Establishing EPC Contracts

Suitable for Today's Sustainable

Infrastructure Projects

Benjamin Hubbard, CEO | Nexus PMG 2022 Whitepaper

CONTENTS
1
Introduction
The State of the EPC Industry

5
Shifting Project Execution Risk Mentality

6
Understanding the EPC Contract

7
Price

11
Contingency

16
Performance Guarantees

20
Project Schedule Risk

21
The Collaborative Alternative

27
Time to Change
 Without visibility of meaningful work in
INTRODUCTION the future, it is nearly impossible to
Engineering, procurement, and retain critical staff that maintains the
construction management (EPC) firms intellectual knowledge and know-how
continue to recognize substantial losses necessary to execute intricate projects.
due to an inherent risk imbalance that People execute projects. Thus, people
has become impossible to ignore, are the only true competitive
forcing many to exit fixed-price work. differentiator an EPC firm has to offer.
The fixed-price EPC contract is slowly Demonstrating you have executed 25
dying. Yet, the investment community projects in a particular vertical means far
continues to mandate fixed-price less if all the resources involved no
turnkey contracts to govern project longer work for the company.
execution.
This is where things get sticky. EPC
This is the EPC turn-key paradox. companies cannot afford to let go of
incredibly hard-to-replace resources. But
Which begs the question: Are we headed at the same time, they cannot afford to
toward an EPC contract reckoning? keep them on the balance sheet if there
are large gaps between projects or a lull
in the project backlog.
THE STATE OF THE
The result?
EPC INDUSTRY
EPC firms do whatever it takes to book
Managing an EPC business is incredibly work to retain the human capital
complicated. In addition to the required to properly execute projects,
considerable competition, a never- and more importantly, continue to
ending battle for skilled labor, and secure contracts. The alternative is not
constantly evolving market trends, there pleasant. Letting go of resources that will
is the daunting task of managing likely move to a competitor all but
complex staffing profiles. The EPC guarantees a decline in growth.
industry is all about back log.

1
Yet, doing what it takes to book work
typically means signing contracts that
Is Fixed Price the Cause
carry far too much risk, agreeing to or Effect?
prices that require flawless execution,
and taking on unjustified (pending your One could argue that the commonplace
vantage point) liabilities. This is the budget and schedule overruns are the
definition of “kicking the can.” Signing precise reason why a fixed price contract
poor contracts will hold you over for a is preferred and near required by the
while, but eventually those projects near investor community. Why would a
completion, and the ugliness ensues. project sponsor want to take on that
In some respects, EPC industry kind of expected risk?
participants are in a long-term race to
the bottom. To answer that, we must dig a little
deeper.
Unfortunately, the evidence is
overwhelming that the EPC industry is First, let's start with the most common
suffering from this paradox. According to reasons why projects end up so far over
a survey conducted by McKinsey & budget and behind schedule. This topic
Company in 2020, senior project is subject to significant debate, with
executives reported that projects exceed several thousand articles addressing the
their budgets and schedules by 30-45%. matter spanning decades. Most of the
articles speak to very real issues such as
Over the seven-plus years that Nexus poor and ineffective communication,
PMG has been in business, we have delayed or insufficient engineering,
assessed hundreds of projects. Of those, inadequate estimating, ineffective
I can count the number of projects that scheduling, poor commissioning
were not fixed price on one hand. So, if practices, and skilled labor constraints.
most projects are over budget and
behind schedule by 30-45%, who do you However, I tend to believe those factors
think is bearing much of that burden? have one overarching aspect that triggers
them: governance.

2
Simply put, the EPC contract structure determines the level of collaboration on a
project. In a fixed price turn-key environment, the EPC firm has agreed to take on the
majority of project execution risk and is now invested in doing whatever it takes to
achieve or exceed as-sold margins for shareholders (this is exacerbated for publicly
traded EPCs). It immediately leads to a “stay out of my way” mentality for the EPC
company.

Conversely, owner teams do not want to offer up any excuse that could lead to a
justified claim, so they too end up being very procedural and transactional leading to
a “just get your job done” mentality, or risk getting change ordered.

