Negotiating LNG

Negotiating LNG
EPC
EPC
Contracts in a Tight
Contracts in a Tight
Construction Market
Construction Market
Scott A. Greer
International Bar Association Annual Conference - Chicago
LNG from A to Z - September 18, 2006
Scott Greer, King & Spalding
Critical
Critical
Issues
Issues
1. Selection of Contractor
2. Cost
3. Change Orders
4. Schedule
5. Quality of Work and Performance
6. Liability Limitations
7. Financial Security
1
1
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Selection of Contractor
Selection of Contractor
Who should I select as the EPC contractor?
Contractor with LNG experience
Financially strong
Ability to perform within budget, on time
and with quality work
Selection of Contractor
Selection of Contractor
Sample List of LNG Contractors
Bechtel
Technip
Saipem
CBI
Chiyoda
KBR/JGC
Tractebel
Zachry
Aker Kvaerner
Selection of Contractor
Selection of Contractor
But no matter how good the contractor, the
success of your project depends on the
individuals
Must specify contractor key personnel
Selection of Contractor
Selection of Contractor
However, it is a very tight construction
market for LNG projects.
Contractors are becoming choosy.
at least one currently declines most terminal
work
Therefore, currently more difficult to choose
contractors.
Selection of Contractor
Selection of Contractor
FEED Stage
Its become challenging even at the FEED
stage
Why?
Not want to tie up key people
Selection of Contractor
Selection of Contractor
Beware of Key Contract Issues at FEED
Stage
ownership of drawings and specs
confidentiality
guarantee of EPC work
Selection of Contractor
Selection of Contractor
2 Ways to Contract for EPC Work
1 Bid
2 Open-Book Sole Source Negotiation
Selection of Contractor
Selection of Contractor
If Bid . . .
Recommended Approach
FEED by one contractor
Bid of EPC not include FEED contractor
Advantages/Disadvantages
Time
Competition
Flexibility
But Bidding less common in tight market
may be possible only in larger projects
Selection of Contractor
Selection of Contractor
If Open-Book Sole Source Negotiation . . .
More common currently for LNG terminals
Advantages/Disadvantages
Time
Competition
Flexibility
Recommended Approach
Competitively negotiate MOU for FEED and
EPC, setting out key terms, including
markups (profit, etc.)
2
2
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Cost
Cost
Cost of LNG Projects Has Increased
Cost
Cost
Historically, prices dip due to improved technology
Now, due to (1) contractor demand (i.e., profit margin and risk
contingencies) and (2) material and equipment escalation, cost
of LNG projects has significantly increased
Example Liquefaction Plants
Poten & Partners
Recently (2004) - $200 t/yr
Now - $250 - 350 t/yr
Zeus
Recently (2003) - $200 t/yr
Now- in excess of $500 t/yr
Cost
Cost
Reported Examples:
RasGas III EPC - $256 t/yr
Yemen LNG - $300 t/yr
Tangguh - 18 month delay in investment
decision led to increase from $1.4 B to $1.8 B
Woodside Petroleums North-West Shelf Gas
Project -
Reported on September 6, 2006 that Cost
blowouts hit Woodside Petroleum
Increase from $2B to $2.4B for 4.2 M tonne
plant = $571 t/yr
Cost
Cost
LNG projects typically lump sum
with maybe exception for nickel steel
exception to Lump Sum - Chenieres Sabine
Expansion project
But now have seen exceptions for other raw
materials
Contractors have hard time holding prices, or
charge for the risk
e.g., carbon steel
ways to mitigate
contractor hedge
tie to index
limit time of variability
Cost
Cost
Cost
Cost
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IPA Analysis
IPA Analysis
One Study of Project Costs - Independent Project
Analysis (for SPE Foundation, by E.W. Merrow)
# Projects Surveyed: 118 (from year 2002 and forward)
Project Cost Range: $340 million - $6.8 billion
Project Location: North America (5%); Middle East (21%); Asia (19%);
West Africa (25%); South America (16%); Europe (5%); South Africa (5%);
Mexico (3%)
Type of Projects: LNG (17%); Mineral (17%); Chemical (14%); Oil Refining
(7%); Oil and Gas Field Develop. (55%)
Contracting Strategy: EPC lump sum (71%); Reimbursable EPC (71%);
Reimbursable EPCM (17%); and Other (5%)
Contractor Selection: Bid (61%); sole source (10%); preferred (29%)
Escalation
Escalation
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IPA Analysis
IPA Analysis
Profit Margin and Risks
Profit Margin and Risks
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IPA Analysis
IPA Analysis
IPA reports .
