Practical Risk Management for EPC / Design-Build Projects. Walter A. Salmon

because the responsibility for handling such issues should fall to specialists in the area of financial and legal matters, and not to the members of the Project Implementation Teams.Sadly, however, it is often management of the corporate risks where Contractors fall down. Too often, therefore, workers have unexpectedly found themselves out of a job due to the incompetence of their Corporate Management Team and/or Board of Directors, and without any financial cushion to tide them over until a new job comes along. Worse still, it is not unknown for Directors to have received bonuses (or have still been expecting them) even as they walked away from the bankruptcy that their incompetence may well have created.⁴

      2 The Project Implementation RisksThese are the particular risks specific to implementing each of the Projects that the Contractor is handling, and which are predominantly the responsibility of the individual Project Managers and their associated Department Managers to handle.⁵ Those are the risks that this book is principally focused on.

So, instead of swamping the Department Managers with information that is more related to corporate risk management concerns, I have concentrated in this book on those risks that each of the Department Managers really does need to concern himself/herself with, especially in regard to what are known as EPC/Design-Build Projects. However, as pointed out earlier, most of the risks related to both Procurement and Construction activities are common to all Projects for construction work, not just EPC/Design-Build Projects.

3.5 Greater Risks for EPC Contractors

The scope of work and the range of responsibilities and risks placed on the Contractor will vary from one EPC Project to the next. EPC Projects of themselves are risky enough for the Contractor, even if they are of the more preferable (from the Contractor's perspective) reimbursable type contracts (where the Contractor is paid for all costs involved in constructing the Project plus an agreed lump-sum or percentage addition to cover overheads and profit). As observed by Watt, ‘Since the cost of the project is reimbursable, the contractor has much less risk associated with cost increases’.⁶ However, all too often nowadays, Employers are insisting that the Contract Price is lump-sum in nature and fixed in all respects (i.e. no increase is payable to the Contractor for inflation, fluctuations in currency exchange rates, etc.). This means that every extra cent spent must come out of the Contractor's own pocket, sometimes even if the Employer appears to be the direct cause of the unexpected expenditure.

Some additional items added to the list of responsibilities for the EPC Contractor can increase the magnitude of the risks almost exponentially. Examples are such things as: (i) validation of the Conceptual Design and (ii) the provision of ‘single source’ specialist equipment that is fundamental to the required outputs from the completed facility (such as, for example, the Gas Turbine Generators for a Power Plant Project). There are far more possibilities beyond those limited examples. This situation is aggravated even more where the Contractor is also responsible for meeting the Guaranteed Performance Outputs of single source equipment. I have even worked on a Project where, albeit in a roundabout way, the Employer tried (unsuccessfully) to make the Contractor responsible for the quality of the gas that the Employer was responsible for supplying for fuel purposes, and upon which the required outputs from the facility were highly dependent. Such is the lot of the EPC Contractor, all too often ‘not a happy one’.⁷

      If the Employer also insists on an unusually short time-frame for completion (with substantial Liquidated Damages payable by the Contractor if the Project is completed late), then truly effective management of the risks involved becomes an absolutely essential task for the Contractor to perform if the Contractor's expected profit is going to have any chance of being achieved. The Employer will inevitably be very strict on adherence to the completion date in the situation where the Employer is liable to pay heavy penalties to any third parties in the event of delayed completion of the Project. That will be especially so where contractual promises have been made by the Employer to other companies relying on the output date from the completed facility to be achieved.

To put the risks of the above scenarios into perspective, consider how much easier the task of the Contractor would be if the construction implementation work were to be set up under the following ideal risk reduction Traditional Contracting scenario (from the point of view of the Contractor):

      1 all the Engineering work is to be undertaken by others (including the Detailed Design work),

      2 all key equipment items are to be purchased directly from the Vendors by the Employer and installed under separate Subcontracts issued by the Employer,

      3 specialist services installations too are to be undertaken by Subcontractors who will be tied into Subcontracts issued by the Employer,

      4 a very reasonable time-frame for completion will be allowed, and

      5 no Guaranteed Performance Outputs of any sort are required from the Contractor.

Even under the above setting of much reduced risks, a Contractor would still face many risk situations which, if they materialised, would prevent achievement of the expected profit level. Many Projects under the Traditional Contracting approach do in fact have many of those idealistic elements on board. Sadly, however, for Projects considered overall (construction work orientated), KPMG reported in March 2015 that ‘Owners continue to experience project failures: 53% suffered one or more underperforming projects in the previous year. For energy and natural resources and public sector respondents the figures were 71% and 90% respectively. Only 31% of all respondents' projects came within 10% of budget in the past 3 years. Just 25% of projects came within 10% of their original deadlines in the past 3 years’.⁸ It is therefore very obvious that EPC Projects require a much more robust approach to Project Risk Management if the Managers of a Project are going to be able to hold their heads high when the Final Acceptance Certificate is issued.

3.6 Principal Disaster Areas on EPC Projects

      In a nutshell, the ‘real and present danger’ for any EPC Contractor is the actual occurrence of any one of the following four disaster scenarios on its EPC Projects, since each issue mentioned is under the Contractor's direct control:

      1 Time DisasterThe time for completion may be severely delayed due to poor management of the Engineering, Procurement, and/or Construction activities as well as the interfaces between them. This can then lead both to unrecoverable additional costs and the Contractor's income being seriously eroded due to the requirement to pay Liquidated Damages to the Employer to compensate for delayed completion.

      2 Commercial DisasterEven if the Project is completed on time, the expenditure may significantly exceed the income due to the inadequacy of the Contractor's internal controls (not only in respect of purchases and subcontracted work but also for worker productivity and wastage levels).

      3 Quality DisasterThe quality of the finished work may be well below the required standard. This could then lead to litigation over arguments as to whether or not the facility is suitable for its intended purpose. In the worst case scenario, it could lead to a complete breakdown of the facility and also involve loss of life.

      4 HSE DisasterAn untoward health, safety, and/or environmental issue may cause a severe problem that could irreparably destroy the Contractor's reputation for a good while to come, as well as being costly to remedy (or provide compensation) for the negative effects experienced.

      I have observed that far too few Contractors realise that, from the moment the Contract signing has been concluded, the Contractor has entered into the equivalent of a war zone, where time is the Contractor's principal enemy. The different ways in which time can be lost are many, some of which are almost indiscernible. Time moves along at a constant pace and is unrelenting in its progress,