Tongues started to wag some months ago when European contractors declined to bid at all for the construction of a significant UK offshore wind farm development on an EPC basis. But the pundits should not have been surprised. EPC contracting has been under mounting pressure from market forces for some years, especially in the offshore renewables sector. Its popularity may now be in rapid, indeed terminal decline.
Engineering Procurement Construction ("EPC") contracts typically pass all design development and construction risks to the contractor. The developer acquires a "bankable" turnkey project and, at least theoretically, pays a premium for the assumption of risk by the contractor. This has worked well enough for many years in engineering and construction sectors where technology was proven and project specific risks such as geotechnical conditions, adverse weather conditions and regulatory interventions were relatively small compared to potential rewards. It is also implicit in these arrangements that the underlying profitability of the project was sufficiently large to fund the assumption of risk by contractors.
For all these reasons, the EPC contract became the medium of choice for large, high value process plants of all descriptions. From the outset utilities and energy companies who wished to develop offshore wind farms – and who often had extensive experience of EPC contracting from their core businesses – assumed that the EPC contract would work in this arena too. But those assumptions overlooked fundamental differences between the emerging wind sector and traditional process contracting.
The first difference is that the emerging turbine technology has developed rapidly as both output and, one hopes, reliability have improved. While this is very welcome, this has increased uncertainty and therefore the perception risk. Some high profile failures have not improved that perception.
The second difference is that the geotechnical and weather risks associated with offshore construction of wind farms are relatively large in relation to the capital costs of the developments and their (to date) modest returns. The short weather windows for installation mean that even a few weeks critical delay can completely upset a project and with it the underlying financial model.
The third and perhaps most important difference arises from the unavoidable fact that wind farms are completely dependent on turbines which are supplied by manufacturers who, rather understandably, do not regard offshore contracting as part of their core business and are reluctant to assume the associated risks. This dynamic simply exacerbates the underlying commercial and financial pressures on the EPC model because it makes joint venture contracting and hence another layer of risk allocation and contingencies almost inevitable.
In retrospect, letting offshore wind farm projects on an EPC basis was always going to be difficult and so it has proved to be. The straw which has broken the back of EPC contracting in this market is that the relative bargaining position of developers and contractors has reversed. Demand now out strips supply: turbine manufacturers have bulging international order books for relatively low risk onshore installations. Contractors with the requisite skills and experience likewise have a spring in their step as a result of booming business in their core markets. Neither needs or, therefore, wants to accept the high risk/low margin model they associated with EPC contracting in the offshore wind sector.
Happily, a more realistic model of contracting is emerging which takes account of both the underlying commercial realities and the growing sophistication and maturity of the offshore wind market. It is being called somewhat misleadingly "multi-contracting".
In essence multi contracting intends to capture 3 themes
- to allocate ultimate contractual responsibility for project specific and interface risks to the developer, recognising the market reality that the developer is not only the most appropriate party to bear these risks but in present market conditions, the only one that can.
- to employ directly and separately the turbine supplier, civil and electrical contractors, typically on a target cost model.
- to "over-lay" these arrangements with mutual alliance obligations to drive better management of technical interfaces, construction schedules and construction risks on a project wide basis.
While undoubtedly more complicated than EPC arrangements, multi-contracting seems to offer a pragmatic way forward. The resulting contracts should be cheaper because they eliminate unmanageable and disproportionate risks from the supply chain. Even more important, they should be more attractive to suppliers and contractors and hence promote greater competition for projects in the market.
Very early indications are that the market is willing to buy in to this concept and it may in coming years prove to be the new contracting standard for offshore wind farms.
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