Introduction
The appetite for Engineering, Procurement and Construction (EPC) contractors accepting project and contractual risks fluctuates with supply and demand in the market. In recent years, as project sponsors have found it challenging to attract financing for downstream oil and gas projects in emerging markets and the transaction pipeline has slowed, EPC contractors have been asked to shoulder greater risks in order to win major downstream oil and gas project work in those markets.
This is particularly the case for projects in challenging jurisdictions where "first of a kind" transactions introduce a higher level of completion risk and where project sponsors wish to limit the extent of the completion support given to their project finance lenders. In extreme cases, without a marked shift in risk allocation to the EPC contractor, certain emerging-market downstream oil and gas projects would not have been able to attract finance and proceed.
This article explores five areas in which there has been a shift in risk allocation in certain multi-billion dollar downstream oil and gas projects in emerging markets over the last couple of years. Each of these issues requires EPC contractors to push the boundaries of what they would ordinarily accept. While individually these issues may not be new or unique, there is a trend to see risk shifted to EPC contractors across many key issues and when taken as a whole the extent of the risk shift is readily apparent.
1. Single Package EPC/Joint and Several Liability
Usually multi-billion dollar downstream oil and gas projects are broken down into packages. Separate EPC contracts are used for the different project packages in order to utilize the particular expertise of different EPC contractors and to allow for manageable contract sizing. For instance, a refinery or petrochemicals project may involve one or more packages for processing units and another for utilities and offsites.
Recently, pressure from project sponsors and lenders has led to the entire scope of multi-billion dollar projects being awarded as single package EPC contracts. A key driver for this shift is the reduction in interface risk. Under such a structure it is not possible for one EPC contractor to avoid responsibility by blaming another for interface issues arising between processing units or utilities. Where a single EPC contract has been awarded, it has often still been necessary for the scope to be undertaken by several EPC contractors due to relevant EPC contractor experience, EPC contractor capacity and, importantly, the desire to maximize available export credit agency funding. Under these circumstances, the EPC contractors comprising the consortium have been required to accept joint and several responsibility and liability for the entire contract. EPC contractor solvency and credit risk is, therefore, shifted onto the EPC contract consortium. Although the EPC contractor consortium will have internal arrangements for allocating responsibility and liability among its members, each member of the consortium takes solvency and credit risk on its joint venture partners. Project owners and lenders only bear EPC contractor solvency and credit risk under such an arrangement if all consortium members become insolvent. In the current climate, solvency and credit risk of joint venture partners is not an insignificant risk for an EPC contractor to shoulder.
The appetite for EPC contractors accepting project and contractual risks fluctuates with supply and demand in the market.
2. Point of Handover
Downstream oil and gas project facilities are often handed over from the EPC contractor to the project owner at the point where they are ready for start-up. Therefore, the project owner assumes care, custody and control of the facility before the start-up, commissioning and performance testing of the units and the facility as a whole. Delay liquidated damages generally stop at this point of time. Where a project is implemented by way of multiple EPC contract packages, handover at ready for start-up prevents the owner suffering prolongation claims from contractors where one EPC contractor delays the start-up, commissioning and testing of the other units or the facility as a whole.
Pressure from project sponsors and lenders has led to a shift in the hand-over point for certain downstream oil and gas projects. The award of an entire project on a single EPC contract basis allows for the handover of the facility to be moved to the point when all units and the facility as a whole have been commissioned and started up and performance have been proven by the performance tests, without the risk of prolongation claims on the project owner. It also allows the EPC contractor to be responsible for timely completion right through until performance of the entire facility is proven. Therefore, any delays resulting from issues arising during commissioning, start-up and testing remain the responsibility of the EPC contractor.
Under this structure, if one member of the EPC contractor consortium is in delay, all consortium members are liable to the project owner for delay liquidated damages. In addition, the EPC contractor retains risk and responsibility for loss or damage to the project throughout this extended period.
