EPCM and EPC Contractors: Risk and Allocation
For many years now it seems that the most desired way for an Owner to procure a major construction project, particularly one being project financed, was via a fixed price, lump sum turnkey route; the so called engineering, procurement and construction contract (“EPC contract”) with an EPC contractor. By this route, funders and Owners expect to get the degree of certainty as to time and costs that they require. Such has been the popularity of this method of procurement that organizations responded to the need for appropriate standard forms that more closely reflected market conditions by, for example, the introduction of its Conditions of Contract for EPC/Turnkey Contracts with an EPC contractor.
However, whilst it must always be appreciated that the lump sum EPC option usually remains the most desired procurement route for Owners and funders, in response to market conditions EPC contractors are increasingly proffering and, on occasion, demanding, alternatives. In recent years there has been an increase in cost reimbursable contracts (usually with a target price pain/gain share mechanism built in) for EPC contractors. More recently, there has been a significant increase in the EPCM contract procurement route for international infrastructure and major construction works instead of contracts signed with an EPC contractor. Although historically this method of procurement was certainly not uncommon in the mining sector, the use of EPCM contracts has become more prevalent in other sectors of construction. Particularly, EPCM contracts are increasingly the market response to major projects in the petrochemical and mining sector and also in the power and desalination sectors.
It seems to the authors that the meaning of EPCM (as opposed to the one related to EPC contractors) is still relatively unknown amongst a large part of the construction fraternity. The key confusion which often arises is that whilst the “C” in “EPCM” stands for “Construction”, this is in the context of “CM” i.e. Construction Management. Under the EPCM model the EPCM contractor does no building or construction – rather EPCM contractor develops the design and manages the construction process on the Owner’s behalf. The confusion is added to because there does not appear to be any standard form of contract for this type of procurement for both EPCM contractor and Owner.
This change of emphasis away from lump sum turnkey perhaps reflects the bargaining position of many EPC contractors in today’s market and, to some extent, the increasing size and complexity of the projects being tendered internationally for EPC contractors. In the petrochemical sector, as an example, there are simply not enough EPC contractors with the experience and balance sheet to take on the major capital projects that are coming on stream, particularly in the Middle East. Equally, with so few major EPC contractors with the know-how, resource and experience to undertake such projects, funders have had to open their minds to other procurement routes (and greater risks) in the face of rising lump sum EPC prices. Bank rolling a major project with EPC contractors with no track record of success is not usually an attractive or viable option.
As a result, the major EPC contractors have seen their negotiating position significantly improved in recent times. This has arguably led to a correction in market prices (profit levels for EPC contractors have increased) and levels of risk being transferred back to project sponsors and lenders. This has resulted in a relative shift away from the lump sum turnkey model. In some markets (petrochemical and mining sectors particularly) obtaining a lump sum contract with one EPC contractor might even currently be considered the exception rather than the norm.
With these market conditions in mind, it should be explained how the typical EPCM contract by an EPCM contractor works and, in doing so, identify some of the key differences to the EPC contract by an EPC contractor. After all, they sound the same but there are still many people involved in construction that are not able to elucidate the differences. Indeed, it has not been come across a single article on EPCM contracts – a Google search of “EPCM” will bring up lists of EPCM contracts and EPCM contractors but virtually nothing explaining what an EPCM contract is!
In short, an EPC contract by an EPC contractor is a design and construct contract where a single EPC contractor takes responsibility for all elements of design (engineering), construction and procurement. In contrast, an EPCM contract by an EPCM contractor is a professional services contract which has a radically different risk allocation and different legal consequences. The key difference is that under an EPCM contract, other parties construct the project – the EPCM contractor is not the builder/constructor.