This inevitably results in issues that cause delays and cost overruns.

Open and honest communication comes second to protecting margins. Rather

than addressing concerns as they materialize, a “we will course correct, so it is not
worth addressing” mentality dominates. Risks ultimately materialize and the
mitigation options that would have been viable are no longer a possibility and
impacts are felt.

Change orders or commercial disputes take far too long to resolve, resulting in
schedule impacts arising from delayed decision making.

Project management becomes an arrears function. In a fixed-price contracting

environment, the amount of time project management spends satisfying internal
reporting requirements is considerable. Executive management wants to know
the precise status and risk profile of higher-risk projects. Surplus time spent
satisfying internal requirements is time not spent looking out for the client.

3
 Owner teams and owner's engineers cannot deliver mutual support on risk
mitigation strategies. For example, if an EPC firm is struggling to find a good
specialty contract for an aspect of the job and the owner's engineer has a great
connection to one that would be ideal, it is unlikely to be exploited. The potential
liability of influencing the EPC firm (“well you told me to use them”) must be
considered and thus it is likely necessary to let the EPC find their own way. This
likely results in schedule delays, cost overruns, and even poor-quality work.

The EPC company is responsible for getting the plant to substantial completion
and satisfying the performance tests. There is nothing wrong with this. However,
in the age of less mature sustainable infrastructure projects, EPC companies are
rarely qualified to commission and start-up such facilities. But you cannot have a
plant performance guarantee (fixed-price or not) if the EPC firm does not take
this work on. Startup and commissioning should be a highly coordinated team
effort, bringing in the appropriate balance of experts, regardless of which
stakeholder brings them to the table.

If I told you that I wanted to partner with you in pursuit of a major endeavor, and on
day one of doing so we agreed that we must protect our respective interests, would
that be a partnership you would sign up for? That is the natural environment that a
fixed-price contract creates. An EPC company has a responsibility to its stakeholders
to maximize profits, protect downside and reduce contractual liability and cost
exposure. The owner team has the same responsibility.

Thus, unfortunately, there can only be one outcome when things do not go according
to plan: cost overruns, schedule delays, and dispute resolution.

4
Shifting Project Execution To answer that, we have to understand
the investor mindset.
Risk Mentality
Project execution from the investor lens
Executing complex infrastructure comes down to three things.
projects is difficult. It requires proactive
planning and intense project Cost risk exposure
management. There are countless Schedule delay exposure
moving parts, and cohesive collaboration Plant performance exposure
is arguably the single most important
means to delivering a project on time All of these are a threat to returning their
and on budget. invested capital and achieving expected
pro forma returns. Investors are not out
The Nexus PMG team has been a part of to break even. However, most real-asset
thousands of projects. Most of them investors (general partners) are investing
were fixed-price turnkey with money on behalf of pension funds,
performance guarantees. Most of them insurance funds, large corporates, etc. It
were over budget and behind schedule. is much easier, if not required, to defend
That is the truth. I do not think this will an investment into a project where,
come as a surprise to most reading this contractually, the risk is allocated to
as it is a constant topic of conversation credit-worthy third parties.
and frustration amongst investors,
developers, contractors, and advisors. If guarantees exist that cause contracted
stakeholders significant pain if they fail,
So, why is this the status quo particularly that is a good place to be.
in sustainable infrastructure sectors?
Why do we keep doing things the same Until it is not.
way if it is not working?

5
It is time to change the perception of The hard truth is that a project that runs
project execution risk. This will require significantly over budget and behind
general partners to spend adequate time schedule is far worse for the sponsors
educating limited partners (and and investors than it is for the EPC
themselves) on the practical and company. EPC liabilities are capped at a
inherent nature of project execution. modest percent of the contract value
Ultimately, it requires a significant (often 20%). The sponsor liability is the
mentality shift. One that results in balance of the investment (the
establishing a more commonplace
remaining 80%).
project execution structure that
rationally decreases cost, schedule, and
Let’s examine four influential
performance exposure. Paper-based de-
components of the EPC contract and
risking is worth the value of the paper it’s
their influence over risk allocation.
written on.

