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Sharing Risk with EPC Contractors Can Lower Project Costs for Owners

Sharing Risk: Lowering EPC Project Costs for Owners

Owners of large infrastructure projects naturally try to off-load as much of the risk of the project as possible, but that also can significantly add to the overall costs. As an alternative, owners should examine ways to lower their costs by accepting some level of reasonable risk and working with high-quality EPC contractors.

Project owners can engage in risk sharing by shifting some of their focus on the “bankability” of the EPC (engineering, procurement, construction) provider, thus giving them a much higher comfort level in accepting risk. But what exactly is bankability?

“Bankability should be a key differentiator in selecting an EPC contractor,” said Ted Pintcke, Black & Veatch Vice President, Energy. “It means the banks and equity/debt providers that are standing behind these investments want to know if the contractor has a strong history of completing successful projects . They will examine the history and  financial strength of an EPC contractor to see what sureties they have to ensure that the job will be done at the stated price, completed by a given date, and the facility will perform at the levels of expectations.”

According to Pintcke, the developer and the banks will examine the balance sheet of EPC contractors, as well as the ability to bond or provide the necessary surety in order to determine the real financial strength behind the company. Those that pass the litmus test are “bankable,” meaning the owner/developer is more likely to be successful in financing the project.

“Ultimately, the banks are asking, ‘Can the EPC contractor perform this job? Do they have the wherewithal to stand behind this multi-million dollar project and get it done?’” Pintcke said.

Risk Management and Bankability in EPC projects

Lowering Costs with Risk Sharing

By examining a provider’s bankability, project owners can better determine whether they want to assume any of the risk, and seek to lower some of their costs.

“Every project has a risk element to it and owners can participate in sharing that risk or they can choose not to participate in sharing that risk,” said Blake Childress, Senior Vice President, Design-Build for Black & Veatch’s water business. He said if the owner requires a performance bond or payment bond, that adds to the cost of a project.

“In my experience, I’ve done several projects with private clients who waive the need for a bond because they know the company that they’re hiring, they know they’re going to be there at the end of the day to provide the services that they’ve signed up for, even if there’s an issue,” Childress said.

Putting Equipment on the Owner’s Books

Pintcke said a lot of clients today want to have a hand in the equipment selection, particularly if they are working with an open book contract where the owner can see all of the costs, not just the lump-sum price of the contract. Some owners are comfortable with carrying the cost of certain big-ticket equipment on their books. In doing that, they accept some of the risk.

“They accept the risk for the equipment that they’re providing to the EPC contractor – that it will meet its performance, and it will be there on time. So they’re sharing in that risk,” Pintcke said.

When an owner does that, it enables the EPC contractor to shed some of that risk, and it could mean less need for complex contingencies in the contract.

“Those unknown events, particularly in a fixed lump sum contract where the owner’s not taking any risk, means we have to carry risk premiums and contingencies for those unknowns,” Pintcke said. “So when an owner steps in and shares that risk, works with the original equipment manufacturer (OEM) they want, and contracts separately with the OEMs, it’s a nice marriage because it enables risks to be looked at differently. The effect can be a lowering of overall costs.”

Childress agreed that many details in a contract can have an impact on the total cost.

“There are a lot of other risk areas that have to do with contract terms and conditions, the amount of retainage, the amount of liquidated damages (payment for not meeting contract requirements), or whether liquidated damages are uncapped,” Childress said. “All of that has a cost impact to the owner, and the owner can write a contract that’s more favorable to both parties or the owner can write a contract that’s more onerous to the design-builder, and it therefore has a cost impact.”

For legal reasons, he said, many utilities don’t take advantage of risk-sharing. This, however, varies from utility to utility – some are comfortable, some are not. 

“They’re being advised by their legal counsel not to take on additional risk,” Childress said. “Owners are often encouraged to put as much of that risk – particularly the performance and process risk – on the design-builders as they can afford to.”

But that negates the bankability of an EPC contractor, and keeps the costs higher.

“Bankability is a key differentiator for Black & Veatch,” Pintcke said. “I know our clients consider it and appreciate it.”

 

Subject Matter Experts
Ted Pintcke: PintckeTP@bv.com
Blake Childress: ChildressAB@bv.com

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