| Power Systems Studies |
| Minimizing Risk in Power Plant Development
Projects |
| By Peter Reimann, Wellington, New Zealand, +64 4495 8615,
reimannp@pbworld.com |
Power
plant developers naturally focus on money and time, but a variety
of pitfalls that often have engineering roots can lead to project
cost and schedule overruns. Apart from taking these pitfalls on board
ourselves, we have a responsibility to educate our clients about them.
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Many power plants are constructed by developers who obtain funding
from banks and other lending institutions. To minimise risk, the construction
is awarded to an engineer, procure and construct (EPC) contractor,
often on a "turnkey" basis. The developer, or "owner,"
frequently hires an engineer to oversee all or part of the project.
The lenders usually employ an engineer also-the "independent
engineer"-in an auditing role, to ensure the project in which
they have invested is robust. Despite these precautions, some projects
have been dogged with cost and schedule overruns and the final plant
has been less than satisfactory.
The engineer, who has been involved in the implementation of a variety
of projects, is in a unique position to comment on the pitfalls that
cause these problems. These pitfalls, which often have engineering
roots, are avoidable. Apart from taking these on board ourselves,
it is our responsibility to educate our clients about them. It is
hoped that this article will provide a starting point for this process.
The cases presented are drawn from recent experience and observation.
Inadequate Feasibility Study/Concept Design
The feasibility study for a project should identify areas of uncertainty
that require further investigation. Time constraints may dictate proceeding
with preparation of contract documentation before these areas have
been properly resolved, however, and before the conceptual design
has been completed.
Outcomes and Risks:
- Delays in completing the contract documentation
- The need to issue addenda to bidders after contract documentation
has been issued
- Issues not coming to light until after the contract has been
awarded, requiring time and resources to resolve.
Mitigation: Adequate time and resources for the feasibility
study and conceptual design are essential.
Capital
Cost is too Low
The capital costs estimate is used at the conceptual stage to decide
on the viability of a project. If the EPC contract is awarded several
months later, the capital costs may be higher for one or more of the
following possible reasons:
- The full extent of the project scope may not be fully understood
at the conceptual stage (e.g. foundation requirements).
- Conditions of the contract are not formulated at the early conceptual
stage (e.g., terms of payment).
- The suppliers' budget prices that are used to make up the estimate
can be unreliable.
- Market prices, exchange rates and political influences can change
radically.
- The contingency margin is inadequate.
- Some optimistic assumptions have been made.
Outcomes and Risks: Too low a price places pressure on all
subsequent phases, forcing the owner to take possible actions that
introduce risks as follows:
Mitigation: The conceptual stage is too early to form reliable
price estimates, so developers and bankers need to apply an appropriate
margin in the sensitivity analysis during financial modelling. The
engineer can assist in establishing this margin.
Project
Schedule is Too Short
There is a natural tendency to compress the schedule for a quick return
on investment-even more so when the project is marginally viable.
Outcomes and Risks: A compressed schedule puts pressure
on all phases of the project, introducing the following risks:
- Lateness
- Errors and omissions that arise from all who are involved in
the project working under extreme pressure.
Mitigation: Risk of lateness is usually transferred to the
EPC contractor by imposing a penalty payment. The owner should consult
with the engineer and prospective supplier at the conceptual stage
to ensure that a realistic schedule is adopted.
Owner's
Engineer is Inappropriate
The owner's engineering firm is usually selected on the strength of
its proposal in response to a brief prepared by the owner. The price
for a project needs to be fixed for financing purposes, so the contract
with the owner's engineer is on a fixed-price basis. The appointment
of an inappropriate owner's engineer can result from the selection
of the lowest priced proposal.
Outcomes and Risks:
- Owner's engineer has inadequate experience.
- Owner's engineer has inappropriate personnel.
- Owner's engineer has allowed for carrying out the duties, but
to insufficient depth.
Mitigation: The owner should provide a detailed, comprehensive
brief that, if necessary, is prepared in consultation with prospective
engineers. Adequate time must be given for proposal preparation. The
engineer's proposal should demonstrate that adequate quality systems
are in place. The owner needs to recognise that the lowest-priced
proposal may not be the most cost-effective, and should give most
weight to reputation and experience.
Inappropriate
Personnel/Clashes
The appointment of inappropriate personnel or clashing personalities
or cultures can be a disaster for a project. This potential problem
applies across the combination of owner, owner's engineer and EPC
contractor. These appointments are often made on the apparent strength
of the curriculum vitae (CV) or resume, aided by the verbal acumen
and networking of the candidate.
This approach is far from infallible. CVs can distort the facts. For
example, the management record on a CV may look impressive, but conceal
incompetence. Referees nominated in a CV will be those who the candidate
feels are more likely to report favourably.
A person may be impressive at an interview, but later performance
shows otherwise. Even if the exercise of appointments is successful,
a project can still be riven by personality clashes or insensitivity
to cultural differences.
Outcomes and Risks:
- Errors and omissions
- Delays
- Lack of cooperation
- Low morale.
Mitigation: The independent engineer can play a key audit role
of personnel during the progress of a project. A periodic audit can
be based on a questionnaire that is structured to reveal any weaknesses
of key members of the project team-the owner, owner's engineer and
EPC contractor. An independent party who is skilled in this area should
conduct the audit for the independent engineer in order to preserve
impartiality and confidentiality. The audit report should be circulated
to all parties, including the lenders, for appropriate action if necessary.
