24 August 2015

Whole Life Procurement

This is another of those interesting trends in construction which has taken hold globally.

The world of construction procurement keeps changing. This process is driven by many factors: sometimes it is technological advancements or efforts within our industry to do things better – and I have written before about Building Information Modelling (BIM) and about partnering and alliancing. Sometimes it is driven by external factors such as the worldwide impact of project finance. That has driven substantial changes in the way we write and negotiate contracts – it has also influenced the published standard form contracts: the official history of the FIDIC Silver Book (EPC/Turnkey) tells us that it was written in response to funder requirements to toughen up core risks from the project owner’s perspective.

Most of the discussion however has been about construction contracts i.e. how best to look after the capital expenditure through management of the core construction phase risks: time and cost control, quality and performance of the built asset. There has always been a connection in planning, between building and operating a facility. For instance there are long term service agreements typically sitting within supply contracts for big plant such as turbines. Also BIM and partnering/alliancing philosophies can stretch into the operational phase.

More commonly however, the operation and maintenance arrangements have been dealt with separately.

So what is changing? For a few years now the thinking has been going further, into considering operational efficiency from the beginning as well as the construction spend. This is logical of course; operational cost efficiency – and the quality of it – are just as important, maybe more so. Particularly where there is such a large proportion of engineering projects in power, water and chemical engineering. In these sectors the operational expenditure may well exceed capital expenditure over the life of the asset. Again, this new thinking is rooted in project finance.

PFI/PPP

Our experience of Private Finance Initiative (PFI) or Private Public Partnership (PPP) procurement is now substantial and it has made our industry think in more detail about how to measure and value operational services over a long period.. PFI/PPP has spread through the world in the past 15 years. From this, we have become familiar with the idea of “whole life procurement” and we have learned a lot about how to do it. In a typical PFI deal to procure (for instance) a hospital or a road on a 30 year concession, the construction phase is the easy part. It might not look that way sometimes but at least the construction can be specified, priced and programmed in a way similar to a traditional procurement – and it all happens straight away after financial close.

The “new tricks” are really in the operational phase activities. These can be anything from clinical or cleaning services in a hospital to street lighting and road surface maintenance. Whatever it is there are now established methods of checking and measuring quality and availability of the assets and the services to be supplied – and of adjusting payments accordingly.

Taking that one step further we now have a proliferation of private-sector project based on concessions or arrangements. All have acronyms of course such as DBFO (design-build-finance-operate) which is effectively a private version of PFI. Also BOT (build--operate-transfer) and others.

Design Build Operate

The simplest “whole life” concept is DBO or design-build-operate. This does not involve contractor financing; it is just the joining together of construction and operation-maintenance (O&M) into one contract. The main benefit of course is the removal of the interface between the two phases. To put it bluntly, if a single contractor has undertaken both phases, the contractor cannot tell the owner that the facility is costing too much to run because it is defective.

Added to that is (or can be) the benefit of being able to fix operational cost at the outset. Again if a contractor has built the asset then there is more likelihood of being able to agree a fixed price deal on O&M. This obviously helps investment decisions.

FDIC Gold Book

DBO is generally done on bespoke forms of contract and, as expected, they tend to be lengthy. The FIDIC Conditions of Contract for Design Build and Operate (the Gold Book) is the only recognised published form for this arrangement. The immediate striking feature is that it is a short contract, still only 20 clauses, as with the other main contracts. The whole O&M part is essentially squeezed into clause 10 “Operation Service”. FIDIC is proud of achieving simplicity in its conditions and of keeping to essentially the same format for its suite of main contracts, although this does look too much like a cut-and-paste to join a FIDIC design-build onto an O&M contract.

This is intended for large projects and for long operational terms – 20 years is the default term. It has provisions to handle technological change and price fluctuation across the term. It requires the issue of a Commissioning Certificate which marks the transition from construction to operation phase.

One big question is whether it is suitable as an effective subcontract under a PPP or similar concession. In my respectful view, it is there is simply not enough detail, without a lot of amendment, to cover the usual requirements in a modern concession agreement – notably the detailed setting, measuring and payment provisions relating to service levels and facility availability. These are typically set in the form of KPIs and involve liquidated damages, graduated responses to failures and a range of remedies. It is also disappointing that this contract does not take the main opportunity of DBO as mentioned above, by providing for fixed price O&M services.

A Guide to Doing Business in China

We explore the key issues being considered by clients looking to unlock investment opportunities in the People’s Republic of China.

Doing Business in China
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