Specifics of EPC and EPCM

Chapter 4
Specifics of EPC and EPCM

4.1 EPC and EPCM

At present, the engineer procure construct (EPC) delivery method is used as a brand name for certain types of design-build (DB) projects and contractors. The abbreviation is used mainly to label a specific risk allocation. In EPC projects, the contractor is responsible for engineering including design (the engineer duty), organising procurement of works, plants, materials and services (the procurement duties) and executes the construction works (the construct duty). Compared to the standard delivery methods described in Chapter 3, EPC contracts exhibit some differences. Therefore, EPC deserves separate consideration and discussion.

The EPC delivery method was very popular in the construction industry because it allowed greater prediction of overall price and time for completion. The resulting popularity led to a growing demand for sample contract forms based on the EPC method. This encouraged organizations such as FIDIC to produce separate sample forms (FIDIC EPC/1999 Silver Book). Organizations such as Orgalime, the AIA, the ICC, the ENAA, the ICE (see Chapter 13) and others also issued their own sample contract forms in support of the EPC delivery methods.

An alternative to EPC is the engineer procure construction management (EPCM) delivery method. This approach can be found mainly in the mining, petrochemical and power engineering sectors. EPCM appears similar to EPC in name, but in fact is different in many other aspects.

In EPC and EPCM projects, the plant contractor is in possession of the know-how and copyrights to manufacturing processes. Therefore, they are a key element of the contracting chain. This contractor is usually the lead participant in the contractors’ joint venture or a representative of the main EPC contractor.

4.2 Engineer procure construct (EPC)

EPC projects come under the umbrella of the DB delivery method. EPC projects are characterized by the fact that they allocate the lion’s share of risk to the contractor. The expectation then is that the contractor will be able to control and assess risks in their bid price. This is especially so in construction projects for power plants, steel mills, factories and manufacturing plants in the petrochemical and mining industry and in the field of environmental and water treatment projects. In these projects, in general, plant delivery prevails over construction works to be contracted. The significance attributed to plant delivery and uniqueness of product will no doubt affect the contractor’s negotiating position. For example, when a nuclear power plant is to be constructed, delivery may account for 70–80% of the contract price with the plant contractor being a key player.

Typically in EPC projects, the contractor is responsible for whole project realization and for fitness for purpose of the result. The contractor is obliged to scrutinize the employer’s tender documents, including specifications, geological surveys and design documents (if any). Barring exceptions, responsibility for related errors lie with the contractor. The contractor, for example, is usually obliged to verify the physical environment on site and bears the responsibility for complications caused by geological and hydrological conditions. The contractor only has limited options to claim for additional payments. Naturally, this approach can efficiently be used only in specific construction projects—particularly where there is enough time to scrutinize the employer’s requirements, verify site conditions and where there are only limited risks foreseen. The contractor must assess the risks and include a risk surcharge in their bid price and the employer must expect this.

In EPC projects, the contractor has to deliver work fit for the intended purpose. Because of the lump sum price model, it is in the contractor’s own economic interest to deliver at the lowest possible cost. Most probably the contractor will select and implement cost reduction methods and technical solutions within realization. For this reason, an EPC employer will have to survey the work in progress and verify work performance through frequent testing. Tests in EPC projects are typically divided into three phases: individual, complex (on completion), and warranty tests (after completion). In their tender requirements, some of the employers extend the contractor’s obligations to include operation and maintenance of the work for a certain time after completion. This motivates the contractor to deliver the work at the lowest operating cost and at the highest possible quality.

A DB contractor is responsible for ensuring that the completed work is fit for purpose. EPC contractors and designers are therefore responsible for the results of their work in the same way. In accordance with the employer’s tender requirements, the employer will define the scope and key criteria. In the case of a thermal power plant, for instance, the employer would typically specify the amount of power to be generated over a given period of time, for what consumption of fuel (coal, gas, biomass), and the waste production and the air pollution limits. If an employer fails to include a vital item in their tender requirements, the EPC contractor must remedy such shortcomings in their bid in order to complete the predefined purpose of the work.

