By Joy T. Gloria, William E. Siegfriedt and Andrew Carstens, Sargent & Lundy
Editor’s Note: This article won a Best Paper Award at the 2010 POWER-GEN International conference in Orlando. This is part of our occasional series publishing the best conference papers from POWER-GEN International.
When embarking on a major capital project, the facility owner must select a basic strategy for the contracting of the project. Various approaches exist and for good reasons, the choice of the contracting approach could affect the outcome of the project. The strategy must be selected with careful consideration of not only the potential upside of the approach, but also an appreciation of the demands each strategy places on the owner’s organization. Any of these strategies can result in undesirable consequences if it is selected without the necessary resources in place.
Depending on the structure and culture of the owner organization and the specific circumstances of a given project, the appropriate approach to produce optimal results may be different. The approach that produced favorable results for one owner could be problematic for another.
Many utilities have traditionally contracted large projects on a turnkey EPC, firm price basis, in keeping with its structured procurement process and philosophy of managing projects with a lean staff. One utility asked Sargent & Lundy to investigate the advantages and risks that may be realized by adopting an alternate contracting approach. The utility and Sargent & Lundy agreed to evaluate three contracting approaches:
- Turnkey EPC with firm price (base)
- Turnkey EPC with target pricing
- Multiple contracts with firm prices
Sargent & Lundy has extensive experience with all contracting approaches. For particular owners, and under specific circumstances, any of these approaches may be optimal. The Multiple Islands EPC approach (where a firm-price contract covers the entire boiler building while others cover the turbine building and the emissions control facilities) has gained some popularity, but is not covered here. Likewise, procurement of separate equipment using Time & Materials Contracting is not addressed here.
Turnkey EPC with Firm Price: With this approach, the entire scope is provided by a single contractor on a “turnkey” basis. It is seemingly straightforward: you buy the project as a single item with a known price tag. The prospective contractors submit competitive firm price proposals in response to a specification (with appropriate details). Upon award, the contractor provides a complete facility that requires the owner only to metaphorically “turn the key” and operate it. The contractor’s scope is EPC, including engineering, procurement of equipment and construction. The price is firm at the time of the signing of the contract. However, with this approach you only get what is written in the contract. There is a heavy burden to thoroughly conceive the project and painstakingly define the concept in the specification. Whatever is not defined will be done in the least expensive way the contractor can find.
Turnkey EPC with Target Pricing: The requirement for a complete concept before the firm price is set turns out to be a serious obstacle to fast-track projects. Target pricing was conceived to make turnkey projects feasible on the shortest possible schedule. There are many variations on “target pricing” for construction projects. They vary in terms of:
- Degree of “firmness” in the early price
- Incentives on the early price
- Degree of “firmness” in the post-engineering price
- Incentives on the post-engineering price
- Degree to which the books are open during preliminary engineering, as well as post engineering.
For a potential flue gas desulfurization project, Sargent & Lundy defined a Target Pricing approach representative of what could be attractive to a utility and its contractor for a retrofit emission control project. As with the Turnkey EPC Firm Price approach, this approach also includes the entire turnkey scope, which is provided by a single EPC contractor. Under this approach, the prospective contractors would submit competitive target price proposals in response to a specification (with appropriate details). This approach would be less costly for contractors to bid and may therefore result in increased competition during the bid period.
However, at the time of contract signing the cost would be only a guide. Certain pricing parameters, such as markups, contingencies and profit would be fixed in the contract. In addition, a firm price would be provided for the preliminary engineering phase of the project.
During the preliminary engineering phase, engineering would be performed, equipment bid, the project schedule would be detailed and a definitive estimate prepared. The owner would be included in decisions regarding quality, equipment selection, profit, cost contingencies and schedule. When the preliminary engineering phase is complete, the owner and the contractor would meet and agree on the scope, schedule and price. Typically, the books would be closed to the owner at this point and the contract price would become fixed.
Newcomers to this approach wonder how the contractor is incentivized to be competitive. There are many elements that go into the cost of the contract. The majority of them can be fixed at the time of the initial bidding and contract signing. Typically, the following would be bid firm:
- Contractor general and administrative (G&A) percentage
- Contractor profit margin
- Any premiums for EPC packaging or for acceptance of extraordinary risk
- Contractor markup on purchased equipment
- Contractor markup on purchased materials
- Contractor markup on subcontracts
- Field labor rates, including workweek incentives (overtime assumption) and living expenses (per diem)
- Field labor productivity
- Escalation on field labor rates.