Price
Contingency
UNDERSTANDING Performance guarantees
Project schedule risk
THE EPC CONTRACT
As an infrastructure investor, you are
responsible for putting capital to work
with as much downside risk protection
as possible (within the boundaries of the
expected return profile). This means you
spend much, if not most, of your time
assessing risk. My guess is that you have
personally experienced the pains of cost
overruns and schedule delays resulting
from EPC performance.

6
Price

To understand cost risk, you must first understand how a proper EPC contract is priced.

1.) A Front-End Engineering & Design (FEED) package is completed, often utilizing the
Front-End Loading (FEL) process. This process leverages a phase-gated approach to
maturing project definition allowing for the ability to cut off development capital
spending if it looks unlikely to reach technical or economic viability.

2.) During the progression of the FEL process, equipment package specifications are
being defined and drafted to use as the basis to obtain pricing from equipment and
technology vendors. Detail-oriented communication with such vendors is critical,
regardless if sole-sourced or awarded via a bid process. Equipment costs typically
make up 30-45% of the total project cost. Equipment costs prior to contract signing
should be very accurate.

3.) At the completion of FEL 3, we typically say we have completed Basic Engineering.
This means there is still lots of detailed engineering remaining to be ready for
construction and have firm quantity take-offs, but there is enough work complete to
determine if the project remains viable.

The engineering package typically has enough definition to complete some level
material quantity takeoffs (remaining will typically be factored) and a reasonable
assumption can be made for standard plant equipment such as electrical MCCs and
standard pumps which will be finalized during the detailed engineering process. This is
the process of “measuring” the number of bulk commodities that must be installed.

7
Price (Cont'd)

For example, measuring the number of cubic yards of concrete that need to be poured
based on foundation design. Or the length of small-bore carbon steel pipe that must
be installed.

By measuring quantities as accurately as one can at this phase, you define in

reasonable detail the amount of material you need to complete the project. Once you
know how much you must install, you can calculate the cost to purchase the material
and the amount of labor that will be needed to install it. Material costs typically make
up 25-35% of the total project cost. Material costs before contract signing should be
modestly accurate, but where large assumptions are made, the appropriate amount of
contingency should correlate.

4.) Once you have the quantity of pipe, cable, concrete, instruments, and other
material you can estimate labor costs. There are several ways in which this is done, but
the most common is by applying install unit rates. EPC companies maintain and retain
access to a large amount of data. They know exactly how much time it takes a pipe
fitter to install 2-inch small-bore carbon steel pipe by the linear foot. Thus, the only
missing part of the equation is how much footage is there to install. Multiply the two
and you get the number of man-hours required to do so. Assign a labor rate and you
have the number of dollars required to do so. It all comes back to the ability to
estimate quantities as accurately as possible.

Labor costs typically make up 20-35% of the total project cost. Labor costs risk is like
material cost risk as both are heavily driven by the accuracy of the quantity
calculations and regional trade agreements. Labor unit rates are typically well known
by the contractor, and when allowing for necessary escalation, are modestly accurate.

8
Price (Cont'd)

5.) You also have subcontract considerations. Most EPC companies subcontract out a
portion of their work. Many of them subcontract most if not all. The most common
subcontracts are specialty trades or supply install equipment packages (vendor
installed). An EPC company can execute entirely as a general contractor (GC), but the
ability to self-perform is typically advantageous. Self-performed work is often
completed by craft labor that maintains a history of working together which impacts
performance.

6.) Last, but certainly not least, you have commissioning and startup considerations.
This one is always a hot topic.

From the above, it is obvious to see that the amount of engineering definition,
equipment vendor engagement, and effort put into generating material takeoffs drives
estimate accuracy. If satisfactory engineering and project execution definition does not
exist, capital cost estimate accuracy is inherently decreased which should serve as a
major red flag. When done properly, an EPC pricing effort is an aggregate of producing
material takeoffs (MTO’s), completing labor studies, adequately negotiating major
equipment packages, and defining the balance of plant cost risk. In other words, data-
driven analysis, and assumptions.

9
Price (Cont'd)

The following table from the association for the advancement of cost engineering
depicts the various classes of estimate and expected accuracy driven by the maturity
of deliverables.