It is extremely important for an EPC employer to prepare their tender requirements as accurately as possible. In particular, the project must be feasible and the performance criteria achievable. These performance and functional criteria may also be simply defined as ‘categories’ with particular values to be filled out by the contractor in its bid. These values often become subject to evaluation along with the price and other criteria quoted in the contractor’s bid. It is vital for the contractor to have enough time to prepare the bid and to scrutinize the employer’s requirements.

The specifics of EPC risk allocation are further confirmed, for example, in the following ICC case no. 12090 (2004) (ICC, 2012). In this case, an employer (a company) entered into an EPC contract under English common law with the contractor (also a company) for the supply, installation and commissioning of 80 wind turbine generators for a wind farm project. Within five years of installation, most of the wind turbine generators had ceased functioning due to high wind turbulence and a high rate of grid failures at the site (despite being designed to have a 20-year useful life). A damages claim followed. The contractor argued that based on its past dealings with the employer, it was only responsible for supplying standard turbines and that it was not responsible for investigating wind conditions at the site. The tribunal found that, according to the EPC contract, the contractor was responsible for supplying site-appropriate turbines as the contract referred specifically to the particular conditions at the site, including wind data in several places. The tribunal found that it was up to the contractor to design and supply the wind turbine generators that would suit the site and it was also up to the contractor to ensure that it had all the relevant data about the site (and to make appropriate use of the data), in order to ensure that the wind turbine generators supplied would fulfil the requirements of the contract. This applies to the wind conditions, the characteristics of the terrain, the electrical grid characteristics and everything else about the site that any wind turbine generators designer would need to take into account. The contractor sought to avoid liability for the failure of its wind turbine generators by further referring to an expert report that claimed the effect of high wind turbulence and the high rate of grid failures at the site were so extraordinary that the contractor could not have been expected to have provided for them. However, the sole arbitrator decided that the allocation of responsibility provided by the EPC contract prevailed over these conditions.

4.2.1 Main advantages and disadvantages of EPC

The following are often recognized as advantages of the EPC delivery method:

  • single point contractor’s responsibility for construction works and design;
  • lump sum (foreseeable) price;
  • simpler budget policy from the lender’s perspective;
  • faster project implementation and foreseeable completion date;
  • enforcement of performance liabilities can be narrowed to one particular entity;
  • contractor efficiency in searching for cheaper and quicker solutions.

The following are often recognized as disadvantages of the EPC delivery method:

  • Limited employer control over the design in progress and over project realization. In conventional DB projects, the engineer—who is often also a designer as the author of the basic tender design documents—is in control of design development. However, there is usually no engineer in an EPC project and the competence of the employer’s representative and their capacity to supervise design and project realization depend on their abilities in these fields.
  • The final contract price tends to be higher than in a conventional DB or where General Contracting is used, mainly due to (1) higher bid preparation costs; and (2) delegation of more risk to the contractor. This in turn may lead to contractor profit when the risks are not realized. The level of competition and the particular phase of the economic cycle can impact on the contractor’s prices and risk surcharges.

4.2.2 Key issues with the EPC delivery method

The key issues that must be dealt with whenever an EPC contract is being prepared are as follows:

  • definition of the scope of works, its performance and other technical criteria;
  • a contract administration approach;
  • allowance for claims for additional payments or extension of time for completion;
  • risk allocation (mainly the responsibility for errors in the employer’s requirements, errors in setting-out, errors in the employer’s design, risk allocation of unforeseeable difficulties, exceptional events or force majeure);
  • responsibility for obtaining the respective permits and licences;
  • variation procedures;
  • tests and taking-over procedures;
  • performance and other guarantees provided by the contractor;
  • defect notification and operation period;
  • training of employer’s employees;
  • responsibility for delivery of spare parts and other necessary service materials;
  • intellectual property rights and their protection, licences and know-how for plants;
  • insurance and securities. See Loots and Henchie (2013) for more details.

4.3 Bespoke EPC contracts

Contractual relationships in EPC often take the form of a ‘bespoke contract’. EPC employers, engaged in the fields of power engineering or manufacturing plants, often have their own employees to take care of procurement and management. These employers are usually well experienced in project management within their field, being competent to manage and efficiently cooperate with the contractors.