Significant increase in profit margins:
2 to 5% from 1990 - 2002
9 to 12% targets from 2004 and 2005
Significant increase in risk contingencies,
particularly West Africa and Middle East
Significant premium for EPC lump sum
compared to reimbursable/mixed contracts
Costs
Costs
What can be done about the rising costs?
increase competition
additional investigation prior to contract
signing
allow flow-through of costs for certain
volatile raw material costs
where financing and plant performance will
allow it, consider whether the project can be
divided into smaller projects
negotiate profit margins, etc. up front
3
3
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Change Orders
Change Orders
What contractual measures can you
implement to reduce Change Orders?
Change Orders
Change Orders
Actions Before Contract Signed?
Good Scope of Work
Both parties work diligently on scope
Performance based specifications, to the
extent possible, but with sufficient detail to
describe requirements.
Owner should fully vet scope of work,
particularly if FEED contractor is same as
EPC contractor
Change Orders
Change Orders
Soil Issues - key area
of claims
Risks
unknown soil
piles
Mitigation - drive test
piles before signing
EPC (if possible)
Change Orders
Change Orders
Contract Measures?
Get Contractor contractual buy-in to scope
Tight change order clauses:
Change only by change order
Unilateral by Owner or mutual
Monthly lien & claim waivers
No cumulative impact claims
4
4
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Delay
Delay
What measures can
you take to reduce
your chances of
having a late
project?
If it is late, what are
your remedies?
Delay
Delay
Scheduling
Obligations
Good, detailed CPM
Schedule
Strong contract rights
re: scheduling
obligations
Must tie to TUA
obligations
Delay
Delay
Identification of Milestones/Damages
Milestones:
Ready for Cool Down (RFCD) or Ready for LNG
Critical juncture is the delivery of LNG
Partial Operation?
Notice Requirements - tie to TUA obligations
Substantial Completion
Operation
Final Completion
Others?
Delay
Delay
Delays Caused by Owner, Force Majeure, etc.?
Clear definition of force majeure
Clear definition of when schedule extension
is justified
Effects of 2005 Gulf Coast Hurricanes
Delay
Delay
Late delivery?
Recovery rights
Acceleration rights
Delay LDs at Substantial Completion
Daily liquidated damage amounts
stepped - low to high
ranges of LDs
Caps
Exceptions to caps
willful misconduct, gross negligence
Not exclusive remedy
Delay
Delay
What if there is a delay at RFCD or Ready for
LNG for a terminal?
Contractual protection ---
indemnification for demurrage charges
Liquidated damages
5
5
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Performance
Performance
Guarantees and
Guarantees and
Warranties
Warranties
Key Issues with Performance Guarantees and
Warranties
Performance Guarantees/Warranties
Performance Guarantees/Warranties
Performance Guarantees
Tie Contractor obligations to
commercial obligations in TUA
If inadequate performance, what is the
sponsors remedy against contractor?
Liquidated damages?
Fix?
Examples: send-out rate
Performance Guarantees/Warranties
Performance Guarantees/Warranties
Other Critical Issues Re: Performance
Guarantees
New technologies - ex: regasification
Availability of ships for terminals
Downstream capacity
Who operates prior to Substantial
Completion?
Performance Guarantees/Warranties
Performance Guarantees/Warranties
Warranties
Length of warranty - usually 18 months to 2
years
Owner right to correct
Assignment of Subcontractor warranties
6
6
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Limitation of Liability
Limitation of Liability
Aggregate Liability Cap
Range of Cap
Exceptions to cap:
Willful misconduct & gross negligence
Contract specified exceptions
Common law exceptions
Insurance proceeds
Obligation to finish work
Indemnification obligations
Limitation of Liability
Limitation of Liability
Delay & Performance Liquidated Damages
Exceptions to cap
Applicability in the event of termination
Combined cap?
7
7
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Financial Security
Financial Security
What financial security should
I get from the Contractor?
Financial Security
Financial Security
1. Parent Guarantee
2. Letter of Credit/Bank Guarantee or
Payment/Performance Bonds
1. general sponsor preference - letter of
credit/bank guarantee
2. range of amount of letter of credit/bank
guarantee
3. Retainage -
1. Trend: letter of credit/bank guarantee taking
the place of retainage in many cases
THANK YOU
THANK YOU
Scott A. Greer
www.kslaw.com