W7_TRI_ EPCI Payment Term & Tender Price

1.      Problem recognition, definition and evaluation

EPCI (Engineering, Procurement, Construction and Installation) contract is widely implemented by industry practices nowadays. There is one critical issue that shows up frequently in many tender processes, namely in which contractor price is higher than Company / Owner Estimate (OE). This will analyze how difference between company and contractor perspectives in viewing project cost.

2.      Development of the feasible alternative

The US$ 150 million project is a sour gas project that will be built onshore in remote area outside Java. Due to risk and technology, company selected EPCI in lump sum contract as contracting strategy. The bidders shall submit the EPCI price of such a project, and one bidder will be chosen as winner according to lowest bidder price mechanism. The tender is conducted in two stages two envelopes scheme.

3.      Development of the outcome

The project cost mainly consists of material and installation and PMT (Project Management Team).

4.      Criteria

The company has always OE US$ 150 million with budget tolerance ±10% to execute the project. It is also mentioned that contractor shall follow to EPCI payment term stated in contract document.

In the other side, contractor principally will pass back to company any cost that might be incurred in the future, thus the contractor price will cover not only direct cost (material and PMT), but also indirect cost. The indirect costs cover risk (security, resources etc), contractor margin including corporate tax, penalty claim and cost of fund.

5.      Analysis

Firstly, the company payment term and contractor proposal (in percentage payment) during negotiation stage 1 is shown in Figure 1.

Figure 1. EPCI Payment Term

It is clearly shown that contractor must be ready in financing their cost to avoid negative cash flow since there will be lag in payment as presented in Table 1 (assumed EPCI cost is the same).

Table 1. Payment Deviation Company-Contractor

Next, contractor will calculate the cost of fund (CoF) to finance its negative cash flow as calculated in Table 2. The CoF will also include performance bond contractor shall allocate during project lifecycle (4 years).  

 

Table 2. Cost of Fund of EPCI Contractor

And then, contractor will put all direct and indirect costs into bidder price and submit it to company as shown in Table 3.

Table 3. Tender Result

The contractor price depends on what assumption put in Table 1 and Table 2. For instance, if PMT cost and WACC is higher so that the EPCI cost will be higher as well.

6.      Selection of alternative

How contractor came up with total EPCI price of US$ 188.6 Million? Table 4 describes the comparison of EPCI cost in company and contractor view.

Table 4. EPCI Cost Comparison

Although the contractor bare price could be cheaper because their effort in negotiating material prices with subcontractor/vendor, tender was failed since it exceeded +10% OE and it must be retendered. It looks difficult to bring contractor price going down due to all cost components above, unless the contractor bare price decreases dramatically that is caused from sour technology change or optimization.

This presented a fixed lump sum contract in high risky project might be not correct. The alternative contracting strategy is that non fixed lump sum contract which is able to share the risk between company and contractor.  

7.      Performance monitoring and post-evaluation of results

The alternative contracting strategy which is able to share the risk is that reimbursable cost/cost plus contracts.  It can be chosen from several types of cost plus contracts: cost plus percentage, cost plus fixed fee, or cost plus fixed fee plus incentive.

References:

·         DiMatteo, Larry A. (2010, Jan). Strategic Contracting: Contract Law as a Source of Competitive Advantage. Retrieved from http://works.bepress.com/larry_dimatteo/3

·         Giammalvo, P.D. (2012). AACE Certification Preparation Course Module

·         O’Toole PEng, Jacqueline, Dr. George Jergeas PEng. (2010, Sep 24). Lump Sum Contracting on Western Canadian Oil and Gas Capital Projects: Industry Opinion.