Engineering, procurement and construction lump sum contracts – failsafe or failure?
Risks are inherent in every major oil and gas project, and many owners believe that there is greater security in using a fixed price lump sum contract pricing model for their contracts in the belief that it allocates most of the risk to the contractor. Evidence has shown, however, that these contracts can fail to achieve the certainty that the owner requires, resulting in projects finishing late and over budget.
As contracting strategies change in line with demand on the supply chain, what are the real triggers that should determine how a project contract should be awarded in a growing market and what are the genuine risks of imposing a fixed price?
We have recorded a live, 40 minute webinar with key decision makers across the natural resources industry to identify why lump sum contracts are often chosen to create cost and schedule certainty, but repeatedly fail to achieve that result. We also investigated the use of contractual incentives and onerous contract clauses used by owners to transfer risk to the contractor.
By watching our recorded webinar below you can expect to come away with answers to questions including:
- When are lump sums not fit for purpose?
- Are specific contract terms required where lump sums are used to safeguard the owner?
- Can contractual incentives be utilised to assure cost and schedule certainty?
Cost certainty and risk management
Live polling questions during the event challenged participants to answer three important questions:
As an owner, how likely are you to use an engineering, procurement and construction (EPC) lump sum contract for all, or part, of your next project?
Almost one quarter of attendees said that it was "highly likely" they would use a EPC lump sum contracting strategy, saying that they preferred to transfer risk to the contractor. Less than five percent of attendees believed it was "unlikely", with the remaining three quarters choosing "possibly" with the decision depending on the project type, location and experience of the contractor selected.
As an owner, is it reasonable to impose onerous terms on the contractor to achieve cost certainty?
Only twenty percent of owners said it was not reasonable to impose onerous terms under any conditions. Three quarter of the attendees believed onerous terms are sometimes reasonable, depending on the type and location of the project as well as the contractor involved, with the remaining five percent believing onerous terms are always reasonable.
Have you achieved improved project performance from the contractor as a direct result of using incentives?
Although eighty percent of owners have experience of using incentives, only five percent of them believed that the incentives had directly improved the performance of their contractor, with another third suggesting that it had sometimes helped. Half of owners either saw no clear benefit of using incentives or were sure that they had not improved performance.
The polling results showed that a lump sum contracting approach with onerous terms is still very widely used within the oil and gas industry to transfer risk to the contractor, despite evidence showing that this is not always successful.
Our five tips for successfully using EPC lump sum contracts
As we move into a period of greater demand for projects, contractors are less likely to accept onerous terms and a more collaborative approach may be required by owners to avoid adversarial behaviours.
Our view is that EPC lump sum arrangements can provide sufficient motivation for project delivery performance without the need for additional incentives. These five tips are key to set your project up for success.
- Design maturity that is fit for purpose and schedule
- Clarity of risk allocation & aligned objectives
- Contractual terms that are clear and not onerous
- Right behaviours by both parties
- The best incentive is winning the next job