The items that remain open until the definitive estimate include material takeoffs (estimated quantities) and unit labor rates (field labor time required to perform a unit of each task). Thus, the majority of the elements contributing to the ultimate price would be fixed at the time of competitive bidding. Only the last two items remain as a point of negotiation.
Multiple Contracts with Firm Prices
A multiple contract approach may divide the scope into a few or many contracts. More contracts increase the owner’s opportunity to save cost but also increase the owner’s risk with respect to project integration.
Individual contracts were identified to minimize costs associated with markup on subcontracts as well as risk premiums on work to be performed late in the project. This approach would allow the early work (chimneys and their foundations, transformers and the FGD system) to be awarded early in the project, whereas the balance of plant (BOP) would be awarded over a year later, closer in time to the execution of that work. For purposes of this study, each package would be bid at a firm price, but there would be greater interface work between the packages.
Comparison of Contracting Strategies
To compare the different contracting approaches, Sargent & Lundy drew on its own experiences, but also conducted several interviews with owners and contractors. The insight provided by outside sources was extremely valuable.
According to almost all of those interviewed, the Turnkey Fixed-Price approach is better utilized when a substantial amount of up-front engineering work has been performed. Preliminary engineering is required to clearly define the contractor’s scope of work. A poorly defined scope for such a large project will have consequences that affect all categories of risk. If unforeseen scope items or existing plant conditions are discovered after contract signing, the cost of the additional work is difficult to control, and achieving the scheduled startup date may become a problem. Consequently, the contractor may be forced to take shortcuts in their design, procurement and construction processes in order to meet the schedule, which will likely have consequences on quality and cost. Perhaps the most important consequence of a poorly defined scope is the risk premium the contractor assumes due to scope uncertainty.
The Turnkey approach, by nature, puts virtually all of the project risk upon the contractor, who must decide how large a risk premium must be added to the fixed price to cover his risk. Therefore, a poorly defined scope will force the contractor to increase his price in order to assure a profit. For the utility, a considerable effort has already been put forth to clearly define the scope; therefore, Sargent & Lundy believes that the risks associated with scope uncertainty have already been minimized.
A significant advantage of the Turnkey approach is that resources can be shared between work areas that would otherwise be under separate contracts with the Multiple Contracts approach. Sharing of large cranes is a major opportunity for savings. Sharing of cranes avoids repeating the major expense of mobilization/demobilization of cranes for each task. Likewise, manpower resources can be shared across the work areas. Steelworkers erecting steel for one work area can be the same crew that does so for another area. Pipefitters installing pipe for one system may be employed for another that would otherwise be under a different contract. Sharing of manpower resources avoids costs for recruiting, training and optimizing the makeup of these crews.
Because the contractor under this contracting strategy assumes most of the project risk, the owner has less control over the quality of materials and equipment purchased beyond what is in the specification. By nature of a Fixed-Price contract, there is an incentive for the contractor to purchase the least expensive material and equipment to satisfy a history of low bid/high rate of change orders during the bidder qualification process. During contract execution, the owner’s engineer must monitor and audit change order requests.
Several interviewees noted that contingencies and risk premiums can significantly increase cost in a Turnkey Fixed-Price approach. One source noted that this was largely due to the compounding of risk premiums. In their experience, the prime contractor adds risk premium to original equipment manufacturer (OEM) work, to which the OEM has already applied risk premium. Furthermore, one OEM noted that the prime contractor assigns higher risk premiums when they are responsible for subcontractors’ guarantees. In addition, a risk premium on the project schedule would be added when a subcontractor’s scope of work is on the critical path. In spite of these cost items, many of those interviewed believe that the cost premiums associated with EPC packages would be largely offset, when compared to a Multiple Contract approach, due to the additional owner’s staffing requirements, owner’s risk and owner’s engineering costs associated with a Multiple Contract approach.
For the Turnkey Fixed-Price approach, the future labor cost must be considered carefully. At the time that the proposal is submitted, the bidder must evaluate the risk of extraordinary inflation over the period of the contract. The bidder must include a risk premium according to the likelihood of such inflation and the possible magnitude of the escalation. Because this evaluation must be made so early, this approach will include the highest risk premium for future labor cost.
