Legal & Regulatory

Allocating Risks Strategically: How to Complete Successful Power and Energy Projects

Power and energy construction projects are often complex and nearly always full of risks. On some jobs, miscalculating schedules and underestimating material expenses can result in hundreds of millions of dollars in unexpected costs. That’s why time spent managing risks before ground is ever broken is so important to project success.

Every utility and engineering, procurement, and construction (EPC) contractor negotiating an EPC contract aims to maximize its legitimate, competing self-interests. However, most power plant projects that are built on-time, within budget, and free of major claims and disputes, have a common trait—the owners and contractors looked not only at their own self-interests, but also carefully developed, at project inception, a comprehensive understanding of the risks inherent in the project and a plan to manage those risks.

1. Successful projects don’t just happen—they require careful planning and sound risk management throughout the job. Gantt charts are commonly used by project managers to update tasks and track progress toward milestones. Source: Shutterstock

Risk is defined as “exposure to the consequences of uncertainty.” Power and energy construction projects inherently have numerous unknown consequences and potential outcomes arising from complex systems and equipment, high costs, substantial time for completion (Figure 1), new technologies, and changing regulatory schemes. The success of a project depends on properly managing those risks.

Project Management

Based on our years of experience, there are six best practices that can help manage and allocate the risks associated with power and energy projects.

Negotiate and Draft Key EPC Contract Provisions Carefully. The principal mechanism to manage project risk is the EPC contract. An EPC contract is nothing more, and nothing less, than an amalgamation of assumption of risk formulas. It is no coincidence that the EPC contract provisions associated with the allocation of the greatest risks are frequently at issue in major claims and disputes. A successful project requires that these provisions be carefully considered in every contract.

Key provisions include the EPC contractor’s standard of performance; project time and schedule; mechanical, substantial, and final completion; delay and performance liquidated damages; changes; limitation of liability; suspension, termination, and default; and disputes. Project participants that strategically analyze the risks associated with these provisions, and negotiate and draft these provisions carefully, increase the likelihood of the project’s success.

Develop a Reasonable Schedule and Budget. Claims and disputes regularly arise because the project schedule, budget, or both, are unreasonable and fail to properly account for the project’s needs. For an owner, the negative consequence of delays is defined if the owner has a power purchase agreement in place that contractually requires power generation by a certain date. To mitigate against an owner’s risk of delays, the EPC contract should include delay liquidated damages in the event the EPC contractor fails to achieve substantial completion by the required substantial completion deadline.

Additionally, the contract should carefully define excusable delays, which will grant the contractor time but no money; compensable delays, which will grant the contractor both time and money; and concurrent delays, which are overlapping excusable, compensable, and inexcusable delays. Owners should also consider negotiating an early completion bonus to incentivize early completion, and a contractual right to begin generating power prior to substantial completion if one or more generator units can do so safely.

An EPC contract provision that imposes delay liquidated damages in the event the project fails to achieve substantial completion in a timely manner can also help an EPC contractor define its risk in the event of delays, noting the risk of inexcusable delays can be significant.

To provide a real-world example, we represented a merchant power company on a $533 million power plant construction project in asserting a delay claim against a power plant construction contractor and secured nearly $27 million in delay liquidated damages. To mitigate against this risk, it is imperative that EPC contractors agree to an achievable schedule that builds the risk of delays into the project schedule.

It is similarly critical that owners and contractors develop a sensible budget that sets realistic and reasonable expectations for the cost of the work. Claims and major disputes regularly arise because either the EPC contractor overpromised the time or cost necessary to complete the project or acceded to unrealistic demands during the negotiation process.

Select an Appropriate Project Delivery System and Pricing Model at Project Inception. In the most-traditional EPC model, which we characterize as a “full wrap,” the EPC contractor will engineer and construct the project; procure and install the major equipment, such as turbines and generators; and is responsible to the owner for the performance of the plant and equipment. By contrast, under a “partial wrap” project delivery system, an EPC contractor may be responsible for all engineering, procurement, and construction, with exception of certain equipment that the owner will procure, and the EPC contractor will install.

