Choosing between EPC and EPCM

Today engineering, procurement and construction (EPC) contracts are being increasingly used in the Middle East for projects ranging from buildings to complex oil and gas projects and process plants.

They have become so popular that many clients have begun to think of them as the preferred option for procuring any project. However, before deciding upon any contract strategy, developers would be wise to consider what it involves and whether it represents the best means for meeting their goals.

Under a true EPC contract, the contractor takes full responsibility for engineering, procuring, designing, constructing and commissioning the project – in short, everything. The input of the client, should be so minimal that it is often likened to the act of "turning a key" to commence operation after completion (such agreements are alternatively known as "turnkey" contracts).

EPC contracts are considered to provide a strong degree of certainty that the project will be delivered within budget and on time, and will perform as intended. Under an EPC contract, responsibility for controlling risks is usually left to the contractor with a few limited exceptions, such as occurrence of events beyond its control. However, it would be incorrect to assume as a result that an EPC contract is a client's most appropriate contracting form for a project.

Dogged by acrimony

To cope with such levels of project risk, the contractor will demand a higher price and greater levels of contingency. The price increase is often more than appropriate to compensate for added risks. Moreover, major EPC projects are sometimes dogged by acrimonious relationships between client and contractor. One complication is that many EPC arrangements are not genuine turnkeys; rather than hand over full control, the client preserves the same risk allocation but retains the right to approve aspects of design and construction. The danger is that the client's involvement may turn into interference and reduce the contractor's scope for cost engineering. Contractors also face high insurance costs for taking on the risks.

Substantial project risks occurring on EPC arrangements have contributed to the demise of several top contractors. Others have simply chosen to leave the EPC sector, reasoning that the potential rewards do not justify the risks involved.

Some employers have focussed too heavily on EPC to the detriment of cost-effectiveness. Aware of the premium charged for risk, clients seeking better value are turning to alternative structures such as EPCM (engineering, procurement and construction management) as well as alliancing and partnering arrangements.

EPCM involves the sponsors and clients shouldering a greater share of the cost and time risk, with the contractor designing and managing the project on the client's behalf. The construction is carried out by trade contractors. It is critical that the client has the resources and experience to handle an EPCM project.

Alliancing and partnering represent a cultural shift. Here, client and contractor collaborate for the benefit of the project. More client involvement is required than under a EPC arrangement and the benefits to both parties may only be felt over the course of a long-term project or several projects. The balance of risk is less clear than under EPC structures. If external finance is needed, funders tend to be more wary of EPCM, alliancing and partnering arrangements than EPC ones.

The best value

EPC contracts remains appropriate in many cases so employers should consider how to extract best value. It may be sensible to consider whether they are better placed to absorb or share certain risks. Site conditions, for example, are often a key battleground in negotiations, the contractor usually being required to take responsibility for undiscovered hazards despite the client being more familiar with the site. Similarly, government clients may be better suited to deal with changes in law, while insurance cover may be used to mitigate other risks.

Sponsors and funders often use EPC contracts to achieve peace of mind. Sophisticated clients, however, may wish to strike a balance between risk and cost. By tailoring their agreements to suit project circumstances, there is a greater likelihood that this aim can be achieved.


- The writer is a senior associate at international law firm King & Spalding. The views expressed are his own

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