Turnkey EPC with Target Pricing
The Turnkey approach with Target Pricing, in contrast to a Fixed-Price approach, is appropriate when insufficient preliminary engineering has been conducted to thoroughly define the project scope. All of those interviewed agreed that the most important criterion to engage in this contracting strategy is that the owner must have a good relationship with the contractor. As emphasized by some of those interviewed, trust is critical to the success of this approach. In addition, the trust must be mutual:
- The owner must trust that the contractor is working to the owner’s benefit and is not out to exploit him.li>The contractor must trust that, when issues come up, the owner will work with the contractor as a team to resolve the issue, instead of immediately resorting to legal recourse.
The necessary trusting relationship must be built largely of experience working together on projects. It derives from the familiarity with one another’s business practices and working procedures. It derives from familiarity with one another’s overall business perspectives: Does my counterpart keep detailed records and expect the same of me, or does he depend more on the daily relationship? Does he set small issues aside, accumulating them before expecting settlement, or does he want to settle each detail with as much zeal as a major contract item? Does my counterpart value our relationship into the next job, desiring to earn/pay a fair profit on each project, or does he only care to maximize his benefit on this project?
This trust is necessary to select a bidder without a firm price and to conduct the review of the definitive estimate. In this review, each line item will be reviewed to determine its accuracy and fairness. Is the estimated material takeoff (MTO) accurate for the preliminary design? Is the labor estimate (hours per unit for the installation task) reasonable for that work under the circumstances that the work will be done? Neither party has strong leverage over the other in this give-and-take, yet after the contract is written, this is the one place where the price will be made or broken for both parties. If the trust borne of experience working together is not present, this negotiation could break down. The result of such a breakdown is either a contract neither party wishes to be a party to, or the owner must forfeit the engineering cost and re-bid the project for startup one year later than planned.
With respect to schedule risk, it is commonly thought that the Target Pricing approach takes longer than the Fixed-Price approach. This is because with the Fixed-Price approach, the design work on some components can be in parallel with fabrication and construction of others. With Target Pricing, the preliminary design phase could extend the project a few months, since significant effort goes into design prior to the full release. According to a survey participant, the schedule may not be extended, although his experience with Target Pricing is mainly with construction-only contracts. His experience was that if the contractor had good experience, they could often meet or beat the schedule of an analogous project with a Fixed-Price approach.
With respect to risk on project performance, there is less risk associated with this approach compared to the Fixed-Price approach for both the contractor and the owner. This is because costs are finalized after substantial engineering is done, which minimizes scope uncertainty, and all equipment is bid, which minimizes cost uncertainty. The owner works intimately with the contractor during the preliminary engineering phase. The owner has direct control over the quality of material and equipment selection up until the time that the scope, design, and contract value are agreed upon and the books are closed.
Because the owner is directly involved in the project cost estimating, one could argue that there is less overall risk on project cost compared to the Fixed-Price arrangement. For example, by the time the books are closed on a Target Price contract, the level of contingency in the final target price should be significantly lower than the contingency built into a Fixed-Priced contracting approach. In addition, many owners will negotiate for shared savings (if cost comes in under the fixed price) and a cap on the cost (if an overrun were to occur). On the other hand, the owner would have to select the contractor with no real assurance of what the final contract price would be. In that respect, at the point of contractor selection, there would be more cost risk to the owner associated with this strategy as compared to the Fixed-Price approach.
While the Turnkey Target Price approach would theoretically yield more bidders because their proposal efforts are reduced, Sargent & Lundy observes that there may be a limited number of contractors with whom any given utility has the length and depth of experience required to establish the level of trust required for this approach. Utilities also may be required to open its procurement to all qualified parties. Sargent & Lundy observes that some utilities do not have relationships with sufficiently large Target Price contractors that include the necessary degree of mutual trust. Combining the required procurement process with the Target Pricing approach may result in a contract to an unfamiliar contractor who lacks the important mutual trust.
For two reasons, the impact on the concern over future labor cost is somewhat less for the Turnkey Target Price approach than with the Turnkey Firm-Price approach. First, the amount of field work is better defined for the Target Price approach because the estimate is made after the preliminary engineering has been done, and the resulting definitive estimate has better resolution than the proposal estimate on which the Firm Price would be based. Second, the final price under the Target Price approach is set some nine months later than the Firm Price would be set. This would cut some 25 percent off the time lag between setting the price and incurring the cost of the most expensive labor, electrical field labor, which would significantly reduce the risk premium on this labor.
