all concerned that design integrated with and overlapping construction should lead to cheaper and speedier implementation.
- The owner has to interface with the EPC contractor only throughout project implementation period and even after completion during defects liability period, thus providing the owner with a Single Point Responsibility.
- The EPC contractor is responsible for executing the project within the committed cost. Thus minimizing the owner’s exposure to variation. This also guards the owner against foreign exchange variations and interest rate fluctuations.
- Since the delivery schedule for completing the project is fixed for an EPC project by the EPC contractor, it reduces the chance of any time over run. A big advantage of EPC projects is that, the procurement and the engineering activities can take place simultaneously resulting in the reduction of overall delivery schedule.
- The EPC contractor provides comprehensive guarantees to the owner, which includes mechanical warranties, quality of workmanship and process guarantees capacities and capabilities, cost effective productivity in some cases.
- In some projects, the EPC contractor also takes a stake in the equity of the project to ensure commitment as well as to reinforce a confidence for the investors and financial institutions, which take positions in the equity and debt of the venture. Some financiers and owners make equity stakes compulsory for the prequalification in BOT as well as mega EPC projects in India and abroad
EPC Construction Risk Management
Often EPC construction contemplates a turnkey approach to project delivery. In other words, the project owner or employer will look to the EPC contractor as the single point of contact for all facets of the project, from basic design through commissioning and start-up of the facility. EPC projects offer a mutually beneficial and exciting form of project delivery for both the owner and the contractor. But, with the EPC contract come many new risks that are often severe due to the complex nature and high cost frequently associated with this type of project. Understanding these risks and some of the other unique characteristics of EPC contracting its critical to a successful project where both the owner and the contractor obtain the high rewards for the risk. Project owners have attempted to shift more risk to the contractor, understanding at least theoretically, that this risk allocation carries a higher price tag some important features that differentiate risk in an EPC contract as compared to a regular contracts can be seen below.- Risks traditionally assumed by the owner in design-bid-build and design build contracts may no longer fall under the owner’s umbrella of responsibility. For example, the contractor may be required to assume the risk of unforeseen site conditions and may be responsible for events that would traditionally be viewed as force majeure (i.e. beyond the control of either party).
- The greatest risk for the contractor in entering into the EPC contract is not necessarily anything inherent in the EPC form of contracting. Instead, the problems most frequently arise when the contractor commits to a lump sum or fixed price.
At the initial stage a strategic review is carried out of the works to be carried out. This is followed by the “offer kick off, which is in the form of proposals submitted by the EPC contractor, defining how and at what price the project should be undertaken. After the contract agreement is review is conducted to ascertain whether the engineering by the contractors conforms to the contractual obligation.
In this section, a short-key description of various phases in the execution of the EPC turnkey project is been discussed.