3. Extension of Scope of Responsibility
Project sponsors and lenders have been pushing to extend the scope of responsibility of EPC contractors to areas which have historically fallen within the project owner's responsibility. An example of this is with respect to process technology risk. Even if the project owners have selected the technology for their projects and engaged the process licensors to prepare the FEED packages, EPC contractors are being asked to take full responsibility for the process performance. What makes this a greater risk transfer is that project sponsors and lenders have not accepted a limitation on the liability for failed process performance at a level which could be recovered on a back-to-back basis from the process licensors. Process licensors only accept very low limits of liability, yet EPC contractors are being expected to accept significantly higher potential liability in the event of process performance failure. This risk shift is only likely to be achievable where the technology selected is proven at scale and the technology providers are market leaders.
Similarly, there is a push to limit rely-upon information to an absolute minimum. For example, limiting it to the feedstock and product specifications and nothing more. EPC contractors have been required to check and adopt as their own on all other project related information.
4. Acceptance of Site and Other Risks
There has been an increased emphasis on EPC contractors taking site risk, especially sub-soil geotechnical risk. This has been driven by a need for true fixed pricing and the avoidance of price fluctuations due to unforeseen geotechnical conditions.
This risk shift has been dealt with in two principle ways. The first has been to require the EPC contractor to accept site risk from the outset. Under this scenario the EPC contractor is required to accept and adopt as its own any existing site survey findings or to conduct any site investigation works it wishes to perform prior to contract award. The alternative has been to give EPC contractors a short time period (e.g. 3 months) after the award to complete site investigation works and discover any issues affecting the time for completion or the contract price.
Following such period, the EPC contractor becomes time barred from raising claims irrespective of what is subsequently discovered and whether any such discovery was foreseeable or not. The second approach has found acceptance with lenders, where sponsor equity is paid up front as prior to initial drawdown of the debt, any adjustments to the contract price arising from adverse site conditions have been concluded.
Pressure from project sponsors and lenders has led to a shift in the hand-over point for certain downstream oil and gas projects.
Similarly, there has been a shift in the concept of "excepted risks." These are commonly included in EPC contracts and are risks which are the responsibility of the project owner, not the EPC contractor. They often include those matters which may amount to a force majeure event but for which insurance does not cover the loss associated with the event, such as some political risks including war risk in the project country. Under such circumstances, the EPC contractor could claim an extension of time and the project owner would normally be responsible for any loss or damage associated with the event. Recent experience suggests that EPC contractors are being required to, and are agreeing to, accept these types of risks in certain cases. Where it accepts such risk, the EPC contractor gets the benefit of additional time to complete the project, but it bears the risk of loss or damage arising from the event.
5. Carve-Outs to Limitation on Liability
EPC contractors are agreeing to extensive exclusions from their caps on liability, effectively allowing for uncapped liability for a number of specified events. Of particular importance for project sponsors and lenders is the growing acceptance of a carve-out relating to the achievement of minimum performance levels. Considering joint and several liability of each member of the consortium, shifting the handover point, the acceptance of greater site risks, EPC contractors are being asked to take process risk for technology they have not selected and without back-to-back liability of licensors, the general shift of responsibility toward EPC contractors, the acceptance of uncapped liability for completing the project within a certain period at the minimum performance levels, represents a considerable adoption of risk by EPC contractors.
Conclusions
Of course, passing risk to an EPC contractor has the potential to increase the EPC contract price. However, EPC contractors seem to be limiting the risk contingency they are adding to their bid pricing for the acceptance of additional contract risk. This indicates that competitiveness in the market for EPC contracts in emerging markets, and willingness of a number of substantial players in the market to bid aggressively for multi-billion dollar projects, is exerting downward pressure on risk contingency that many EPC contractors are including in their EPC prices for accepting such risks.
The ability to transfer risk from project owners and lenders to EPC contractors clearly depends on the market and demands on EPC contractor (and subcontractor and vendor) resources. While the trend in emerging market downstream oil and gas projects is for a shift of risk towards the EPC contractors, in certain other markets, such as the United States, it is apparent that there are currently different supply and demand dynamics at play and the trend is somewhat different.
Not all EPC contractors are willing to accept a high level of risk. Many major players in the EPC contract market remain risk averse and do not accept the shift in risk allocation mentioned in this article. However, there are certainly a number of players in the competitive EPC markets that are willing to push the boundaries of a "normal" risk allocation.
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