If you properly evaluate the process in which an EPC price was established, you can
begin to understand how accurate the price likely is. That comfort level should
significantly influence the decision-making regarding which commercial cost structure
is preferred. If a rigorous pricing exercise is completed as described, is it fitting to
execute a fixed price agreement that increases capital costs (EPC firms incorporate
their own contingency) and assume all the noted downsides created by an inherently
self-serving environment?

10
Contingency

Also impacting cost is the consideration of contingency. A cost contingency budget

(which is different from schedule contingency) exists to cover uncertainty. To be clear,
there will always be uncertainty and execution risk no matter the contract structure or
the extent of project scoping. The key is to use best practice techniques to capture and
quantify that uncertainty to establish the appropriate contingency budget.

There are two predominant forms of contingency:

Estimate Contingency Event Contingency

The contingency established by the Often referred to as unknown unknowns,

amount of measured uncertainty within event contingency captures external
the detailed capital cost estimate. Were influenced events. What happens if a
widely variable assumptions made to selected equipment vendor goes
calculate electrical equipment costs? bankrupt and the process to award a
Was there a specific equipment package contract to an alternative vendor delays
that was not quoted but rather taken schedule? What if a pandemic occurs?
from a similar project? Estimate Are you building in a union labor
contingency is often referred to as the environment with a history of strikes?
“known unknowns.”

11
Contingency (Cont'd)

HOW TO ASSESS CONTINGENCY REQUIREMENTS

There are several methods to assess contingency requirements. Unfortunately, the most
common method is selecting a percent of the total cost based on similar projects or the
estimated class. That can work in industries that are mature and where hundreds of
similar facilities have been constructed (compressor stations, simple cycle power
stations, solar farms). Even then, every project has its own risk profile. In sustainable
infrastructure, that method is not suitable.

Arguably, the industry-standard method is to utilize a combination of quantitative and

qualitative assessments.

Quantitative Assessment Qualitative Assessment

A quantitative assessment makes use of A qualitative assessment is an evaluation

probabilistic analysis techniques such as that relies on the experience and
the Monte Carlo simulation method. The knowledge of key project stakeholders
process requires building a logical to identify items that have the potential
model where risks are identified from a to impact the schedule and cost. This
variety of sources, including the type of assessment is typically managed
qualitative assessment. The model is via the project risk management plan
subject to simulation through multiple and risk register.
iterations performed with a random
activity duration selected from a
predefined distribution.

12
Contingency (Cont'd)

Risk Register

A risk register is exactly what it sounds like. It is a register of identified known unknowns
and unknown unknowns. It is comprised of the following key components:

Risk item
Likely risk trigger
Risk response plan
Risk owner
Estimated impact (cost and schedule)
Probability of occurrence

Not only is this an extremely valuable tool to manage risk throughout the life of the
project, but the information can be used to calculate contingency requirements.
By assigning a potential impact value and probability of occurrence, you can identify the
potential cost and schedule impacts to a project.

13
Contingency (Cont'd)

Monte Carlo Simulation

Below is an example of a Monte Carlo-driven contingency analysis that measures

contingency requirements at confidence levels in increments of 5%. For example, a
P80% means that if you were to proceed with the amount of contingency
recommended at that level, you have an 80% chance of completing the project with
enough money. This makes logical sense if you presume that the more contingency
you carry, the better chance you have of finishing the project without requiring more
capital.

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Contingency (Cont'd)

It should be noted that in a fixed price contract environment, EPC companies add their
own (hopefully calculated) contingency into their price to cover their known
unknowns. They own it. We often see a 10-15% increase in price (as compared to non-
fixed price contract structures) due to EPC contingency. On top of that, you must add
your assessed owner’s contingency which typically ranges between 5-15% regardless of
contract structure to cover unknown unknowns.

“But what happens if the desired estimate accuracy proves to be not so accurate?”

This is a question posed to me often by investors. The fear of overrunning budgets by

30%+ is crippling. Financial models cannot stand that level of capital cost sensitivity, so
a 10-15% higher price that is fixed provides more comfort and perceived certainty. But
what if you took that 10-15% and added it to the owner’s contingency budget and
absorbed the cost-risk with a strong owner’s engineer at the helm?