Take a worldwide active steel manufacturer as an example of such an experienced EPC employer. Every steel mill is a complex system of technologically diverse, but separable and independent assemblies. Such steel mills often have their own coke-oven batteries, blast furnaces and/or electric furnaces and related power plants to power them. Closely related to such a steel mill tend to be manufacturing plants such as a rolling mill or a forge. Possible combinations of various independent technological units are numerous there. In the overwhelming majority of cases, such a business entity will have these technological units built by independent manufacturers within EPC projects for both greenfield constructions and reconstructions or extensions of existing manufacturing capacities.

Sometimes it can be the case, however, that an experienced EPC employer will naturally maintain, on a long-term basis, its own capacities for the procurement and management of the EPC contractors. This can lead to a partial cost saving on activities that need not necessarily be undertaken by the contractor because the employer will retain these activities. At the same time, an experienced employer’s team will manage and supervise project costs so that they are incurred in a reasonable way. Last, but not least, the employer’s EPC team must coordinate the technological compatibility of independently built (or existing) plants by formulating specifications and supervising the work while it is being carried out.

4.4 Turnkey EPC contracts

EPC projects are sometimes called ‘turnkey projects’. There is typically minimal employer intervention during realization and they assume take-over of a fully functional work that is fit for purpose. Even though the ‘turnkey projects’ brand has many diverse uses and an unclear meaning, the approach is appreciated and used by employers in need of implementing a one-off or very specific EPC project. Turnkey projects are preferred where the employers lack the necessary experience or where such projects include extensive plant delivery or risks that cannot be assumed by the employer—particularly where the objective is to allocate maximum risk to the contractor. The FIDIC EPC sample form (the Silver Book) is a template for use intended for such employers.

Imagine, for example, an investor, a member of a traditional and large business holding in a developing country engaged in a variety of activities, ranging from industrial production to import and representing foreign contractors. In response to the newly liberalized local power market, this investor decides to extend their business activities in an attempt to penetrate the power market as well. This is why they, as one of the first applicants, have obtained the necessary energy producer’s licence issued by the government of this country. However, due to a shortage of power plants and a growing need for energy by the country’s rapidly growing economy, the licence is of limited duration. Due to this time limitation, the government motivates the investor to commence construction of a power-generating unit as quickly as possible. The investor must therefore commence construction without any undue delay, as they face the further risk of potentially losing the licence. Such a situation will hardly allow the investor to develop their capabilities and capacities within a reasonable timeframe. Therefore, they have to engage an experienced contractor with expertise in power engineering—someone who is able to supply such a new turnkey power-generating unit quickly and without undue delay. An EPC contract for a power-generating unit construction project will be the best option for this investor.

Take another example of an experienced local investor with long-term involvement in running power plants, including construction and overhaul. This investor decides to include a new nuclear power plant in their portfolio, following a long-term strategy of product diversification. More than 70% of such nuclear power plant construction rests with the technologies to be delivered. Despite the investor’s extensive experience, the key role will belong to the contractor who will deliver the parts not available and known to the investor. The investor has neither the necessary know-how, nor the resources to allow them to complete the construction on their own. In such a case it will be advantageous for the investor to procure the nuclear power plant construction project as an EPC with a contractor or perhaps even with a joint venture of other contractors. The contractors will design, construct and put into operation a fit-for-purpose product and provide the necessary training of the investor’s personnel for safe operation of the plant.

4.5 Front end engineering design

Normally, an EPC employer prepares the initial design for the purpose of awarding the contract on a Front End Engineering Design (FEED) basis. With the employer’s requirements to hand, the contractor will provide the detailed design and be supervised by a representative hired by the employer.

When formulating their requirements, the employer will further, as a rule, elaborate on a preliminary time schedule, contract price estimation and obtain some of the necessary permits from the public authorities. The amount of detail of the employer’s tender documentation will depend on the particular project, the specific branch of industry, the country, the location of project implementation, etc.

Within the limits of this preliminary phase—but preceding the commencement of the contractor selection stage—the employer must make a choice between EPC and EPCM for project implementation.