Demands of Contracting Environment

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Demands of Contracting Environment

• Dr Abdullah Malik

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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

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Typical EC Projects in Pakistan

• PARCO
• Motorway
• Gwader Port
• Airport
• Fatima Fertilizer
• Power Plants
• Motor car assembly units

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Emerging Approach
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Key ECs 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

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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

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ECs Evolution in Oil Sector

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

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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

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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 !

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The Institutional Partners

• The owner of the facility
• Contractors (EC)
• Authorities
• Customers and feedstock suppliers

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The Project Life CycleDevelopment

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

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Development Stage Demands

• Define clear project objective
• System control
• Traceability of all design work i.e. data sheets,
  PIDs
• 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.

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Team Triangle
Sales
Engineering
Proposal
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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.

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Typical ECs Task Force
Project Manager
Engineering Manager
Lead Piping Engineer
Lead Process Engineer
Lead EI Engineer
Lead Civil Engineer
Lead Mechanical Engineer
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Engineers Level of Input
Chemical/Process
Civil/Structure
Mechanical/Piping
EI
Input Level
Execute - Detailed Engineering Construction
Commissioning and Operation
FEED
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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.

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Key Institutional Attributes

• Generally, in the world, ECs 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 ownercontractor relationships.

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Typical Owner-Contractor Agreements Map
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Generic Options for Contractor Selection
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Key Drivers of a Contract Business Deal
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Additional Hierarchical Contract Components

• Conditions of effectiveness of contracts
• Acceptance
• Insurance
• Force Majeure
• Premature termination
• Taxes
• Applicable law
• Dispute arbitration and resolution

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Case Studies

• Technical Specification
• Quality of cost estimates
• Payment Terms
• Schedule

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Technical Specification

• 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 clients
  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 worlds 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.

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Quality of Cost estimates

• 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.

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Payment Terms

• Key attributes Contractors mostly receive a
  515 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
  510 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.

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Schedule

• 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.

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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.

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Contract Type Selection

• Depends on
• Type of Technology New or already been built
• Size of installation
• Risk levels

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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.

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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.