Why are power producers looking beyond turnkey contracts for new projects

A world with increasing demand for cleaner and more sustainable energy sources, independent power producers (IPPs) face a multitude of intricate challenges, especially in the realm of contractual structures.

The energy and power sector is on the cusp of a transformative new era, driven by a confluence of factors that are reshaping the industry landscape. This new era is marked by significant shifts in technology, policy and market dynamics — all aimed at achieving greater sustainability, reliability, and efficiency in the production and distribution of energy. In a world with increasing demand for cleaner and more sustainable energy sources, independent power producers (IPPs) face a multitude of intricate challenges, especially in the realm of contractual structures. Gone are the days when having ‘turnkey contracts’ where a single contractor oversaw all project phases was the norm. Instead, we now find ourselves in an era where multi-contractor arrangements take centre stage.

Traditionally, IPPs heavily relied on lumpsum engineering, procurement and construction (EPC) contracts as their primary method for project procurement. These EPC contracts result in the transfer of broad, substantial and well-defined risks to the primary contractor. While this transfer of risk resulted in increased costs for IPPs (including overhead, profit, and contingency mark-ups that could exceed those of procurement models with more owner risk), the trade-off of the reduction in the risk that the owner was exposed to, provided the much-needed assurance and confidence to the project financiers. However, as power projects have become more and more intricate along with their ever-increasing cost overruns, both IPPs and contractors have become increasingly cautious about committing to lumpsum turnkey EPC contracts. IPPs are now exploring alternative strategies to retain contractor involvement while ensuring the economic viability of their most substantial projects.

Alternative To EPC Contracts

Currently, various alternatives to traditional contractual structures are being considered by IPPs and contractors to successfully navigate the shifting market dynamics. One such emerging structure is the hybrid framework, designed to strike a balance between the cost and risk exposure of the project owners and contractors. This balance is achieved by either allocating distinct pricing components to different phases of the project (for example, pricing engineering and procurement services as a lumpsum with lower inherent risk, while valuing construction work using a unit rate remeasure or reimbursable basis with higher inherent risk) or by assigning tasks to different contractors. For instance, the equipment supplier may provide the necessary equipment and spare parts, the technology provider may oversee engineering and procurement-related activities, and a regional construction specialist may handle on-site construction activities.

For IPPs, this shift in approach presents both opportunities and challenges. Coordinating various specialized contractors, each responsible for distinct project aspects is one of the paramount challenges that the IPPs face. From the design and procurement to the construction and commissioning of the project, it is pivotal that all the parties involved work in synchronisation and harmony to ensure project success. However, such a convoluted coordination can sometimes lead to delays, conflicts, and potential cost overruns.

Maintaining consistent quality standards is another crucial consideration in this new contractual landscape. With different contractors managing various project phases, establishing clear quality control mechanisms and standards that all parties must adhere to is an integral part of successful project management. Furthermore, the allocation of risks among contractors becomes a complex puzzle for the IPPs that requires careful resolution. Determining who bears responsibility for delays, defects, or unforeseen circumstances involves extensive negotiation and documentation between the IPPs and the contractors. The challenge is not only in allocating risks but also in ensuring that all parties are aware of their responsibilities and accountabilities.

Proactive Strategies Needed

To successfully navigate these complexities, IPPs must employ proactive strategies. Clear and comprehensive contractual agreements, expertly drafted with legal guidance, serve as the cornerstone for smooth operations. These contracts should leave no room for ambiguity, outlining each contractor's roles, responsibilities, timelines, performance benchmarks and dispute resolution mechanisms.

Effective project management also plays a critical role. Experienced project managers with a deep understanding of the industry's intricacies can oversee the entire project and coordinate activities among various contractors. Open and consistent communication channels among all stakeholders, including contractors, are essential to the seamless implementation of the projects. To address such communication needs, regular project meetings and progress reports help identify issues in the early stages and facilitate timely resolutions.

Lastly, robust quality assurance processes including regular audits and inspections are vital for upholding the standards outlined in the contracts. Additionally, developing detailed risk mitigation plans that outline how potential issues will be addressed provides an extra layer of protection to all the stakeholders. For IPPs, performance bonds and guarantees from contractors offer further security against unexpected challenges that may come up during the implementation of the projects.

In a nutshell, while the shift in contractual structures introduces complexities, it also offers opportunities for innovation and specialization. By embracing clear and comprehensive contracts, experienced project management, quality assurance, and robust risk mitigation, IPPs can successfully navigate these complexities. In doing so, they contribute not only to the growth of cleaner and more sustainable energy sources but also to the resilience and adaptability of the energy and power industry in this transformative era.

Sudipta Ghosh is General Counsel, Apraava Energy. Views are personal, and do not represent the stand of this publication.