Development Phase
The development phase is the first stage of the EPC project process and covers the important aspects of engineering. This can be viewed as an extension of the planning process. The engineering process produces a range of deliverables, which includes- Feasibility Study
- Estimates
- Designs
- Drawings
- Specifications
- Data sheets
Tests Results
Having made a decision to execute the process on EPC turnkey basis, the employer appoints a consultant and states his requirements in the form of a design brief. The consultant then expands the design brief into a more explicit employer’s requirements,” taking into account the project development phase during which the design responsibility is handed over to the contractor.Financing Stage
The employer has to achieve financial closure, which involves the promoters brining in their own funding in the shape of equity as well as organizing loans. This should ideally precede or proceed with parallel with the EPC negotiation process.Bidding Award of Contract
Having made a decision to benefit from a contractor’s expertise and experience by selecting the EPC Turnkey approach the Employer, usually in collaboration with his chosen consultant, will, first of all, express his requirements in the form of a design brief. The consultant, normally employed to oversee the project, advises the Employer from the conceptual stage of the project and is then involved in expanding the brief in to the more explicit “Employer’s Requirements”’ taking into consideration, up to what stage it has been decided that the design responsibility should be taken over by the successful contractor. The consultant, with or without the aid of the Employer, will then incorporate the Employer’s Requirements into bid documents for presentation to various prequalified bidders before finally being involved in the technical and financial assessment of the successful contractor’s bid in response to the same. It can be seen, therefore, in reality that in EPC Turnkey projects contractors may have to assume responsibility for completing and/or developing an incomplete design at any time from briefing onwards.Negotiating Stage
The consultant incorporates the employer’s requirements into the bid documents and brings out a notice for prequalification. This is done so that only established parties are short listed as bidders. Thereafter, a notice inviting tenders (NIT) is issued by the consultant on the employers’ behalf. The short listed contractors are then required to submit a two part proposal. The technical part contains details of all deliverables and processes. Those technical bids that are found satisfactory are put through the commercial bidding process. The price of the bids finally determine the contract award.Contract Agreement
After the contract has been awarded, the two parties, that is, the contractor and the employer, sign the contract agreement. The contract includes the following aspects to be covered.- The time and the mode of payment of the works
- It also consists of the warranty terms and tenure in addition to the damages that would be payable if the contractor deviates from the contract in terms of specified design or commissioning schedule etc.
- The contract also covers the interest payable to the turnkey contractor in case the employer is not able to release funds in time.
Intricacies Involving Handing Over Incomplete Design
However, as normally happens in major engineering contracts, by bid stage the Employer’s consultant will have already prepared at least part of the design and when the transition of responsibility for design to the contractor occurs, all the interconnected parts of the project might not necessarily be at the same stage.It is essential, therefore, that the contractor is clear about precisely where he takes over and what the Employer and his consultant have already done, i.e. what exactly are the Employers’ Requirements and what are the contractor’s obligations.
At the time of the bid submission contractors’ proposals will indicate how the employer’s proposal is to be achieved. So in accepting a contractor’s bid based on an incomplete design the intention is that the Employer accepts statements of intent about the residual or outstanding parts of the design upon which a “fixed and firm contract sum” is based. This fact is rendered all the more important when it is considered that at Contract execution stage whilst the design is still not fixed, the Contract Price certainly is. Once the Contract has been entered into, the contractor takes upon himself the responsibility for satisfying the Employers’ Requirements by, first of all. Verifying the incomplete Bid Package or basic design, and by expanding the same into a full and complete “description” of the required project in the form of residual and detailed design. Engineering, drawings, diagrams, specifications, purchase orders and other matters specified in the Contract documents.
Design and Manufacture of Equipment
This is a vital aspect especially in case of power projects, which have been discussed in this study. Once the contract has been signed, the selected EPC contractor assumes his responsibility for satisfying employer’s requirements. Verifying does this first the incomplete bid package or basic design and then expanding this design into a complete description of the required project in the form of residual and detailed design, engineering drawings, diagrams, specifications, purchase orders and other specified matters.Procurement
After the completion of all design related parameters, the procurement process begins. The contractor is responsible for supplying all the equipment and procuring all the equipment from the vendors. In this process, the EPC contractor also assumes responsibility for inventory and materials management.Procurement becomes important because it is here that project management can be most effective in cutting time without compromising quality. For this, either the EPC contractor puts together a separate team or hires a project management.
Construction
Once the project and related subsystem have been designed, manufactured and supplied, construction begins. This includes pre-installation. Civil construction as well as installation of the project at the identified site.Training
In an EPC contract, it is also the responsibility of the EPC contractor to import training to a team of engineers or other technical staff of the employer at the site during the pre-commissioning and commissioning of the project. In addition training programs are also arranged at the supplier’s works.Commissioning and Handing Over
This is the final stage of the EPC contract. Once the pre-commissioning and commissioning trials of the individual equipment and of overall systems are complete, the contractor has to commission the contract as per the term of the contract. The contractor has to conduct the trail run or the reliability run–trials at full load, varying loads etc. for a period defined by the contract. Following this demonstration the project is handed over to the owner.Given below is an attempt to express the above phases is a simplified & figurative manner.
