Why EPC Contracts are bound to be delayed
As the most common form of Contract for an industrial facility is an EPC Contract, we refer to EPC contractors, isn’it?
This is a little misleading I believe… and offers an opportunity to unveil what I believe to be a systemic cause to EPC Project delays.
One could imagine an EPC contractor to be a company covering the whole range of activities for the execution of a Project, from the drawing board to the pipe erection at Site.
Such integrated model existed, up to the eighties, but has disappeared, Engineering companies having first cut their construction labour and equipment then their construction supervision.
The EPC Contractor one will find today is typically an association of two companies, one doing Engineering and Procurement (E&P) and the other one the Construction (C).
There are 3 types of associations between these two companies: a JV, a consortium or a sub-contract. The most frequent is the last one, the Construction contractor being sub-contractor to the Engineering Company, to which is awarded the EPC Contract.
Let’s look at the pro’s and con’s of each type of association to understand the paradigm leading to systemic delays in EPC contracts execution:
The Joint Venture seems the ideal: both parties share a common profit or loss. There is no conflict of interests.
The issue lies with how one party controls the costs charged by the other party. It is very difficult for an Engineering Company to control the manhours of manpower and equipment charged by a Construction contractor. The Construction contractor is likely to inflate the latter to make its own profit on these charges, regardless of the profit it could get from the JV.
The consortium has each party responsible for its scope, expenses and profit. This provides an incentive for each party to minimize its costs. There is a non recourse clause in the consortium agreement that prevents one party to claim to the other.
The issue lies with the impact that could be suffered by the Construction partner due to the delays in drawings and materials deliveries from the Engineering company. These delays will typically result in idle manpower and equipment. The Construction contractor will not be able to claim the resulting extra cost from the Engineering company. Knowing this, it will include such costs in its bid which will affect the price competitiveness of the consortium bid. This type of scheme is therefore not often seen…
Finally, the most commonly found type of association is the sub-contract. The Engineering company sub-contracts construction activities to a construction sub-contractor.
The construction contractor is commonly paid applying unit rates to installed quantities, e.g. so much for a cubic meter of concrete cast, so much for a ton of pipe erected etc. This means that the construction contractor will be paid a fixed amount for a given amount of work done whatever its actual consumption of resources (manpower, equipment) is. In other words, the construction contractor bears its productivity risks.
The productivity of the sub-contractor is however highly dependent on timely deliveries of drawings and materials by the Engineering company. In case drawings and material deliveries are delayed, idle time of manpower and equipment will be suffered by sub-contractor, as sub-contractor will still be paid the same amount for each erected ton of steel and the manpower and equipment will require to be mobilized over a longer period.
In theory the sub-contractor could claim for such extension of time and related costs. Such claims are indeed made possible by the sub-contract type of association, contrary to the consortium.
In practice, the sub-contract usually contains difficult to match conditions to such claims. The claim might, for instance, be eligible only of there is a proven overall – not local – lack of workfront. The sub-contractor might also be required to prove that the delay impacts the schedule critical path etc.
As engineering and material deliveries are always subject to out-of-sequence and delayed deliveries, and the above claims are difficult to make, the sub-contractor will be careful not to mobilize too early. The sub-contractor will rather aim to always be a little under mobilized to achieve the best productivity.
On the other hand, the EPC contractor will not be fully transparent with expected engineering and material delivery slippage as its interest is construction progress rather than productivity.
Here, I believe, lies the systemic factor that leads to delays of EPC Projects organized under such contractual schemes.
As such scheme is the norm, one deducts that the owner is more concerned with price than schedule and has accounted float in its overall schedule for delay in the execution of the EPC Contract.
The scheme still entices the EPC contractor to complete as early as possible to avoid both Liquidated Damages and extra costs of prolonged presence at Site.