With global business headlines currently dominated by debt restructuring issues facing Dubai World, the Gulf region is again subject to the negative gaze of the West. Despite this, the UAE and the broader Gulf region is likely to be a fertile region for major international contractors over the coming years.
Imminent infrastructure projects in the Gulf, as well as the current one, will provide major contractors with opportunities when global pickings are slim. However, contractors are already facing, and will continue to face, an increased transfer of risk combined with compressed margins in respect of new infrastructure projects and EPC contracts.
‘Pressing the Contractor’ under the EPC contract – Four major heads of risk for Gulf-based EPC Contractors
The power of procurers in the current global market, and the risk adverse position currently adopted by funders, means increasingly onerous contractual conditions for contractors. Particularly in the Gulf, governments and private sector employers are reverting to single-point responsibility ‘EPC’ procurement strategies, without affording contractors the larger profit margins typically expected under EPC contracts or the autonomy to deliver the project.
We are seeing, and expect to continue to see, increased risks for EPC contractors on four major fronts, which are briefly noted below.
Price pressure and ‘margin compression’
Price pressure, or margin compression, is likely to a common theme faced by EPC contractors in the ‘new world.’ Whereas debt financing for government-sponsored or privately backed projects in the Gulf was readily available prior to the Global Financial Crisis, and despite the ‘green shoots’ of recovery that have sprouted around the world, international banks remain reluctant to support large infrastructure projects.
Increased liability and further exclusions from liability caps
When times were good, EPC contractors were able to negotiate overall limitations of liability in the region of 20% – 50% of the total contract price. Assuming that the employer’s performance criteria were sufficiently precise and the contractor had undertaken sufficient due diligence to be confident of its attainment, the likelihood of the EPC contractor suffering a net loss on the project was, to an extent, mitigated.
With the advent of PPP delivery, and given the reluctance of financiers or equity participants to accept any risk in project delivery coupled with the thin capitalisation of the SPV, EPC contractors are unlikely to see limits of liability in the range of 20% – 50% of the total contract price. We expect imitations of liability at 100% of the total contract price, coupled with a raft of exclusions from the liability cap.
Performance security and bonding risks
Employers will continue to require performance security typically in the form of unconditional bank guarantees. The events that may entitle an employer to call on a bank guarantee are greater under an EPC contract than under a traditional construction contract, and the fact that debt financing remains tight means that employer’s may be more willing to call on bank guarantees than would previously have been the case.
Erosion of contractor autonomy
While a number of the major standard form EPC contracts do not contemplate the involvement of an engineer (see, for example, the FIDIC Silver Book), the involvement of employer’s representatives and employers themselves is apparent and is likely to continue to increase. There are a number of reasons for this, but typically the reasons at the core of the involvement are employer’s mistrust of the EPC contractor’s ability to deliver what is required and, on occasion, a misunderstanding of the contractor’s right under an EPC contract.
Although the risks facing EPC contractors are increasing, the Gulf market will provide a fertile hunting ground for the well advised and disciplined EPC contractor. An important strategy for success in the new market will be implementation of appropriate risk mitigation techniques, coupled with effective contract administration.
By Sachin Kerur and William Marshall