From here on, we will move on to some points very specific to EPC i.e. the sensitive issue of the completion of designs by the contractor from the point where they were handed over to him.
Contractor’s Freedom to Interpret Design
In developing the Employer’s Requirements into a buildable design the contractor will, obviously be faced with many unanswered questions, namely, will the post contract design development be accepted by the ? Or when, in fact, does the Employer’s or his consultant refusal to accept that the Contract is being satisfactorily turn into a change in the Employer’s Requirements, which should be paid for etc. So the main issue involved in all EPC projects is “what are the fixed limits within which the contractor ought to be allowed the freedom to adjust and innovate during progress”, whilst still managing to meet the Employer’s Requirements.In any real EPC project, it is contended that whilst contractor’s proposals are to be a reasonable extension of the Employer’s Requirements, they ought, within the limits, to be able to be modified as to their detail in the design development. If, for example, the Employer’s consultant or, perhaps, a process licensor has closely determined a basic design, it will mean that certain constraints of payout, sizes, arrangements, etc. will have been given but the contractor should be left to interpret them so as to be able to evolve and develop the same to meet the Employer’s Requirements.
This will be all the more important if the Employer’s Requirements encompass many interconnecting parts of the project at varying stages of design, since it will not always be possible to freeze matters which may be subject to later modification depending upon what is finally agreed in other parts.
Consequently, as the design is incomplete and possibly fragmented at the outset then the contractor, unless clear mandatory stipulations are imposed, must be allowed some measure of discretion within whatever was actually agreed as to what he is to provide with regard to the detailed design.
This is, therefore, the contractor’s freedom to develop the optimum response whilst at the same time meeting the Employer’s Requirements, the whole exercise being a question of interpretation of what actually meets the Employer’s Requirements as the design is being developed. Unfortunately, many Employers and their consultants do not undertaid that the contractor cannot allow for drastic design revision major technical development, or more often than not personal evolve during the currency of the project and therein lies a obtaining Employer “approvals” following on form a highly subjective interpretation of the employers requirements. The period for development of the detailed design should, therefore, simply be used by the Employers and his consultant to ensure that the contractor in developing the design is not deviating too far from the requirements or that he is not lowering standards. This situation, in view of the problems of interpretation referred to above, obviously calls for a more detached attitude from both the Employer and his consultant with both of them stimulating ideas rather than just turning down what is simply not liked, albeit that it satisfies the Employer’s Requirements when considered from an objective point of view.
Neither the Employer more his consultants is responsible for checking that the contractor’s design is correct or even adequate but only that it conforms to the Employer’s Requirements set down in the Contract and as required by the Employer under the contracting scheme, being solely responsible for the design and its workability. The Employers and his consultant, on issues of design interpretation, must, therefore, stick to the framework of the Employer’s Requirements and the contractor’s proposals for the same, so that only departures from the framework can be disputed and not developments within it. Unless, of course, the Employer is prepared to pay for such changes. To ensure that the above is fulfilled the Employer and his consultant ought, of course, to have provided the contractor with all the information in their possession and which was used to prepare the Bid Package or basis design.
There are references in the majority of EPC Turnkey contracts whereby any information given by the Employer is for guidance only and that any comment or advice from the Employer on the contractor’s designs will not relieve the contractor of his responsibility for bringing the project to successful completion in accordance with such design. Therefore, the Employer or his consultant should be “reviewing and not approving”’ approval in the strict sense of the word being, inconsistent with any denial of responsibility, and merely noting the contractor’s proposals as apparently satisfying the Employer’s Requirements expressed in the Bid Package or basic design, by now incorporated in to the Contract.
