Demands of Contracting Environment

1. Demands of Contracting Environment Dr Abdullah Malik

2. What is an Engineering Contractor (EC)? • Traditional Approach – Build only • Hiring a company who has a team of experienced engineers (Chemical/Mechanical/Civil/Electrical etc – can vary with the field of work involved) to build large engineering set ups i.e., Production plants for chemical and mechanical products; mechanical part production system • Emerging Approach – Build, Own and Operate • Hiring a company who has a team plus resources to fund the whole set up of Build Own and Operate

3. Typical EC Projects in Pakistan • PARCO • Motorway • Gwader Port • Airport • Fatima Fertilizer • Power Plants • Motor car assembly units

4. Emerging Approach

5. Key EC’s Strengths • Holds library of equipment design and cost • May have carried out many similar projects • Holds equipment procurement data base • Strong project management and control systems in place • Capacity and capability to deliver the services

6. What an Engineering Contractor (EC) does? • Play a key role in the life-cycle of large multi-million dollar projects/facilities. • This is normally achieved in following stages: • Development • Implementation

7. EC’s Evolution in Oil Sector • 60’s - A few oil companies; ran their EPC themselves • 70’s – emerged international EC’s • 80’s – oil price crisis led to huge redundancies leading to contracting out all detailed engineering work • Now – EC’s have become an indispensable part of the development and implementation of new processing facilities in oil, gas and petrochemical sectors. • Many EC’s holds licence for certain process technologies

8. Future of an EC • World marketed energy consumption to grow by 40% - same as per last 20 years – means processing capacity to be doubled in the last decade • Oil Sector is already seeing an overheated contracting market for large Engineering and Construction Projects

9. Large EC ProjectKey Elements • Building large ECP is technically complex – best illustrated by the high level of availability • Have high demands on the quality of the technical development and implementation BUT The risks are high !

10. The Institutional Partners • The owner of the facility • Contractors (EC) • Authorities • Customers and feedstock suppliers

11. The Project Life CycleDevelopment • Most critical part of project life cycle when location and main functionality parameters are defined ie project feasibility, alignment with client’s business strategy and selection of preferred options • Detail of functionality, CAPEX, schedule and organisation are developed in stages • Confirm compliance with client’s integrity management and personal safety standards, environmental legislation and HSE framework • Normally 1-3% of the total installed costs

12. Define clear project objective System control Traceability of all design work i.e. data sheets, PID’s Legislation directives ie SIL, HSE, EA Hazard and Risks ie HAZOP/HAZAN Whole life cycle analysis and process optimisation ie enhance process efficiency by minimising raw material, water, steam and energy Doubled man-hours charged as the Bag is becoming heavier. Development Stage Demands

13. Team Triangle Sales Proposal Engineering

14. The project Life CycleImplementation • Detailed engineering, procurement, construction • Following implementation a distinct reference point in the project life cycle is the start-up of the facility when the responsibility is transferred to operating company.

15. Typical EC’s Task Force Project Manager Engineering Manager Lead Process Engineer Lead Mechanical Engineer Lead Civil Engineer Lead E&I Engineer Lead Piping Engineer

16. Engineer’s Level of Input Chemical/Process Civil/Structure Mechanical/Piping E&I Input Level Execute - Detailed Engineering Construction Commissioning and Operation FEED

17. Contractual Arrangementskey attributes • A systemic organisational framework for institutional cooperation is required • Projects inherently require the ability to adapt to changes and uncertainly - this is important as to the long time nature of projects This area is weak in Pakistan and requires built in provisions cater contractual flexibility for long duration projects like PSDP, facility development.

18. Key Institutional Attributes • Generally, in the world, EC’s common observations are: • EC Projects require competence to cope with risks and turbulence. • They become manageable through the design of strategic systems. • The infusion of governability. • The transformation of institutions. • The design of financial arrangements, and the building of owner–contractor relationships.

