You are on page 1of 4

5/9/2016

3.4 Considerations in Developing the Conditions of Contract - Road to Success - IPLOCA WIKI Collaboration Platform

3.4 Considerations in Developing the Conditions of Contract Created by Guy Henley, last modified by Mustafa
3.4 Considerations in Developing the Conditions of
Contract
Created by Guy Henley, last modified by Mustafa Abusalah on Nov 20, 2014
Traditionally, contracts terms tend to be issued by clients,
and market forces and/or financial institutions tend to
drive in their favour. Too often risk allocation continues to
be pushed from one party to another depending on
prevailing environmental or market conditions, with little
consideration to the loss of potential value and earnings
incurred due to inattention to reducing the risk to begin
with.
3.4.1
Pipeline Project Specifics
3.4.2
Clarifying Risk Responsibilities
3.4.3
Probability of Risk and Cost Outcome
3.4.4
Conclusion
However, as a general principle, the conditions of contract (general conditions and particular conditions) should
not be overly favourable to one contracting party vis­à­vis the other(s). Indeed, experience shows that
construction and operational risks are best allocated where they can most appropriately be managed and borne. A
fair contract helps to significantly reduce the risks of conflicts, delays and disruptions when difficulties occur in the
performance of a project by clearly identifying the agreed risk allocation and providing fair compensation for
bearing them.
Several (unsuccessful) attempts have been made in the past to develop standard balanced contract conditions,
applicable to all types of major onshore pipeline projects. The failure of these attempts was largely due to the fact
that national clients are bound to abide by the local contracting practices and global clients have, over the years,
developed their own contract conditions which, they feel, can adapt to the varying context of their projects.
3.4.1 Pipeline Project Specifics
Whatever the conditions of contract used, the recommendations above acknowledge the specificities of onshore
pipeline projects as well as the uniqueness of their sites. Unlike the relatively small concentrated areas of other
construction projects (such as terminals, pump/compressors stations etc.), onshore pipeline projects often extend
over several hundred kilometres, crossing state and/or international boundaries.
The likelihood, therefore, of encountering conditions different to those upon which the initial design and
construction programme were predicated is higher than in other construction projects, hence the requirement for a
good FEL as the likelihood of changes is inherent to pipeline projects. This requires that the parties analyse
potential risks at an early stage (during the bid phase) and that the contractual baseline is set accordingly to
ensure that anticipated risks are fairly allocated. Both parties can benefit from prudent front­end loading (see
section 2).

5/9/2016

3.4 Considerations in Developing the Conditions of Contract - Road to Success - IPLOCA WIKI Collaboration Platform

3.4.2 Clarifying Risk Responsibilities As demonstrated here, the baseline of a good pipeline construction contract must
3.4.2 Clarifying Risk Responsibilities
As demonstrated here, the baseline of a good pipeline construction contract must include a clear definition of
inclusions and limitations for key risks. The scope of works provides the basis for an agreement between
contractor and client. Under ideal circumstances this would be sufficient for an onshore pipeline contract.
However, in reality, risk events, when they occur, lead to contractual disputes unless the contract addresses these
issues. Contracts should therefore include terms which allow sufficient commercial flexibility to address these
inevitable variances while still preserving the performance incentives inherent in the commercial terms for the
baseline portion of the scope.
This requires the recommended “spirit of trust and mutual co­operation between the parties” and the situation
where lack of clear and concise scope and engineering definition leads one party to consider exploitation at the
cost of the other should be avoided. The client may see under­priced lump sum bids as a benefit, whilst the
contractor may see the opportunity for change and scope increase during the execution of the work. In actual fact
the result is disputes, delays and additional costs seldom to any party’s benefit.
Exemplary preferred conditions of contract have been achieved in international onshore pipeline projects. Clauses
of general interest for all construction contracts such as exchange risk, country risk, indemnities, insurance,
payment terms etc. are not further developed herein as they may be found in general contract literature. There are
certain contractual topics that have a particular importance for onshore pipeline projects. The guidelines included
in Appendix 3.4.4 address the following:
The weather conditions/inclement weather
The environment and archaeology
The definition of (and access to) the site
The programme (and adjustment thereto, including compensation)
The relations with third parties (pipeline projects involve an unusually large number of third parties)

5/9/2016

3.4 Considerations in Developing the Conditions of Contract - Road to Success - IPLOCA WIKI Collaboration Platform

  • The supply of materials

  • The ground conditions

  • The responsibility for design and constructability

3.4.3 Probability of Risk and Cost Outcome

Many a contractor has fallen into a trap associated with risk pricing when clients insist in having the contractor to bear some of the risk impacts. The desire to achieve commercial advantage sometimes tempts a contractor to bid a lump sum contract based on a calculation of the estimated costs of inherent risks.