Multiple Contracts with Firm Prices
The contracts for this approach are selected to assign direct contract responsibility to each contractor to manage his scope and responsibility directly. This approach enables the owner to manage cost uncertainty by awarding work no sooner than necessary. Of course, each contractor will need to make a profit and will need to include some contingencies for uncertainties in pricing. However, each contract would be separated so that the individual contracts consist of only elements with which the contactor has the greatest comfort. Thus, in terms of percentage, the risk premiums would be reduced significantly. In addition, the owner would have a direct contract with the OEM with regard to performance guarantees, while the Design Engineer and the BOP EPC contractor would be primarily responsible for the project schedule. The key risk premiums that would be lowered by this approach are:
- The risk on the OEM portion due to a deferred award of up to three months compared to the Turnkey Fixed-Price approach.
- The risk on electrical construction labor due to a deferred commitment and better definition of the BOP construction portion typically more than a year later than the Turnkey Fixed-Price approach.
- The risk on the electrical construction materials and labor due to a deferred commitment of the BOP construction portion to a time that is after the engineering of the electrical work is mature.
It should be noted that, in the event of rapid escalation in the construction labor market, delayed commitments of the packages with field labor could have the opposite effect, increasing costs rather than reducing them.
While there is a greater probability that the total project cost would be lower than with either of the Turnkey approaches because of reduced contingencies, the owner’s risk is increased due to the obligation to coordinate the contracts with this approach. In this case, performance, cost, and schedule risk are all tied to how skillfully the owner integrates the work of the contractors. The owner and the owner’s engineer would need to exercise extreme diligence with respect to interfaces among the multiple contracts. The multiple specifications must avoid any scope overlaps or scope gaps among the contracts. In addition, the work must be carefully coordinated among the multiple contractors lest one aspect of the project cause a delay in another. The reality remains that a major unforeseen delay in one contract could lead to major cost additions in several other contracts.
The demand that this contracting approach would place on utility personnel and the need it would create for streamlining business procedures would be substantial. This approach, applied to a large project, would create an extraordinary demand for high-performance individuals performing demanding work. The Multiple Contracts approach would require substantially more owner personnel than the Turnkey approaches. In addition to the personnel needs, the Multiple Contracts approach would demand that a utility client have effective processes in place for procurement, handling of technical issues, processing of technical and payment documents, etc. For the Multiple Contracts approach to deliver on its advantages, the utility must commit to finding enough of the right people to make it a success and to establishing the streamlined work processes necessary for success. One utility employee surveyed suggested that even if the utility were to assign the right people and upgrade its procedures, there is no assurance that the Multiple Contracts approach will deliver on the promise of lower cost. For this approach to succeed for a utility, a strong commitment to staffing additional key positions and to modifying procedures to allow timely and decisive action would be critical.
With a turnkey project, it is clear who assumes the responsibility in the case of a project concern. All responsibility rests with the single contractor. With Multiple Fixed-Priced contracts, every interface involves two contracts, with the owner in the middle. In case of a dispute, this situation makes it more difficult to assign responsibility. Of the three approaches discussed here, this is the most likely to devolve into interface issues, making any real claims against a contractor difficult to realize. For this strategy, the expertise of the owner’s engineer and the design engineer would be essential to reduce the burden on the utility.
The impact on the Multiple Contracts approach of the concern over future labor cost is significantly less than with either of the Turnkey approaches. This is primarily because the electrical field labor would be included in the BOP contract, which would typically be bid up to two years later than the Firm Price bid, just before the execution of the work. The risk premium on this labor would be almost eliminated.
A non-cost consideration in favor of the Multiple Contracts approach is that the smaller packages create opportunities for local contractors that may or may not exist under a Turnkey approach. In particular, local contractors will likely be attracted to packages such as the BOP (electrical construction and pipe/cable racks) and Foundation/Underground packages.
