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MEED - Weighing The Contractual Risks PDF
MEED - Weighing The Contractual Risks PDF
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While majority of oil and gas projects are led through EPC contracts,
the build contract model finds greater favour in the construction
industry
Whether upstream or downstream, the vast majority of the GCC’s oil and gas sector projects are
delivered through engineering, procurement and construction (EPC) contracts, although there have been
a few notable exceptions.
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State-upstream operator Kuwait Oil Company (KOC) is set to launch tenders for the construction of new
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gas production facilities under a build-operate-transfer
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The major advantage of the EPC contract to the client over other approaches is that it provides a single
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point of responsibility. Within this, the lump-sum turnkey contract is the dominant procurement model in
the GCC oil and gas market.
The model transfers the risk of cost overruns and benefits of any cost savings to the contractor, with only
a limited ability to claim additional money due to variations in the work. Occasionally, clients will allow
reimbursable contracts.
Disadvantages of EPC
While there are advantages to using the EPC contract, there are also disadvantages, including higher
prices as a result of contractors taking on almost all the construction risk. Contractors factor this transfer
of risk into their price, building contingencies into the price for events that may never happen. Whether the
increased price is worth paying is something clients have to bear in mind during negotiations.
Within the EPC contract, some clients are also looking for new ways to move their projects ahead.
Traditionally, oil and gas projects are developed in three phases with conceptual and feasibility studies
followed by a front-end engineering and design (feed) and then EPC. Studies are typically carried out in-
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house, with some consultant input to define the broad parameters of the scheme.
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Since it comes with a relatively smallYou
cost
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equipment, feed represents a stage-gate in the client’s decision-making
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One disadvantage of the feed and then EPC approach is that once the design is tendered, the EPC
contractor needs to spend hundreds of thousands of dollars to develop their lump-sum cost estimate.
“What’s the point in spending all this money, especially for the large projects, and risk not getting it?” one
source, who has worked on both sides of the fence, tells MEED. “In today’s environment, many
contractors may not even bid. This is also disadvantageous for the client.”
The nature of the oil and gas sector is also very important. Upstream projects tend to need less
equipment, and there are more established norms for cost estimates. However, the further downstream
you go, the more complex the processing and more divergent the routes to get to this final product.
Contractors are unwilling to risk offering a cost proposal without having done extensive engineering.
Adnoc is a rare example of clients’ shifting attitudes towards the process. The company is adopting a new
strategy for dealing with contractors, as it looks to save money and time on a raft of major new oil and gas
projects planned over the next few years, beginning with the planned $1bn development of the offshore
Belbazem oil field.
There are other permutations to the contracts used for projects, depending on the clients’ ultimate needs,
and how it balances its schedule versus costs. Also factored in are the contractors’ appetite for risk,
spending time and money on developing a lump-sum price only to see it awarded to a rival.
The new approach has clear advantages, in theory. It relies, however, on the client making timely
decisions to make sure it does not risk losing any advantage it would have gained. The strategy requires
a strong project management team from the client, most likely with support from a project management
consultant.
“Clients always struggle to meet their own schedules. The reality is, this type of contract has never
happened, for whatever reason, so changing this needs a brave decision,” one source says.
PPP projects often include contracting firms as consortium members responsible for the delivery of the
construction work. This is not only an investment opportunity for contractors, but also a way to deliver
large-scale construction projects without being so reliant on clients for payments.
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