Merits and Demerits of Execution of Hydro Electric Projects on EPC/Turnkey Basis
Merits and demerits of EPC/Turnkey Contracts as spelt out by FIDIC are given below.
Turnkey contract for the project as a whole
Risk Sharing Considerations
- The mode of contracting does not alter the overall project risks, which depend upon the technical features of the project, logistics involved and the physical conditions under which the project is to be executed. An objective pre-qualification process can be a strategic tool to allow selection of contractors who can handle the ‘risks’ if and when required.
- Risks are weighted more on the side of the contractor in the case of turnkey contracts as compared with the package contract approach. In such cases, the owner runs the risk of the turnkey contractor defaulting on the contract if the risks are found to be unmanageable.
- The risk sharing principles of package contracting are beneficial to both parties, as the owner will sign separate package contracts at lower prices and will only incur a further cost when a particular unforeseeable risk actually materializes. The contractor avoids pricing such risks which may or may not occur. Such risks are not easy to evaluate at the tendering stage in any event.
- Sharing of risks, if not handled in a constructive and fair manner, will result in more disputes. Handling of claims under the risk allocation scheme also becomes sensitive, with both parties tending to adhere to their interpretation for safeguarding their own interests.
- Many risks are basically unassessable at the time of tendering – otherwise they would not be categorized as risks, but the quality and risk-handling capability of the contractor can be assessed.
Recommendations of FIDIC for use of turnkey contracts
- FIDIC has recommended the use of the turnkey mode of contracting for power projects under the following conditions:
- Where the owner requires to have a contract with total responsibility for design and construction undertaken by the contractor and where the owner needs a high degree of certainty that the agreed contract price and time will not be exceeded;
- Where the owner does not wish to be involved in the day-to-day process of the work;
- Where clear project performance criteria can be specified; and
- Where the proponent parties (sponsors, lenders and the owner) are willing to pay more to the contractor and in return the contractor bears the extra risks associated with enhanced certainty of price and time.
- Where there is insufficient time or insufficient information for the bidders to scrutinize and check the owner’s requirements and to carry out their designs, risk assessment and estimation for submission of bids;
- If a project involves substantial underground works and in such cases the risks of encountering unforeseen conditions may be so great that the lowest bid is the one submitted by least knowledgeable bidder or reckless gambler rather than best bidder;
- Where the owner intends to control the contractor’s work and substantial freedom of action is not given to the contractor; or
- Where each progress payment is determined by the owner.
Since execution period of such contracts is long i.e. five years and above any changes in laws enacted by central or state government which increase the burden of cost of the contract beyond those conceived and spelt out in the contract need to be compensated. So also major hikes in petroleum prices, steel prices and cement beyond those provided in the escalation clause of the contract need to be taken care of.
In short if a hypothesis of a transparent contract is taken then the execution of a turnkey contract can be done in time and minimum cost overrun.
Examples of two EPC contracts giving details of disputes are given below:
A) Turnkey Contract – Omkareshwar Hydro Electric Project (520 MW)
- Change in the value of Seismic Coefficient specified in the Contract
- Resulting in increase in quantity of reinforcement steel
- Contractor’s stand:It is a change in scope of work thus extra cost incurred, over & above the Contract Price, should be admissible to the Contractor.
- Owner’s stand: It is a Turnkey Contract, thus contractor is required to absorb the cost of increased quantity of reinforcement steel.
- Resulting in increase in quantity of reinforcement steel
- Change in the type of Energy Dissipation Arrangement, specified as Roller Bucket type, in the Contract to Stilling Basin – Increase in the cost of Energy Dissipation Arrangement.
- Contractor’s and Owner’s stands – Same as in the case of change in the value of Seismic Coefficient case.
- Price Adjustment according to Contract applicable on Ex-works cost of Hydro-Mechanical & Electro-Mechanical Equipment.
- Contractor’s stand Ex-works as such has not been defined in the Contract, whereas “WORKS” has been defined as “Project site”. Thus as per the Contractor the BOQ cost should be the Ex-works cost for application of Price Adjustment clause, because Owner is taking the supply of equipment from the Contractor at Project site.
- Owner’s stand:Ex-works price is “Basic Price” of equipment at manufacturer’s Premises
B) Chamera Hydro Electric Project Stage - II (300 MW)
- Acceleration measures were adopted by the Contractor on the request of the Owner of the Project i.e. NHPC on the assurance that Contractor shall be suitably compensated for the expenses incurred to achieve acceleration on “best effort basis.”
- Project could be completed ahead of schedule by four to nine months from the contractual date of completion.
- Since Project could not be completed ahead of schedule by nine to eleven months, as proposed by NHPC to be admissible for incentive as such no incentive.
The need for awarding EPC contracts was found necessary in early nineties when private participation in execution of power project was found necessary for mobilisation of funds. The contracts were first started on MoU mode and as at present are on competitive bidding in various forms.
The debt/equity ratio for such projects was mooted as 70% & 30%. The cost of the project is recorded by a tariff arrived at as per guidelines given in power policy of 1995.
Since the borrowed money was at an interest rate of more than 12% the cost of money was the single biggest item of cost and could only to economized by executing work at fastest speed to reduce the quantum of interest. To give an example a 300 MW Baspa project had an interest plus revenue of Rs. One crore per day. This indicates that the company executing the project could do it only if he is working on EPC contract. In EPC contract the dependence of the EPC contractor on the owner is very minimal. Successful projects executed in time are Baspa II 300 MW, Vishnu Prayag 400 MW, Omkareshwar 520 MW. The first two projects were on BOO basis and Omkareshwar was on BOT basis.
A contract document for execution of hydro projects is being finalized by GOI, Ministry of Power which is primarily designed to get over such difficulties.
The concept is to make the owner responsible for all his obligations including details given by him in DPR and also a provision is proposed to be made for star prices of cement, steel, petroleum products, labour etc. so that there is no cash flow problems arising out of increase in prices of these commodities beyond what are conceived in the contract.