You would have 15-30% total contingency to manage together with the EPC firm. Under
a profit-sharing model, both parties would be incentivized to work as a team.
Information would flow and change approvals would move quickly. Commercial
disputes will be minimal. Influential response plans would be deployed
collaboratively. Proactive project management and decision-making will govern.
All-in-all, stakeholders would spend more time focusing on project execution, and less
time squabbling over the ownership of profits or losses.

15
Performance Guarantees

A performance guarantee (a performance bond) protects downside risk by holding the

EPC firm accountable for ensuring all the equipment works as expected when
“connected” together. In its simplest form, an EPC performance wrap is an engineering
design guarantee. Each respective process technology package typically comes with a
performance guarantee of its own, but that does not necessarily mean that each piece
of equipment will play nice with the others. A performance guarantee is intended to
motivate the EPC to stand behind the engineering and do what it takes to achieve
nameplate production capacity.

Some EPC performance guarantees require absolute compliance and impose

unlimited make-good obligations on the contractor until attained. In other cases, and
more commonly, the EPC firm will assume liquidated damages with a defined
minimum performance level. These damages are traditionally capped, often ranging
from 5-10% of the contract value. Additionally, there is typically an overall damages
cap of 10-20% which this is factored into.

Are these performance bonds worth it?

To answer that you need to truly understand performance risk. After all, that is what
the performance guarantee is designed to address.

16
Performance Guarantees (Cont'd)

PERFORMANCE QUESTIONS FOR EVALUATING PERFORMANCE

RISK

Is any new technology being deployed?

Is there scaling risk?
Are all vendors providing a guarantee on each piece of equipment?
Are there any similarly designed facilities in operation?
Has the fuel supply (often organic feedstock) been adequately sampled, tested,
and considered in the design basis?
Is there a realistic base case startup timeline? This is important because
compressed schedules lead to poor commissioning, startup and operations
practices and performance bottlenecks.

The answer to the question, are performance bonds justified, lies in the answers to the
above questions. One could argue if you do not feel comfortable that the facility will
be commissioned and started up properly over a reasonable time frame, then the real
guarantee is that the performance bond will be pulled upon. If the performance
guarantee is based on the feedstock provided by the owner's team, what is the
probability that the feedstock may change or doesn’t meet specification, thereby
potentially voiding the guarantee?

This is not to say that performance bonds are not valuable motivators, but they only
guarantee you will get some of your money back to pursue corrective actions, not that
the plant will operate properly.

17
Performance Guarantees (Cont'd)
DELAY LIQUIDATED DAMAGES
Schedule liquidated damages (delay damages) are agreed-to costs that an EPC firm
incurs when project completion is not achieved on an agreed-to date. Project sponsors
typically have penalties if they fail to deliver the plant product output to their
customers. Schedule liquidated damages are designed to cover all or some of these
potential delay costs and inspire the EPC company to finish on time.

Liquidated damages are often calculated on a daily or weekly basis, and as a

percentage of the contract price. Schedule liquidated damages typically range from
5-10% while contributing to an aggregate cap. To assess schedule delay damages, one
must understand schedule risk. To understand schedule risk, one must understand the
accuracy of a schedule at any point in time (much like cost estimate accuracy and risk).

PROJECT SCHEDULE LEVELS

Management/Milestone Level Master Schedule (Level 2)
Schedule (Level 1)
Level 2 schedules contain more detailed
A Level 1 schedule is typically a one-page activities for each of the summary
bar-chart and milestone list that outlines, phases previously identified in the Level
1 schedule. This often includes a
in broad form, the project objectives,
breakout of the various disciplines
significant milestones and phase
responsible for the activities in each
relationships. It is simple to digest and
phase, the critical engineering and
serves as a quick way to view and assess
procurement activities, the major
critical milestones. This schedule also elements of construction by work area,
often includes key contractual milestones and general commissioning and start-up
and requirements as it is included in the requirements. Generally, this is the first
EPC contract. level of scheduled detail where logical
links or task relationships may be shown.