Impact of Labor Market
A confounding factor in this study is the question of how the potential changes in the labor marketplace over the period 2011 to 2013 may impact the various contracting strategies. From 2004 to 2008, the cost of skilled field labor escalated rapidly, with severe impacts on project cost. During 2009, availability of labor improved substantially and cost eased significantly. In discussions with equipment suppliers, there is evidence that there may be a substantial upswing in emission control contracts in the 2011 time frame. With the recovery from the economic downturn, it is expected that there will be a general recovery in contracting over the period 2011 to 2013. The concern is that this project may face another period of rapid escalation of labor cost. The biggest impact of such a cost run-up would be to the work to be performed near the end of the project.
Estimating Approach and Assumptions
Sargent & Lundy developed capital cost estimates based on our in-house database of power project costs, which include equipment, material, labor, escalation and project risk premiums. Our database is continuously updated and vetted with cost information based on Sargent & Lundy participation on approximately 40 percent of the emission control retrofit projects implemented by the U.S. power industry in the last 10 years. Sargent & Lundy’s emission control project experience encompasses participation on projects as design engineers on projects implementing a Turnkey contract approach and a Multiple Contract approach, as well as owner’s engineer on projects implementing a Turnkey contract approach. Sargent & Lundy has developed the study cost estimates based on a “bottom-up” approach. Specifically, the following conceptual design information was developed:
- Detailed scope of work and equipment list
- General Arrangement drawing
- Site Development drawing
- Process Flow Diagram
- Electrical Single Line Diagram
- Project Schedule.
The cost estimates were developed to simulate the Firm Price approach, which would be the base estimate, the modifications the contractor would make to its estimate as a result of detailed engineering (Target Pricing approach) or a result of a different schedule (Multiple Contracts approach).
Sargent & Lundy estimated the total project cost for each contracting approach based on a number of parameters, which are discussed in the following paragraphs.
Simulating Bidder’s Estimate: Before adjusting estimating parameters, such as contingency and EPC premium, Sargent & Lundy first modified each estimate to simulate how the bidder’s estimate can change between the request for proposal and the time that the bidder submits the bidder’s estimate. The Turnkey EPC with Firm Price approach will be the basis for comparison. For Firm Pricing, the bidder estimates the equipment, material, and labor at the time of proposal submittal. For this type of a large project, the bidder will have basic engineering done and preliminary estimates of the equipment and material needed. At this time, it would be difficult to account for all the equipment and material required, and the bidder would not have estimated every detail of the project. However, the bidder would anticipate missing items and would consider them when adjusting contingency.
For the Turnkey EPC with Target Pricing, the bidder would submit a firm price estimate after approximately 9 months of engineering has already been completed. At this time, the contractor will have firm prices on major equipment and will have more details on the amount of material required compared to the bidder of the Turnkey Firm-Price approach. To be conservative, Sargent & Lundy has increased the cost of equipment and materials from the original cost estimate for the EPC with Firm Price. The equipment and material costs would increase due to a more mature design and a 5 percent increase was selected as a significant increase yet not overly conservative.
To simulate the Multiple Contracts with Firm Prices approach, Sargent & Lundy extracted engineering associated with the BOP contract and the Foundations contract. The engineering for these two contracts would be included in the scope of the third party design engineer. Sargent & Lundy has estimated the cost of this engineering and separated it from the owner’s engineer scope so that differences in the owner’s engineer costs and design engineering costs can be observed.
Contingency: The contingency for each contracting approach was estimated to be different due to the maturity of the bidder’s estimate. As mentioned earlier, the bidder following the Firm Pricing approach would estimate the total project cost without a significant amount of engineering. Therefore, the contingency would be higher than that for an estimate based on more detailed engineering. The Sargent & Lundy standard contingency for a Turnkey Firm-Price retrofit project is 20 percent, which has been selected for this retrofit project cost estimate.
In Target Pricing, the bidder’s estimate would have a greater amount of accuracy due to the better-defined scope and completed engineering. Since the bidder’s estimate will be more accurate, Sargent & Lundy has estimated that the contingency will decrease. At the time that the books would be closed, most major equipment would have been bid and evaluated. The overall contingency has been lowered based on firm pricing of the direct equipment cost at time of closing. The bidder will decrease his contingency because there is lower potential for variation in price and quantity of equipment and materials at the time of the fixed price.