The baseline cost estimate is normally based on the expected cost of the project. This cost includes the required contingency commensurate with the project definition at that stage of the work, where the contingency is added to the base estimate to a level that is equivalent to the 50/50 (or P50 – see graphic below). Onto this a bidder will add reserve that provides his company with the level of assurance that the execution of the work with all normal risks will achieve his goal of profitability. This level of bid is normally assessed at a level where the company can be 80­90% sure of the outcome or in general terms the P80 estimate (this process is described further in Appendix 3.4.5 ­ Project Cost Estimate and Contingency)

Whilst some bidders may be sufficiently confident in their ability to execute work to an estimated budget based on the 50/50 estimate, or with little­to­no reserve it does assume that the bidder has 100% definition of all risks and unknowns and that his price is complete. This is an unlikely condition and normally results in the bidder placing a high reliance on claims or changes to his advantage.

Some project risks occur in a continuous and incremental fashion, so that the differing price points considered by different bidders will only vary from the actual cost outcome by degree, leaving the bidder a marginal profit or loss in the end.

However, projects often have discrete risks which result in an “all or nothing” cost impact. While the probability of these risks is still variable, their cost outcome is not. Competitive pressures often tempt contractors to bid such risks at less than expected cost on the hope that the unconsumed contingency will become additional profit or can be recovered through claims. When the risk does arrive and is not sufficiently supported with funds, the expected profit is not only lost but profit is drawn from other aspects of the project to offset the risk cost impact. Contractors feel forced to recover their incurred risk costs from their clients, often creating an uneasy relationship with their clients. This inevitably leads to commercial stress and can work to unravel the contractual arrangements made between the parties.

The alternative advocated here is to be overt in the contract as to how much of the risk cost impact is included in the baseline and how the excess or residual risk will be addressed commercially. Clients are especially urged to avoid entering contracts where known risks have been aggressively priced at a point below the likely cost impact. The better answer is to have the client bear the risk and avoid the commercial inefficiency of potentially paying for the risk twice – once in the baseline and again in a claim!

5/9/2016

3.4 Considerations in Developing the Conditions of Contract - Road to Success - IPLOCA WIKI Collaboration Platform

Contracts need to contain an appropriate contractual and commercial mechanism to deal with (unanticipated) risks that
Contracts need to contain an appropriate contractual and commercial mechanism to deal with (unanticipated)
risks that eventuate during the course of the work – despite parties’ best efforts to counter, factor in, or eliminate
these risks. For risk not accounted for in the baseline, parties can agree, in advance, the form of compensation
and the method of calculation of the adjustment.
Therefore, the characteristics of onshore pipeline projects make it more important to attain a well defined
allocation of risks between the parties. Furthermore, parties need to determine early on how they are going to deal
with residual execution risk. This is fundamental to achieving optimum contractual co­operation between the
parties and minimising conflicts surrounding eventual contract adjustments.
3.4.4 Conclusion
The baseline of a construction contract needs to be clearly established including scope of work, the detailed
execution plan with a resourced March chart programme for all linear activities combined to CPM programmes for
all fixed installations, the cost elements and the conditions of contract.
There may be circumstances when the baseline has not been sufficiently developed at time of going to tender and
needs to be improved through early works to arrive at a better contract.
Section 4 will review the main risks of pipeline construction contracts and propose mitigation measures which can
be implemented at various stages of the development of the project.
» Continue with Appendix 3.2.1 ­ Recommendations for Establishing Project Execution Plan ­
Construction Phase
« Back to 3.3 Contract Price Information to Facilitate Evaluation of Changes
« Back to 3. The Baseline of a Construction Contract