18
Performance Guarantees (Cont'd)

Project Level Schedule (Level 3) Control Level Schedule (Level 4)

Level 3 schedules contain all project Level 4 schedules are developed and
scope and are derived from key project maintained by a project execution team
execution stakeholder information and are commonly prepared by project
(equipment suppliers, contractors, leads and construction subcontractors to
construction experts, etc.). This schedule monitor and control day-to-day work
is often referred to as a project schedule activities and serve as the foundation for
and oftentimes will go through a measuring project progress and
baseline approval process as it will performance.
become the foundation for which the
project will be measured. The baseline Detail Level Schedule (Level 5)
schedule will typically have
requirements to meet the Level 1 and Level 5 schedules are typically used for
Level 2 contractual requirements. While managing shutdowns, outages, and
we like to see a version of this as the planned maintenance activities. Some of
level of detail prior to any project the specialty schedules (mini-schedules)
financing, a hybrid of Levels 2 and 3 is for specific work tasks may also fall into
often what is available. A fully detailed this category. We see these types of
Level 3 will only exist if engineering was schedules being utilized for highly
close to 100% complete before contract specialized work tasks or where several
execution. A more common industry contractors and trades need to
standard is to require a Level 3 baseline coordinate work in a specific area.
to be established 60 or 90 days after EPC
contract execution.

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Performance Guarantees (Cont'd)
PROJECT PLAN DEVELOPMENT

Developing the project plan is part art and part science. As described earlier, typical
project stakeholders can consist of the primary EPC company along with their
subcontractors and vendors, all of which have to hold up their portion of the schedule.

EPC firms factor liquidated damages into their profit and loss statement. EPC firms do
not think of it as the need to achieve the schedule but rather focus on the cost.
Schedule issues are compounding. Course correction becomes limited as the project
evolves through the execution lifecycle.
You can’t influence the schedule when the EPC company has the damages.

Project Schedule Risk

Assessing the risk in a project schedule is driven by the amount of detail available when
developing the schedule along with the participation of all the stakeholders. At the point
of project finance, a Level 2 schedule should be available, but a Level 3 is preferred as it
represents a better project definition.

This level of detail typically breaks out enough scope to identify and evaluate the risks that
exist between logically tied schedule tasks. It also should contain enough logic such that a
scheduling software (such as Primavera) can run a PERT analysis to appropriately calculate
project float along with other various standard schedule metrics that can provide a
guideline to evaluate how aggressive the project schedule is.

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THE COLLABORATIVE ALTERNATIVE

There are alternative approaches. Many are commonly used across mature industries;
others are new market products. The appropriate approach to each of the major EPC
contract components should reflect the assessed risk profile.

It should be acceptable not to use fixed-price turnkey-wrapped EPC contracts. If the

project has been well developed and a significant project definition exists, fixed-priced
EPC contracts are likely more harmful than good. If the project lacks definition, and many
assumptions are steering the outcome, perhaps it is appropriate. I would argue it should
be further developed before signing an EPC contract. There is strong evidence for utilizing
more balanced contract terms based on risk profile.

21
Alternative Approach to Price

If a sound FEED package has been completed, material takeoffs exist, and a
collaborative EPC pricing exercise has been completed, the perceived benefits of
fixed price may not offset the negatives. Instead, consider a cost-plus model where
the EPC contract passes through all project costs and applies a fixed markup for
overhead and profit. This means the sponsor is taking on price risk, influenced heavily
by the strength of the engineering package. However, those risks that are of higher
likelihood to occur, and cause greater impact, can be assigned owners contingency
and managed collaboratively. Any large scope gaps would be change orders in either
structure, and thus we are really talking about equipment, labor, and quantity risk.
Those risks should be manageable.

Key Benefits

Reduced capital costs (initial) by eliminating EPC risk contingency, lower fees (EPC
firms are willing to accept lower margins with reduced risk), and equipment and
material markups.
Proactive project management resulting from increased project information
transparency, project tracking, and reporting (there is no reason to hide anything).
Ability to quickly descope certain work packages if necessary (pending
performance guarantee considerations).
Increased flexibility to adapt scope if necessary, to control costs.

