1	Contracting/Commercial Strategy for the21st Century and the Management of Risks on Major Projects (or ‘investing in loss’)
2	"CONTENTS OF PAPER" CONTENTS OF PAPER: Introduction: Project trends, their effect on contract design; location, emerging nations and local requirements: The effect on Contract risk: History: What are the parties risk drivers: An alternative strategy for risk: Can both parties mutually satisfy their requirements?: The consideration given to project life and associated insurances: Conclusions and questions:
3	"Project trends" Project trends, their effect on contract design; location, emerging nations and local requirements: Much Larger Complex Technically Complex Logistically Politically Unstable Areas Local Laws (ownership, local content, etc.)
4	"The Effects on Contract Risk" The Effects on Contract Risk: Contract risks are numerous and many faceted from both parties points of view Much larger contracts with greater risk in each contract reducing the ability to balance such risk over a number of parallel and overlapping contracts Problematic geographic, geological, hydrographical and political locations (sometimes but not always and certainly not entirely, offset by Government/Trade Guarantees - e.g. ECGD and EX/IM) Tighter insurance market (CAR/BAR/PI and even Employers Liability for certain elements of work) Greater transfer of risk to the Contractor (particularly where the contracting strategy includes either Turnkey and/or Functional Specification and/or EPC/EPIC and/or Contractor/Client provided Independent Verification) Longer design/operating/fatigue life requirements Functional specifications Design for decommissioning and total removal
5	"The Effects on Contract Risk" The Effects on Contract Risk: The current climate has resulted in traditional Contractors refusing to bid Turnkey, Lump Sum EPC/EPIC work Alliances and Partnering Incentivised Contracts EPCm Direct Management
6	"The Effects on Contract Risk" The Effects on Contract Risk: An Article by K. E. Arnold entitled ‘Do you play soccer or football’ A thorough estimation process, based on a permanent feedback from previous projects A clear understanding of the risks involved, leading to a very selective bidding strategy An efficient project management process, involving, inter alia, a non-complacent cost-control system A high level of dedication in the project teams and real hands-on management by the company's top management
7	"History" History: Separate Contracts for each Element of the Work Vertical Integration One Stop Shop Turning Tide Current Market EPCm Cost Plus Target Current Situation Risks
8	"Client" Client Maximised Shareholder returns Contractual obligations to Customers (maximising profit and minimising penalties/damages for non performance of obligations) Plant/Facility efficiency with minimal downtime Minimum OPEX Minimum CAPEX Safety
9	What are the party’s risk drivers: Methods of Managing these Risks for both Parties Risk Control Risk Transfer Price Control (cost – Client CAPEX/OPEX and Contractor Turnover/Profit) Availability of construction and operation contractors Ability to carry out difficult to insure work (e.g. UK scaffolding companies finding it difficult to obtain employers liability coverage)
10	An alternative strategy for risk: Methods already utilised CAR provided by Client (sometimes with the deductibles to the Contractor’s account regardless of Client negligence) Mutual cross waivers in respect of death or injury to each party’s (groups including their contractors) personnel regardless of the other parties negligence and in some instances wilful misconduct Mutual cross waivers in respect of each party’s (groups including their contractors) property regardless of the other parties negligence and in some instances wilful misconduct Mutual waivers in respect of consequential losses Waivers of subrogation
11	Can both parties mutually satisfy their requirements: Contractor’s concern with adequately allowing for risks Client’s concern at paying considerable sums for unused contingencies Stage 1 – Execution Phase: The use of full Open Book Cost Plus Target Price and Completion Date (s) (no fee element).
12	Can both parties mutually satisfy their requirements: Contractor’s concern with adequately allowing for risks Client’s concern at paying considerable sums for unused contingencies Stage 2 – Defects Liability Period: The use of full Open Book Cost Plus Target Price and Completion Date (s) continues.
13	Can both parties mutually satisfy their requirements: Contractor’s concern with adequately allowing for risks Client’s concern at paying considerable sums for unused contingencies Stage 3 – Contract Liability beyond the end of the Defects Correction/Liability Period: Open Book Cost Plus Target Price and Completion Date (s) ceases. The Contractor undertakes to provide immediate assistance to the Client in the event of any problems of whatever nature throughout the whole period of the contract liability (through the operating, design, and fatigue life, decommissioning and removal) on a nett cost only basis [in the event that the problem is not found to be of the Contractor’s making a pre-agreed percentage on the nett costs is paid to the Contractor].
14	Can both parties mutually satisfy their requirements: Stage 3 – Contract Liability beyond the end of the Defects Correction/Liability Period:
15	The consideration given to project life and associated insurances: To manage risk in large and complex projects and minimise the cost of such control requires innovative ideas. Traditionally, risks were covered by insurance or devolved to various contractors (hopefully still solvent and existing and/or insured possibly 20-30 years later when claims arose). Many such policies duplicated coverage or left certain risks uncovered. Serious consideration must now be given to project life insurance. Operators/developers have large international portfolios in some of which they may only be minor joint venture partners. Most have sufficient business in construction and operation insurance to generate market interest in mutual agreement of a suitable scheme. Alternatively, consideration could be given to managed mutuals (clubs) or captives. A number of insurance arrangers currently involved in other aspects of the Oil and Gas industry and major project (Channel Tunnel, Heathrow Express, etc.) would be prepared to work closely with Clients to provide managed services. Most Clients already have captives that can be expanded for this purpose but probably better (certainly cheaper and with the added advantage of feed back from the other members) would be a mutual/club (rather like P and I insurance in the ship owning and operating industry).
16	The consideration given to project life and associated insurances: Where does the funding come from? Funding comes from a contribution levied on the turnover or profit of each facility or installation (cheaper the more members or the more facilities/installations owned and operated). In the unlikely event that the fund generated does not cover the costs of rectification then the partners in the scheme make further contributions (based on the proportion of their usual contributions) to make up the short fall
17	Conclusions and questions: Can both parties mutually satisfy their requirements? I believe a contractual and commercially viable agreement can be reached. With a contract let on Cost Plus Target, fully open book basis such cost is controlled by commonality of interest. The target being bid and set by the Contractor – if the Client is able to prepare a budget for sanction, the Contractor can clearly calculate a Target Cost without expensive and tender list depleting FEED contracts. This gives an earlier start and thus a potential 6 to 18 month saving in time to operation and income, no free issue equipment or nominated sub-contractors with all the problems that engenders. Hopefully more real execution Contractors will be encouraged to bid further reducing the overall CAPEX and possibly, if they are able to tender operation and/or maintenance the OPEX.
18	Conclusions and questions: To minimise the budget, the ‘cost plus’ strategy should cascade as far as possible down the chain to avoid incurrence of risk-related contingencies at multiple levels with multiple mark-ups. A Client's budget will still contain the usual contingencies for the overall project (the contractor remaining incentivised by an allocation system of costs against relevant targets in target-based contracts). Effectively by the Client investing in the loss of the ability to sue the Contractor they gain immediate assistance in problem solving, a quicker return to production and an enduring relationship with the Contractor. The Contractor loses the potential no cost profit from an unused contingency or the use of cheaper/lower specification materials and equipment and in return gains the advantage of a contract on which they cannot actually lose money and which forges a long term relationship with their Client. Obviously other cost saving can be introduced to such a contracting strategy but what is most important is that some major Client (preferably a JV) is brave enough to give this concept a serious try on a major project.