19. Typical Owner-Contractor Agreements Map

20. Generic Options for Contractor Selection

21. Key Drivers of a Contract Business Deal

22. Additional Hierarchical Contract Components • Conditions of effectiveness of contracts • Acceptance • Insurance • Force Majeure • Premature termination • Taxes • Applicable law • Dispute arbitration and resolution

23. Case Studies • Technical Specification • Quality of cost estimates • Payment Terms • Schedule

24. Key Attributes: The quality of the specifications includes: adequacy and completeness (executable descriptions, not political statements), consistency between the technical and commercial part of annexes, and the clarity of scope, deadlines and the client’s deliverables. The concreteness of the specifications documentation will heavily determine future change orders or claims, as it defines what is a changed requirement. Example: When building the world’s biggest sulfuric acid plant in Mount Isa, Australia - no clear profile was available of the variation of the SOx concentration in the off-gas of the four different smelters, information that was key to determine and control the specifications of the sulfuric acid plant. When the Sox profiles became available, specifications had already been defined for the acid plant construction contractor. Thus, some equipment had to be changed, causing many significant engineering change orders for which the contractor charged high fees. This significantly increased the cost and the delivery time of the plant. Technical Specification

25. Key Attributes: Ideally, the price and the quality of the underlying cost estimates should be perfectly consistent with the technical specifications, including an adequate cost contingency. The client should avoid to always go for the lowest bid. Example: The joint venture of Cleveland Cliffs Inc. USA and Lurgi Metallurgie Germany to convert iron ore to direct reduced iron with a revolutionary new technology, The contractor then claimed he himself could do the steel erection at the original estimated cost, and was awarded the contract. However, the estimate had been unrealistic, causing him to aggressively claim change order charges in order to cover his costs. This gave rise to a lawsuit, in which the contractor indeed won a claim of $20 million. Quality of Cost estimates

26. Key attributes: Contractors mostly receive a 5–15% down payment, allowing them to start the job. Intermediate payments allow equipment delivery, as contractors rarely have the cash flows to pre-finance their suppliers. The final 5–10% payments are critical. They are frequently tied to mechanical and/or final completion and to passing performance tests and enable the client to exercise maximum pressure on the contractor. Example: In 1991, the British contractor Davy McKee became insolvent as a consequence of the contract conditions they had accepted in the construction of the Emerald Field Oil platform in the North Sea. Davy McKee had accepted a lump sum contract of almost $100 million, payable in one single instalment upon completion. Moreover, it was their first project for this kind of technology. When they ran into significant cost overruns during execution, they could not obtain an extension of their backup financing and were forced to sell off successful businesses, ultimately leading to the sale of the group to the Norwegian conglomerate Kvaerner. Payment Terms

27. Key Attributes: Consistency in, and a shared understanding of, the definition of the key milestones (mechanical completion, function test, cold commissioning and hot commissioning) are vital to smooth project implementation. There has been a recent tendency to compress project schedules in order to improve the clients’ project returns. Example: When Union Miniere revamped its Bulgarian copper smelter, a dispute arose about the timeliness of the restart of one of the copper converters. As the converters were key to the economics of plant operation, every day of the repair shutdown beyond the target period of 10 days was heavily penalized. Schedule

28. Various Contract Types • Fixed price – Lump sum Turnkey (LSTK) • Incentive based • Cost Reimbursable The LSTK concept can address all drivers in one contract with one party, achieving the clearest risk and responsibility allocation and minimizing interfaces.

29. Contract Type Selection Depends on: • Type of Technology – New or already been built • Size of installation • Risk levels

30. Liability Limitation in Practice • About 70% of the clients go for Fitness for Purpose Liability • Rest 30% recognises the practical and commercial problems posed to EC. • Unlikely to obtain cover for fitness for purpose liability – which could lead to the contractor carrying the major uninsured risk – consequently EC prefer to go for reasonable skill and care.

31. Concluding Observations • Typically projects worth more than $100 million are handled via EC • Professional and Prospective Engineers should be aware of the typical requirement EC. • Formal training programmers should be organized through mock projects with in academia • PEC has taken a good initiative by providing an opportunity to introduce the subject. This is only the tip of the iceberg and lot more needs to be learnt through experience within an EC environment.