Introduction:
The purpose of this paper is to analyse the problems that currently exist regarding the execution of major projects in the current international and economic climate and to propose a potential solution for the 21st   Century and beyond.

1. Cheng Man-ch’ing – Master Cheng’s Thirteen Chapters

Project trends, their effect on contract design; location, emerging nations and local requirements:

Many projects worldwide are now much larger often including complex technical, logistical, and political challenges. The Contractor’s risk is therefore frequently spread over a smaller number of very much larger projects.  Many contracts now require a local content that is beyond reality to honestly achieve.  A large number of these contracts are in areas where governments, commercial and tax laws can change at very short notice the latter often retrospectively.  Operating, Design and Fatigue life requirements are of necessity extending as economics drive most large company Clients to invest in new large/long life developments and dispose of smaller and declining developments to others better organised to operate such resources.  

The effect on Contract risk:
Contract risks are numerous and many faceted from both Clients and Contractors points of view.
These risks include a number of factors including some of the more predominant listed below:

The current climate has resulted in traditional Contractors refusing to bid Turnkey, lump sum EPC/EPIC work and attempting and often succeeding in negotiating very low (inappropriate to the relationship of the parties and the Contractor’s advertised advantages/ability and standing) caps on liability in any contracts they do enter into.

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2. ECGD means Export Credits Guarantee Department, it is the UK's official Export Credit Agency
3. EX/IM means The Export-Import Bank of the United States (Ex-Im Bank) it is the official export credit agency of the United States. Ex-Im Bank's mission is to assist in financing the export of U.S. goods and services to international markets.
4. CAR means (in this context) ‘Contract All Risks’
5. BAR means ‘Builder’s All Risk’ (sometimes CAR ‘Contractor’s All Risks’)
6. PI means Professional Indemnity
7. EPC means Engineer, Procure and Construct often used in the Petro-Chem and Process Industries
8. EPIC means Engineer, Procure, Construct and Install  often used in the Petro-Chem and Process Industries

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The principles of alliances and partnering were tested with limited success.  The major problem with these ‘solutions’ was and still is that, unlike some other industries, there is no real financial inducement to the Contractor beyond the construction and commissioning phase.  In the automotive industry for instance the sub-contractors will execute expensive R & D and enter into ‘just in time’ supply deals as the lion’s share of their turnover and profit comes from the after market sales of spares. 
As a result, the lack of interest in true partnering and allienceing for the Contractors operating in the Oil, Gas, Process, Energy and Utilities sectors stems, partially, from the fact that with most Projects and with most Clients there is little involvement post completion or commissioning.  The result is a situation where OPEX9 suffers for lower CAPEX10 driven by a competitive market restricted generally to the CAPEX element of the market. 

Incentivised contracts worked reasonably well but the real problem of long tail risk apportionment and its management was hardly considered or addressed other than by crude and totally inappropriate caps on liability in both Lump Sum and Target based contracts to safeguard (to some degree) the Contractor.

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9. OPEX means Operating Expenditure (life cycle costing, total cost of ownership, value engineering)
10.CAPEX means the Capital expenditure on the Project (a large part of which is generally the Construction Contract especially if land, licence and exploration costs over which the Contractor generally has little or no influence)

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To redress the situation Contractors now frequently offer to carry out engineering and management of procurement and construction (EPCm) contracts on a reimbursable basis.  How they convince Clients that they can manage these risks efficiently for them when they have previously been unable to manage those same risks for themselves remains a mystery.  These Contractors are currently refusing to price on a lump sum basis and appear reluctant to enter into Target based contracts with effectively the same liabilities (apart from cost up to ‘Completion’/the end of the Defects Liability/Completion Period).

Effectively the Clients' only other choice is to directly hire contract personnel and smaller Contractors (essentially the main Contractors previous sub-contractors).  Or is it?  This course of action is not in fact really practicable as the Client organisations do not generally have the in-house ability (certainly not in the numbers and specialities required) to manage and control a large and complex Project especially when those resources that they do have are stretched managing their existing facilities and assets.  This is further exacerbated by the current dire shortage of suitably qualified and experienced personnel.11

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11.See the recent (2007) ‘Market Alert’ Title ‘Engineering and project Management Shortage Likely to Severely Affect Development Costs and Viability’ Special report by CERA

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12. (Article entitled Do you play soccer or football? Offshore Magazine Beyond the Horizon, Volume 63  Issue 2   February 2003)
13. LSTK means Lump Sum Turn Key

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Yes, it is a risky game. But for those who know the rules and have developed the right skills, there is always a chance to win the World Cup.’
Unfortunately over the few intervening years Mr. Arnold’s first bullet point (the estimating process) has been adversely affected by the lack of detailed information collected, collated, and utilised.  This is due in part to the lack of the old fashioned QS’s attention to detail in providing detailed information (from numerous projects for a variety of Clients with a variety of Contractors) to enable reasonably accurate estimating.  In part this is due to a lack of understanding of the very significant differences between the experiences, skills and abilities grown over years of the old fashioned contractor trained agent/project manager and the ‘professional’ project managers of today.  These ‘professional’ managers generally have little practical trade and man management experience and now work for both the Client and now unfortunately for many Contractors which  together with misplaced cost saving in contract administration by mainly the Contractors but also significantly in Client organisations reducing the administration to a level where the necessary detailed information cannot be collected.
Another significant effect is that of the metal markets and a severe shortage of labour and supervision.  All these conspire together in making a fixed lump sum for a Project that may take anything from 4 to 10 years or more to final completion a risk too far.