Moreover, even where the Employer does have the light contractually to instruct design changes, it is contended that neither the Employer, nor his consultant, has power directly to introduce design of his own into the project design. The contractor in an EPC Turnkey scheme carries more than his fair share of commercial risks and should not have to bear Employer/consultant interference. In building up his bid price the contractor has, in the face of the incompleteness of the design, already had to cover all quantitative uncertainties as adequately as possible whilst trying to achieve an optimum economic result for both himself and the Employer.
Instructions and Value Addition
It is for the reasons mentioned in the above section, that the contractor. If he is meeting the Employer’s Requirements, should not, and, without specific provision to the contrary, need not accept design intrusion from the Employer and his consultant. These two parties have to content themselves with the role of consenting to what the contractor proposes, so long as the same conforms to the Employer’s Requirements. The contractor must, therefore, be constantly aware of action amounting to interference and intrusion that will in certain cases become apparent. If by some change the contractor is able to provide a solution which has the same user value but costs less, it is reasonable for the contractor to be paid the full Contract Price, any cost benefit in these cases going to the contractor, is being unusual for an Employer want to pay more in the reverse situation. However, in many cases, especially on Government and Public Sector projects, due to the interference and intrusion into the contractor’s design work; it is possible for the Employer, with the assistance of appropriate contractual wording to identify cost benefit and to claim it for himself, a common phenomenon on projects in India.The Time Aspect
Turning now to the aspects of time, both the Employer and his consultant ought to be very much aware that in performing their consenting functions under the Contract any review of the contractor’s design development must be done without delay, the Employer, and not just the contractor, having undertaken to perform his obligations in order to meet the time schedule. As referred to above major problems occur when Employers arid their consultants indulge themselves in a design “approving “exercise’ exhaustive comments, if any, strictly limited to conformity with the agreed Requirements and any other contractual or legal right, have to be made and dealt with efficiently to avoid endless and unnecessary reconsideration and to allow the contractor to respond to any legitimate needs in a timely manner. This situation can be facilitated when the Employer had given a relatively detailed brief, incorporating all the information that the contractor could have rightfully assumed, he would obtain under the Contract, since the requirements will then be easy to identify and discuss, thus, be limited. As stated above, various parts of the project, although closely interconnected, have been developed to different stages of design, then any review of the separate portions of designs must also take this fact into account.Early decision, whilst they may seem logical, might, in the face of an overall review, be later seen to be leading to illogical or at least suboptimal results. Thus, any attempt on the part of the Employer or his consultant finalize or freeze a part of design without due consideration of this Employer created problem, will clearly lead to disruption and delay at some stage or other in the overall review.
Moreover, as the parties become concerned successively with more detailed matters the slightest delay in settling early problems can only lead to delays on the whore design and consequently the engineering procurement, fabrication and erection.
The fact that the design was not completed pre-contract means it overlaps with construction - this non-completion will impede both off-site and onsite progress if it is not allowed to proceed timely and efficiently.
The contractor is under a program obligation by the time schedule and the Employer, having the undertaken to respect the same, must simply within the limits of his obligations in a timely manner and abstain from interfering in the design process. Thus, if the Employer does make comments in accordance with rights under the contract then the contractor has to consider, depending upon the stage reached and if the proposals meet the Employer’s requirements, whether to take the same into consideration, it being remembered that the contractor is developing the design from the Bid package and basic design documents incorporated into the Contract without adjustment of the price but with absolute responsibility for results. In entering into EPC Turnkey contracts, scheduled for completion within restricted time and with a fixed price. Employers must afford the fullest cooperation and assistance to contractors by
- According timely approvals to their proposals
- Limiting any remarks during the design review to only actual errors and genuine departures from the Employer’s Requirements of the Bid Package.
- Good engineering practice
- Exercising the fullest flexibility in the interpretation of the employer’s requirements
- Ensuring that at no stage would the process of design or construction be stalled or stopped, other than for reasons expressly stipulated in the contract.
- they meet the Employer’s Requirements
- are in accordance with standards, international engineering practices and
- Incorporate materials, equipment and plant to be procured, from already known or even approved vendors.
