Contracting Basics to Deliver Projects in Today's Supply Market

Abstract

Abstract The world of project contracting in the oil and gas industry is in a state of flux, with an unprecedented high demand globally for contractor capability at a time of dwindling people and equipment resources. This is leading to seemingly ever-increasing costs, longer schedules and, all too often, inferior quality in the delivered project. The operators are struggling to find the best response to this variable and volatile situation, and a variety of outsourcing initiatives and contracting strategies are being tried and tested. However, we believe getting the basics right in contracting and procurement is now more important than ever. In many parts of the world during the 80s and 90s, the capital contracting bias of the International Oil Companies (IOCs) and other operators moved towards large Engineering Procurement and Construction (EPC) contracts, with a lump sum reward mechanism. Large engineering firms, in an effort to enlarge their work scopes, started to provide this integrated EPC service, allowing the IOCs to outsource their labour intensive and detailed project management activities. These EPC-lump sum contracts gave contractors a strong incentive to perform well and, driven by fierce competition and a perceived relatively certain business environment, they assumed many of the risks associated with the project execution and delivery, with sharp focus on their own cost performance. The clients saw ‘competitive fixed prices’ being offered to deliver their projects, and this made contractor selection seem relatively straightforward. With hindsight, the mid to longer-term consequences of this strategic approach were not foreseen or, at least, were underestimated. For IOCs, many assumed a (sometimes false) sense of cost certainty. Independent Project Analysis (IPA) insightfully stated that the lump sum price was generally perceived as a ceiling price, whereas in reality it was no better than a floor from which cost could, and inevitably often did, grow. This was made worse by the total lack of cost transparency to the IOCs, and hence their inability to meaningfully negotiate the commercial terms for repeat projects and standardisation, or to adequately assess variations and claims. EPC outsourcing also reduced the skill base of the IOCs, and thereby their ability to internally manage large projects and their interfaces at a component level.