Understanding Costings in EPC Contracts

Estimated reading time: 4 minutes

Understanding Contractor Costing in EPC Contracts

As global demand for power generation continues to grow, there is a growing shift in both the pricing and costing methodologies employed by turnkey contractors. This is largely due to the client or owner wishing to ensure that all (or most) of the risk exposure is to be borne by the main contractor. In response to this, EPC contractors have adjusted the costings of their offerings in an attempt to have project budget to deal with these risks should they manifest. The shift in bargaining power in the parties involved allows Contractors to negotiate contracts in their favour, while understanding the key features of consideration of EPC contracts.

As the risks are transferred from the project owners to the contractors, the contractor usually provides all aspects of detailed engineering, procurement, scheduling, and construction of the project. The contractor company is seen as a ‘one-stop shop’ solution. An EPC contract is highly desirable from an Owner’s perspective as this means that the project should be completed on time and within budget. If this is not the case, the consequences of time and cost escalations are accepted by the Contractor (who is likely to be liable for performance and delay liquidated damages) and not the Owner.

It is important that EPC contracts contain guarantees and that these guarantees are backed by performance liquidated damages if the required standards are not met. Read the rest of the key success factors in managing EPC contracts here.

An EPC contract presents advantages and disadvantages to both the Owner and the Contractor.

Advantages to the Owner include:

• Risks are transferred to the Contractor, including integrating the performance of all package contractors and supply chain related risks
• Provides early cost certainty through the fixed total price and fixed duration of the contract
• Owner is able to focus and monitor on the general progress of the project
• Provides for flexible financing options

Disadvantages to the Owner include:

• Inheriting a risk premium paid to the Contractor for its contingency and risk
• Limited project changes by the Owner, including design changes
• Limiting risk transfer due to liability limitations as per contract
• Increasing the probability of Contractor claims to relieve risk transfer
• Minimizing the Contractor’s incentive to aim for a higher than minimum compliant standard for quality

Advantages to the Contractor include:

• Potential to receive higher margins proportionate with the risk it assumes
• Ability to reduce its competition due to the limited number of Contractors that can assume that risk
• Limited Owner intervention in terms of how the project is executed

However, as with the Owner, the Contractor is at a high disadvantage as it is assuming the maximum amount of risk, while being exposed to uncontrollable factors such as market demand and escalation that are outside the Contractor’s control. An EPC contract transfers more risk to Contractors than any other project procurement methodologies, resulting in higher contingencies and mark-ups for the contract price as a way for Contractors to minimise the impacts of the risks and safeguard themselves.

Understanding Contractor Costing in the International Power Generation Industry is a 3-day training course held from 25-27 November 2019 (Kuala Lumpur). This course provides delegates with a thorough understanding of the key components and their interactions of an EPC contract and will provide focus on the key project management issues required for successful project delivery. This course has been designed to be an immersive experience, with emphasis on problem solving and open dialogue. Many of the underpinning issues that are reflected in project costs are examined – for example, issues such as pollution control and emissions compliance; turbulent market conditions and price escalations in key raw materials.