The third and fourth bullet point highlight the shortage of suitable personnel and ensuing uncertainty of results, despite the number of people in their late sixties and early seventies still to be found in supervisory, management and trade roles on such projects.  In Client and Contractor roles there is a serious need to train people in the necessary skills and attention to detail so sorely missing in today’s market.  Where have all the apprenticeships, indentures, old CATs14 and the old C ITB15 gone?

The content of the second bullet point is however the most important and takes into account all the others in that the Contractors have now decided that the risk of a Lump Sum EPC/EPIC or LSTK are no longer acceptable even with apparently high margins, especially when compared with the building and civil engineering industry.  The current sellers market combined with high oil, gas and other commodity prices have further exacerbated the problem and as a result the Contractors appear to have voted and the Clients are now suffering the consequences.

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14. College of Advanced Technology
15. Construction Industry Training Board

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History:
A cycle is detectable in the manner in which the Contractors are developing their strategies and a feeling of déjà vu ensues.
Taking the UKCS16 as an example; during the early 1980s most clients carried out developments utilising large ‘Engineering’ Contractors (mostly of US origin or parentage) as a Management Contractor (on a reimbursable cost plus fee basis), with engineering Contracts (usually let on the same basis and often to the same Contractor or a subsidiary) with a series of fabrication contracts for modules, jackets, helidecks, pipelines, installation, tie-ins, etc. (predominantly let on a lump-sum basis) with certification, hook-up and accommodation Contracts (let mainly on a reimbursable basis).

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UKCS  means the United Kingdom Continental Shelf (includes NNS, MF, CNS, SNS, West of Shetlands (WoS), EC, IS, West of Britain (WoB). Other offshore areas (South West Approaches, Bristol Channel, Cardigan Bay, Rockall, Liverpool Bay, Manx Basin, Celtic Sea).

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17. EPCm means Engineering, Procurement and Construction - management

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In addition; both Clients and Contractors appear not to have fully understood that if a contract is to be reimbursable, no opportunity exists for Contractors to include contingencies for such risks as reworks, warranty, insurance deductibles, etc.  In the true cost determined contract price therefore there may be a potential problem with enforcing claims for costs related to such Contractor liabilities.  In addition the margins on a potentially significantly reduced company turnover fail to encourage such risk taking.

Recently many court cases have been reported in which the management Contractor has fared badly.  However with a reimbursable contract, Contractors may still retain a potential liability.  Such liability it should be remembered is generally that of the absolute duty of a Contractor and not the restricted and mere duty of care of a consultant or the even more restricted liability of a body-shop contractor.

Surprisingly, the situation has deteriorated so that Clients are now approaching Contractors for suggestions on the type of contracting/commercial strategies to adopt for their Projects.  Some major Clients are even seriously thinking of managing contracts them selves and letting various elements and sub-elements separately.

This opens up a set of common, but divergent problems – Risks; their identification, apportionment and contractual/commercial solution.

What are the parties risk drivers:
We need to identify, risks and their drivers for both the Client and Contractor, deal with their apportionment and contractual/commercial solutions to enable the industry to progress into the 21st Century and beyond.
Let us consider the Client’s key drivers many of which are interrelated and common or interrelated to those of the Contractor:

If we now turn to the Contractor we can see that their drivers have a number of similarities:

The method of managing these risks for both parties is to a considerable extent as follows:

An alternative strategy for risk:

In order to solve the problem with risk adversity for both the Clients and Contractors it is essential that both parties drivers are considered and any loss of ‘rights’ for the Client or liabilities/obligations for the Contractor, are redressed by balancing advantage to the other party with a real solution to those unacceptable risks removed from each of the parties in an endeavour to provide both parties the best solution available.

If we initially remove the cost risks from the Contractor we must also, as far as is possible, remove the contingencies that the Client would otherwise have paid for in respect of the risk the Contractor would have been taking.

In the Oil, Gas and Petro-Chem industries this is already dealt with to a considerable extent in a number of ways as follows:

These would I believe remain in any solution.

If execution rather than engineering contractors are utilised in the future the CAR could easily be transferred to theme as they almost invariably have a blanket policy that Clients pay for anyway via the corporate overheads.

Few if any of the above risk listed terms are available in the wider construction market including major civil engineering and building projects, certainly very few have any where such generous terms ((d) was in part introduced due to the nature and size of profits involved in the industry).

Can both parties mutually satisfy their requirements?:

I think they can.
If we deal with each element from both sides of the equation we can balance matters as follows:

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).

Contractor advantages –     

Client advantages –

Stage 2 – Defects Liability Period:

Open Book Cost Plus Target Price and Completion Date(s) continues

Contractor advantages –

Client advantages –

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 an open book 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 incurred is paid to the Contractor.

Contractor advantages –

Client advantages –

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 arise). 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 agreement to provide a suitable scheme. Alternatively, consideration could be given to managed mutuals (clubs) or captives.
I have already contacted a number of insurance arrangers currently involved in other aspects of the Oil and Gas industry and major project (Channel Tunnel, Heathrow Express, etc.) who 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) a mutual/club (rather like P and I insurance in the ship owning and operating industry).

Where does the funding come from?

Funding comes from a contribution levied on the turnover or profit of each facility or installation (thus it is 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.

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 and 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.
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 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 gain the advantage of a contract on which they cannot actually lose money and which forges a long term relationship with their Client.

David A Roberts (Director and Principle) RCCCL © 13/4/2008