Whereas, in a full-wrap model, the EPC contractor is the owner’s “one-stop shop” for both the project’s engineering, procurement, and construction, and also for liability, in a partial-wrap model the owner assumes greater risk because it no longer has a single entity that it can hold liable in the event of claims relating to the equipment’s performance.

The traditional pricing models available for EPC projects can be categorized as “fixed,” “firm,” and “target” prices. Under a fixed-price model, the parties set a fixed price for the entire EPC scope, subject to increases for owner changes and other factors outside the EPC contractor’s control, and the EPC contractor assumes the risk of the cost of the work exceeding the agreed fixed price. Given the risk assumed by the EPC contractor under this model, it must properly estimate the cost of the work, the reasonableness of its budget, and that it has sufficient contingency for risk.

Under a firm-price model, the parties agree to a fixed price subject to an adjustment for certain escalations. For example, if there is a risk that the cost of certain key building elements, such as steel, may sharply escalate, the final price could increase.

Under a target-price model, which is typically used in very large projects, the parties agree to engage in an open-book estimate process to identify a non-binding target price for the project, and the EPC contractor will receive reimbursements for allowable costs. It is critical that participants evaluate the plusses and minuses of the different project delivery and pricing systems, and determine which are most appropriate for a given project.

Identify Technology Risks and Develop Strategies to Mitigate Against Those Risks. Claims and disputes regularly arise because a project utilizes technology that is new and has not been adequately tested in the field over time, for example, new technology to aid in the project’s compliance with regulatory requirements. Additionally, technology that is so specialized—including older technology—that few engineers or other experts have a working knowledge of, or specialization in, may pose challenges if a need for maintenance or repair arises. Project participants should evaluate what technology risks exist for the project and devise a plan to mitigate and manage those risks.

Strategically Vet Project Teams. A project’s success largely depends on whether its team is composed of effective managers who are problem solvers, as opposed to problem creators. Owners should ensure that EPC contracts grant them the right to vet the project team leadership and approve changes to the composition of the team (Figure 2).

2. Owners should conduct research to understand how project teams have performed on similar jobs in the past. Proper vetting can provide valuable insight, saving time and frustration in the end. Source: Shutterstock

Owners benefit by considering this vetting process in the same manner a board of directors would vet a CEO and leadership of a newly formed multi-million-dollar company. Owners that are actively involved in the process, provide real-time project management, and perform their own thorough quality assurance and quality control inspections to ensure that the EPC contractor is satisfying its contract requirements, are more likely to achieve a successful project with minimal disputes.

Establish an Effective Mechanism to Resolve Disputes. Finally, the EPC contract should provide a mechanism to facilitate the resolution of a dispute if one arises. If a dispute procedure in an EPC contract simply provides that the parties will resolve disputes in litigation (or arbitration) with nothing more, then it is encouraging a fight involving many lawyers, rather than creating a meaningful mechanism to de-escalate and facilitate the resolution of disputes outside of court.

We recommend that every EPC contract require, as conditions precedent to litigation, both executive-level negotiations and mediation. A meaningful executive-level negotiations provision in an EPC contract will require decision-makers to conduct multiple in-person meetings over a set period of time to discuss the claims. It will also provide that the discussions will be privileged settlement discussions that are not discoverable in any subsequent binding adjudicatory process in order to foster open dialogue.

Mediation is a process whereby the parties will meet with a mediator—which the EPC contract should require to be a neutral, experienced, and knowledgeable construction lawyer—who will attempt to facilitate a settlement agreement. Discussions and settlement offers made during mediation are also privileged settlement discussions that are not discoverable in a subsequent binding adjudicatory process. Both procedures are non-binding, low-cost, and effective ways to resolve disputes, and therefore reduce the project participants’ risks.

While certain claims and disputes are unavoidable, properly allocating risks in the EPC contract can save time and considerable costs in the long run. ■

Judah Lifschitz ([email protected]) is principal and co-president of Shapiro, Lifschitz & Schram P.C. in Washington, D.C., and Daniel A. Kapner ([email protected]) is a member of Shapiro, Lifschitz & Schram’s trial practice, construction law, and power and energy construction groups.

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