Misunderstanding Between Owner and Owner's
Engineer
Owners often like to play a "hands-on" role in a project,
and the role of the owner's engineer can be anything from providing
"advice when sought" to full involvement. Owners may insist
on handling all communication with the contractor and outside parties.
Outcomes and Risks:
- Misunderstandings
- Inadequate or incorrect action or omissions on technical matters.
Mitigation: Definition of duties and communication channels
are of paramount importance during the formation of the contract between
the owner and owner's engineer. Both parties should be formed into
a dedicated team in a dedicated office and make the project rather
than their respective source companies, their prime commitment.
Contract Documentation is Inadequate
Lenders demand a fixed cost with maximum risk passed to the EPC contractor.
This arrangement necessitates an approach under which the EPC contractor
performs the detailed engineering and oversees interfacing between
subcontracts.
There is sometimes a perception that only the technical specification
needs to set out requirements for:
- Scope
- Climate
- Performance
- Environment
- Site
- Safety and health.
In this case, the bidder will opt for the lowest-priced equipment,
with quality only high enough to ensure that there will be no risk
during the warranty period. During project implementation, the EPC
contractor will provide minimum information for review. This situation
presents an ideal opportunity for short-cuts and provision of lower
quality than required.
Outcomes and Risks:
- Plant is less than satisfactory.
- Lower reliability and shorter plant life.
Mitigation: The technical specification needs to include:
- Definition of standards, materials, corrosion protection and
other specific technical requirements that clearly state the quality
of the plant
- Requirement that a certified quality system be in place together
with third-party inspection and witnessing of tests
- Detailed lists of information required for review during project
implementation
- Clear scope/interfaces if any detailed design is to be carried
out by the owner/engineer.
The owner needs to ensure that there is sufficient budget for the
project team to monitor quality adequately through the design review,
manufacturing and site construction, and commissioning/ testing phases.
Bid Evaluation is Inadequate
Bid documentation sometimes gives an inadequate definition of the
evaluation methodology and of the information required for tender
evaluation. Particular omissions may include:
- The cost adjustment to be applied for efficiency or output
- Information about how the quality of the plant will be evaluated.
Outcomes and Risks:
- Inappropriate plant is provided.
- Contractual arguments develop later.
Mitigation: A bid evaluation should include price, operating
and maintenance (O&M) cost, efficiency/fuel cost, net output/revenue,
adherence to the specification and conditions of contract, as well
as experience, schedule, availability, degradation, quality system,
safety/health and training provisions. The assessment of technical
features should look at risks, capability of handling off-design situations,
start-up times, maintainability, operability and implications for
external provisions.
The bid documents need to detail:
- The tender evaluation methodology so that the bidders will
know what weight will be placed on the above aspects
- Technical schedules and lists of information required in the
bid.
Excessive Pressure on Bidder During Contract
Negotiations
At the negotiation stage, the owner is in a position to apply pressure
to reduce the price. The bidder may succumb to these pressures, particularly
if needing to secure the work.
Outcomes and Risks: The contract negotiation stage is critical
in setting the climate for the subsequent implementation. If pressure
is too great, a highly adversarial relationship can result. The contractor
will try to take short-cuts and lodge as many claims as possible for
contract variations, at inflated prices. Particular risks are:
- Less than satisfactory plant
- Considerable increase in work for the project team, policing
compliance with the contract, and dealing with the claims for
contract variations
- Stressful relationships between owner and EPC contractor, owner
and engineer, and engineer and EPC contractor.
Mitigation: The owner should be aware that excessive pressure
applied during negotiations can achieve the opposite effect to that
intended in the long run. The ideal relationship is a cooperative
one that is fostered largely by attitude. The EPC contractor could
take up some equity in the project to help achieve a cooperative relationship.
Inadequate Attention Given to Safety and Operability
All projects carry safety and operability risks. It is the team's
duty to ensure that statutory regulations, standards, quality assurance
and testing are adhered to. There is a risk of inadequate coverage
of these areas if a hazard and operability study (HAZOP) is not carried
out.
Outcomes and Risks:
Mitigation: A HAZOP study should be carried out when it will
be relatively easy to incorporate modifications that result from the
study findings, but also when designs are near enough to finalisation.
The HAZOP study brings together all participants-owner, independent
engineer, owner's engineer, EPC contractor, major sub-contractors
and O&M contractor. Each system is then examined in a structured
way for "what if" scenarios. A secondary benefit of the
HAZOP study is that it provides an excellent opportunity for the O&M
personnel to learn about the system and to contribute.
Conclusions
The EPC or turnkey type of contract is ideal for developers because
the capital cost is fixed at the outset and the risk is placed onto
the EPC contractor. There are many pitfalls that can result in a less
than satisfactory plant. These may lead to capital and O&M cost
increases, lower reliability and life, as well as accidents and schedule
delays.
It is important that these pitfalls are Recognize so that they can
be avoided. The engineer, having had past involvement in implementation
of a variety of projects, is in a unique position to assist if introduced
to the project at its inception and retained to play a full, active
role as owner's engineer throughout. This approach will result in
the most cost-effective plant for the entire period of the investment. |
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| Peter Reimann is a mechanical engineer and Senior
Professional Associate who, for more than 35 years, has accumulated
wide and varied experience in a number of countries. He has worked
predominately in the power generation and thermal energy fields with
consulting, manufacturing and government organizations. |
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