Conclusion
The road infrastructure is main catalyst for the development of important key sectors of economy like Agriculture, Industry, Mining, Energy, Forestry, and Dairy Development. These sectors are mainly depending on the development and maintenance of the road network and efficient transportation system. Generally, India has made appreciable investment in development of wide road network in the country such as National Highways, state Highways, Major District Roads, Other District Roads, and Village roads.The National Highway Development Programme, for which National Highways Authority of India is the nodal agency, is perhaps the biggest episode of India’s infrastructure development story. It is estimated that by 2012, an investment of Rs 2,20,000 crores would be required to upgrade India’s national highway network covering nearly 66,000 km. what is most encouraging is that what started off as a ministerial project, financed by the government and implemented through cash contracts, is now moving to be an inspiring example of the public-private partnership philosophy. While the first two phases of NHDP were largely implemented as EPC contracts, the subsequent phases have been envisaged to come up on BOT basis. This is the biggest salute to Indian entrepreneurship-contractors turning into entrepreneurs that not only construct the project but also raise finances and share the business risks.
For such projects, it is necessary for the Contractor to assume responsibility for a wider range of risks than under the traditional Red and Yellow Books (FIDIC). If the Contractor is to carry such risk, the Employer must also realize that asking responsible contractors to price such risk will increase the construction cost.
After studying the various aspects in detail, the following conclusions were drawn from the study:
- First, it could be clearly seen that the costs incurred an EPC contract is clearly greater than the general split packet project with respect to the client.
- In spite of the greater cost, in today’s date the demand on the contractor to finish a work in the shortest possible time attaining the maximum quality has become of utmost importance.
- Another point that was brought out in the course of this study was the ability of the client to utilize the expertise of a contractor in every phase of a project and not only in any one particular activity of the project. This means, a contractor specializing in a particular field would be familiar with every aspect and detail of a various phases of a project, more so than a new client. By giving this contractor an EPC project instead of one activity in a split package, his expertise and technical know-how can be totally exploited by the client.
- Another aspect that was studied and analyzed in detail was the accepted level of interference that the client is allowed in an EPC project. From the study of various standard EPC contract documents, it can be concluded that in the case of a typical EPC project, the client should look upon the project only with respect to meeting the end–result satisfactorily. The intermediate progress should be left completely to the contractor.
- With respect to the previous point the amount of approvals required from the client or any of his representatives can become a bone of contention in case of a typical EPC project and should be clearly defined in the contract document itself.
- The main importance of EPC is to have a single point of contact for the client with respect to all the aspect involved in a project. The client needs only to approach the main contractor for progress analysis as well as payment and all the other aspects of the project including various subcontracting as and when required is taken care of totally by this main contractor, acting as the window for the client in the project.
- Having this single point of contact means that the contractor is liable for completion of contract in all aspects of time and quality. In other words, an EPC contract holds the contractor highly liable to the proper and satisfactory completion of the contract.
- Thus, even though it is necessary to adopt large number of EPC Turnkey contracts, as is apparently occurring, for the timely and satisfactory completion of the various large projects planned for the country, it is also necessary to remember that all Indian contractors may not be in a position to take up such a large responsibility.
- Thus for successful completion of large scale EPC contracts, it becomes increasingly important for the contractors to develop their bearings in all aspects of a project like design, procurement, project management competencies, quick mobilization, construction and erection and also to posses new machinery and adopt technological advancements without delay.
Recommendation
The EPC contractor must posses the following basic strengths within his own organization or has to build up a consortium of agencies those posses such qualification:- Manufacturing of major equipment or capacity for procurement of required equipment from diverse agencies.
- Construction abilities.
- Sufficient financial strength to tackle such large value projects and to be able to take the various high risks involved.
- Sufficient experience in managing such projects so as to inspire confidence of financial institutions, projects clients and stake holders of the project.
NBM&CW July 2009