It is important to note that managing this type of contract structure requires a strong
owner team or owner’s engineer. Proactive project management, timely decision
making, effective contingency management, and accurate project tracking and
reporting are all critical to delivering a project on time and on budget.

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Alternative Approach to Contingency
This must be discussed in conjunction with price because the price is driven by
contract structure (risk allocation). In a fixed price environment, the EPC firm controls
their internal contingency (built into their estimate), and the owner the same. Owner’s
contingency covers unforeseen events that are not a direct result of the EPC
company's actions, and change orders typically derived from scope changes. In a cost-
reimbursable or comparable contract structure, all the contingency is owned by the
sponsor. This is powerful. Not only do you carry a large self-controlled budget, but
you also control how and when it is spent. One could argue that contingency control
and management is the single largest influencer of cost control.

Key Benefits

Increased control over timing and implementation of risk response plans.

Greater flexibility to “spend money to save money.”
Greater control over schedule acceleration initiatives.
Ability to value engineer or control scope.
Increased collaboration.

23
Alternative Approach to Performance Guarantees
To reiterate, performance guarantees are not a guarantee the plant will perform. It is a
financial mechanism to motivate the EPC company to get the plant operating to
nameplate capacity and allows the project sponsor to recover capital to rectify their
inability to do so. The concern should be obvious. If a highly qualified EPC contractor
is unable to get the facility to operate properly and satisfy performance requirements,
who can? Is it too late anyway? Will off-takers remain patient? The truth is the best
performance guarantee is one that is focused on directly influencing the performance
itself.

There are several ways to accomplish this.

Allocate capital and identify third-party commissioning and startup support

resources or organizations that have deep experience in the specific plant
process. This could be in lieu of the EPC firm taking on this scope, or in addition to
(owner team side).
Leverage equipment vendor resources. Most, if not all, process equipment
vendors can and will supply resources to help during commissioning, startup, and
operations. In complex sustainable infrastructure, the more knowledge you have
around the table working collaboratively, the better (within reason).
Establish a realistic commissioning and startup schedule. A rushed commissioning
process is the kiss of death for plant operations. If the process is rushed due to
unrealistic expectations, or to make up for construction delays, you all but
guarantee a longer timeline to stable operations (at best).

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Alternative Approach to Performance Guarantees
(Cont'd)
Key Benefits

Transitions mentality from contractual performance to “boots on the ground”

performance.
Reduces cost (for acquiring performance guarantee), allowing contingency capital
to be deployed to correct performance-related issues.
Opens project execution up to several additional qualified counterparties that
may likely take a pass on the project due to the intensity of performance
guarantee requirements.

25
Alternative Approach to Liquidated Damages

Sticks are not always better than carrots. Consider structuring the contract such that
incentives are provided if certain milestones or accomplishments are met. These
incentives should extend beyond traditional construction project level milestones
and include things such as leadership, communication, and reporting. We often forget
that it is the little things that make all the difference during the execution of a
complicated project. Providing incentives for consistently issuing meeting minutes,
limiting turnover of key project employees, and issuing consistent reporting on time
are all simple ways to incentivize the small things that often have the biggest impact.

Key Benefits

Provides opportunity for more collaborative relationships and culture driven by

incentivizing good project management practices and effective communication.
Better aligns ownership and mitigation of risk between EPC contractor and
sponsor.

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TIME TO CHANGE
If you take anything from reading this whitepaper, let it be that the better defined a
project is during project development, the more flexible you can likely be for project
execution and contracting strategy. Selecting an EPC firm and defining the
commercial arrangement is a matter of defining and assessing risk. Think about it this
way: If you live on the top of a hill in a dry part of Texas, you likely will not purchase
flood insurance.

So, what comes next? Does the investment community shift their mentality around
project execution risk and more EPC contracts are governed by an alternative, more
collaborative, commercial structure? Or do EPC firms force the hand of investors by
simply no longer offering the fixed price turnkey performance wrap contract product?

Either way, it is time to change the fixed mentality toward fixed-price contracts.

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