Contingency for the Multiple Contract approach varies with the scope of the contract. For the contracts that only supply standard commodities, such as the Chimney and Transformer contracts, contingency has not been included. The estimated cost of the Chimney and Transformer contracts would be the same as the cost estimate in the Turnkey EPC with Firm Prices because the bidder would still estimate the same price for the same equipment. The value of these contracts would only include the cost of the commodity that is estimated in the bidder’s proposal. Therefore, Sargent & Lundy has estimated that the contract would not require any contingency. However, the remaining contracts will include equipment and material that will be designed much later than when the contract will be signed. Therefore, the contingency for the remaining contracts was estimated to be the same standard contingency as the original Turnkey EPC with Firm Price.
EPC Premium: EPC Premium is the additional cost that the bidder will include in the total project cost to cover any unforeseen costs due to subcontracting, in particular due to interfaces between subcontractors. The standard 10 percent EPC premium on subcontracted packages was used for the EPC premium in the Turnkey EPC contracting approaches. Under both the Firm Pricing and Target Pricing approaches, the contractor is responsible for the entire scope of the Turnkey EPC package. Therefore, either approach would be subject to the unforeseen costs and therefore the EPC premium. The Multiple Contracts approach will only include one EPC contract, the FGD System. Since the FGD System contract includes subcontracting of the construction, the 10 percent premium is applied here.
Escalation: The escalation parameters (equipment, material, labor and indirects) depend on the market value and projected wage rates for the time of the contract. These parameters have been estimated using the information from all of the past and present emission control projects in Sargent & Lundy’s estimating database. Escalation parameters are not dependent on the type of contracting approach chosen for this retrofit project and remain constant for each of the three total project cost estimates.
Comparison of Engineering Scopes
The scopes of work for both the owner as well as the owner’s engineer will vary for each of the contracting approaches. Some of the pre-award and post-award activities for the three cases will be similar. The owner’s engineer will be responsible for evaluating the proposals and supporting the owner after the contract has been awarded. For pre-award activities of the Turnkey EPC with Target Pricing Contract, the owner’s engineer will support the owner in defining the approach for the contract. Pre-award activities specific to this contracting approach include establishing the target date for the end of preliminary engineering/Phase I and determining the pricing basis for preliminary engineering. As for the Multiple Contracts approach, not only would the owner’s engineer prepare specifications to support five separate packages, but would also evaluate five separate proposals.
Engineering design work would only be required of the owner’s engineer for the Multiple Contracts approach. The engineering scope of work would include engineering/design work for all the foundations, pipe and cable racks and electrical wiring.
The majority of the post-award activities will be similar for the three cases, but the Turnkey EPC with Target Pricing case requires additional supervision by the owner’s engineer. During preliminary engineering/Phase I, the owner’s engineer will need to closely monitor engineering activities and the development of the definitive estimate. The owner’s engineer is responsible for evaluating the fairness of the definitive estimate and should closely monitor the contractor’s activities.
Total engineering estimated in the original Turnkey EPC with Firm Price includes both EPC Engineering and Design Engineering. In the case of Target Pricing, the EPC engineering will be separated into preliminary/Phase I engineering and detailed/Phase II engineering. After Phase I, approximately 20 percent of the EPC engineering will be completed and the remainder will be completed in Phase II. EPC engineering for the Multiple Contracts approach will only be required for the FGD System contract. The remainder of the engineering will be completed by a Design Engineer.
For the purpose of this study, it has been assumed that the efficiency with which the BOP engineering is done is the same whether it is included in the Turnkey package (first two approaches) or performed by a third party design engineer (Multiple Contracts approach). In fact, one approach may be slightly lower cost and lower quality, but the productivity of the engineering would be similar.
Comparison of Owner Staffing Requirements
Turnkey EPC with Firm Price: The Turnkey Fixed-price approach is appropriate when owner staffing levels would not support the engineering and procurement that may be required for other contracting strategies. With this approach, one contract is negotiated. While review of design documents and witnessing of equipment testing require owner participation throughout the project, this contracting approach creates the least demand on the owner’s personnel. Excluding the additional operating and maintenance personnel, utility staffing levels are currently adequate to move forward with a Turnkey Firm Price approach.
Turnkey EPC with Target Pricing: With the exception of the preliminary design phase at the beginning of the project, the staffing requirements for the Target Pricing approach are the same as with a Firm Price approach. To get the greatest benefit from the preliminary design phase the utility should devote significant involvement of its personnel as well as the resources from the owner’s engineer. A concerted effort is desirable during this phase to assure that the most appropriate scope, design elements, and costs are agreed upon.
Multiple Contracts with Firm Prices: Because there would be five contracts, one of the main stresses on personnel that would be experienced is within the utility’s procurement department. Undergoing the same process for five contracts may be a significant disadvantage to this approach. This approach also requires more staffing to manage the interactions between the five contractors. The owner’s engineer can substantially handle this work, but a number of procurement, legal, technical and managerial roles should be filled by utility staff.
Schedules for environmental retrofit projects have been subject to severe swings over the past five years. For this reason, the context of the project schedule should be discussed before attempting to compare schedules for the three contracting approaches. During the period 2006 to 2008, there was a sharp increase in demand for emission control systems, which substantially exceeded the industry capacity. As a result, prices spiked and project durations lengthened. During the fallow years before 2005, a wet FGD retrofit could be achieved in as little as 30 months, from Notice to Proceed to commercial operation date. However, as shops filled up, materials became scarce and equipment suppliers became backlogged; the market quickly normalized to 36 months and finally extended to 42 months. Sargent & Lundy surveyed recent projects and held discussions with industry sources. Based on this input, Sargent & Lundy believes the market is currently in another lull, but this one will be short. We expect lead times will extend.
Once the contract is awarded to the FGD OEM, the number of months required to complete would be similar for all three contracting approaches. However, the duration of the contract may be longer as the release is deferred into the marketplace that is expected to be increasingly active.
This dependency of contract duration on contract release date has some impact on selection of contracting approach. The date of the NTP will vary for each of the contract approaches.
In the schedule for the Turnkey EPC Project with Fixed Price, procurement is the first thing that occurs in the project. The OEM is able to procure equipment shortly thereafter and the project proceeds on a short schedule.
In the schedule for the version of Target Pricing envisioned here, no procurement occurs until completion of the preliminary engineering/definitive estimate phase. Thus, the NTP to the OEM is delayed a few months, with a commensurate delay in the rest of the project.
For the Multiple Contracts schedule, the award of each contract is spaced such that each contract is signed at the time the work must be started for that portion. As discussed before, awarding the contracts closer to the scheduled outages can lead to a reduction in risk premiums for the FGD and BOP contracts. However, the owner and the owner’s engineer will require time and effort to carefully coordinate the five contractors. Without organization, the project may be delayed by emergency coordination or settlement of disputes. With the appropriate coordination, the Multiple Contracts approach is estimated to conclude at the same time as the Turnkey EPC with Firm Pricing approach.
Sargent & Lundy has prepared a Total Project Cost for each of the three project approaches. This comparison illustrates that compared with the 1.0 price for the Turnkey Firm Price approach, the Turnkey Target Pricing approach is estimated to save 2.1 percent of the project cost. Likewise, the Multiple Contracts approach is estimated to save 6.8 percent. These projected savings are contingent upon the project being executed as planned.
For the Target Pricing approach, proper project execution includes:
- Achieving a list of bidders both sufficiently large enough to execute the project and sufficiently known and trusted to enter into a Target Pricing agreement
- Investing the personnel and effort to monitor/participate in the preliminary engineering and development of the definitive estimate, such that the lowest fair price is achieved and the utility is comfortable closing the books.
Proceeding without these, the Target Pricing approach is likely to fail to produce the desired results. It is possible that an environment of distrust will evolve. It may become impossible to agree on estimate quantities and the total cost of the project may actually exceed what the Turnkey Firm Price approach would have produced.
For the Multiple Contracts approach, proper project execution includes investing in the personnel and procedures necessary to procure the major packages. If this approach is attempted without exercising the necessary attention to detail when it is needed, cost control will not achieve the estimated benefits. Although the estimate shows estimated savings for this approach, failure to staff the necessary owner functions with qualified individuals may erode the estimated savings.
The Turnkey EPC with Firm Price could be the most costly contracting approach of the three that were evaluated. However, other considerations such as utility staffing, contractor-owner relationships and many utility’s limited experience with the alternate approaches could introduce unforeseen risks. These risks could then hinder the ability of the project team to achieve the potential cost savings associated with the alternative contracting strategies considered in this analysis.
Depending on the project’s size and financing, the savings associated with the multiple contracting strategy with fixed pricing could be worth the risk.
Power Engineerng Issue Archives
View Power Generation Articles on PennEnergy.com