Ways of building a plant

We will discuss purchase and contract, in so far as they are part of the project’s execution, in more detail in subsequent cycles, concentrating on the engineering implications and interface. In what follows we will discuss the contractual aspects of setting up a project organization, namely the contract environment in which the project engineer himself must work.

To set the scene, we will first discuss the options available to an investor or potential investor, ‘the client’, in a process plant project. His fundamental choices are either to do the work with his own resources,

‘in-house’, or to get an engineering company or consultant to do the work, or at least to manage it.

Disadvantages of doing the work in-house include the following.

• Loss of the benefits of focus: most clients’ core business is the manufacture and marketing of product. The engineering and management of major plant construction projects is often not considered to be a core activity.

• In the case of projects which are large in comparison with the client’s in-house resources, all the problems of hire-and-fire to cope with uneven workload, or alternatively the debilitating effects of hire-and-don’t-fire in such circumstances.

• Loss of competition, from which the in-house workforce is inevitably sheltered, potentially resulting in unimaginative, inefficient perform-ance and sub-optimal designs based on individual preference (for example ‘gold-plated plant’).

• No opportunities for risk-sharing if the project outcome does not match up to expectations.

Advantages of working in-house include better ability to retain and develop key technologies and key staff, and the ability to exert greater control over the details of project execution, without the limitations which may be imposed by a contractual arrangement, for instance the need to negotiate changes rather than to impose them.

There may be a perception that in-house work is either more or less costly than work which is contracted out. Such perceptions, whatever they are, may not really be warranted because of the fundamental difficulties of comparing engineering cost-effectiveness, a subject to which we will return.

If the client does not have the in-house choice due to lack of own resources, or makes the alternative choice anyway, there are still several options. Whichever option he chooses, he will have to retain some in-house (that is, directly employed) resources to manage the contracting-out of the work, and eventually accept the completed project.

If the client wishes to promote competition by making the entire project – the provision of a ‘turnkey’ plant – the subject of a lump-sum bidding process, he has the task of defining the project work in a suitable way for competitive bidding. For plant of a standardized nature, for example the more standard water treatment, oil refinery, food, or chemical processes, this is a relatively straightforward procedure, and often the preferred option. It is no easy task for a complex non-standard plant – much engineering is needed to develop the conceptual designs and specifications required to define the project work, and there is the inherent problem that in the process of definition, opportunities for innovation and other improvements may be lost.

Some plant owners try to overcome this problem by specifying in detail the plant and services required for purposes of comparative bidding, and allowing bidders who submit compliant offers to submit alternative offers which will not however be the basis for bid compari-son. This is indeed either an intellectually shabby concept – why should the bidder submit the products of his ingenuity and competitive technical advantage, if it is not taken into competitive account? – or a commercial charade, if the client does in fact take the more attractive alternative into account, or as sometimes happens invite the lower-priced bidders to re-bid on the basis of attractive technical alternatives submitted by others. These possibilities are easily perceived by the bidders, who can be expected to respond by unimaginative bidding, by various subterfuges (including deliberately ambiguous bids or collusion with their competitors), or by not bidding at all.

Alternatively, the client may foster competition by restricting the plant and services specification to the minimum necessary to define plant performance. This introduces into the bid adjudication process the task of determining how multitudes of plant features will affect the plant’s long-term performance, and in particular its reliability and maintenance costs. There is also the risk that this task of evaluation may not be carried out successfully, with the consequence of long-term costs exceeding the short-term savings, or even a plant whose performance or maintainability is unacceptable. Many clients therefore consider this to be an unattractive route, except for simple and relatively standard plant.

The client may try to overcome the problem of long-term performance by purchasing plant on an own-and-operate basis, in which the contractor is responsible for both building and operating the plant, and is paid according to plant output. Lack of competition to provide such a facility (unattractive to contractors because it ties up capital in non-core business) may offset any foreseen gains and, besides, the client may be breeding his own competition to his core business. There are hybrids to these practices in the form of plants purchased with long-term guarantees, but these carry complications of their own, in particular to the management of maintenance and plant improvement without voiding the guarantees.

Another problem with the concept of getting competitive bids for complex non-standard process plants is that considerable time and expense is involved in preparing a bid. The plant must be designed, and the components and their on-site construction priced, in order to submit a bid. To do this properly and accurately may cost each bidder as much as 2 per cent of the plant value, in a business where profits for a successful project may be as low as 5 per cent. Or the bidders may reduce their tendering costs by abbreviating the work and adding a contingency to their price. In the long term, the client can expect to pay these costs and, besides, the whole bidding and bid evaluation process may represent an unacceptable delay to his eventual plant commissioning date.

Why are these problems peculiar to the process plant construction industry, more so than for other types of major investment? The answers lie in:

• the diversity of plant design, including the utilization of many different equipment items of proprietary design;

• the lack of standardization which often is a feature of the optimal design for a given application;

• the complexity of plant operation and maintenance with variable

feedstock and product slate, which often makes it difficult to prove or disprove performance standards;

• the impact of geographical and topographical location, especially for metallurgical plant; and

• the tight project schedule customarily required to suit a changing product market.

Considering some of the issues raised, there are several other contracting structures and hybrids available to the client by which he may seek to balance the conflicting needs of getting competitive bids, getting the best technical solution, and getting his plant built quickly.

Essentially, the activities that go into plant design, the purchase of plant equipment and component parts, the construction, and the project management are subject to fragmentation and may be paid for in different ways.

The basic process design – essentially the process technology package as previously discussed, plus follow-through activities to assist and confirm its implementation – may be carried out by the client, or may be obtained from a third party.

If the process technology is not provided by the client, it may be provided together with the detailed engineering and management services, or as a separate entity. We will generally assume only the latter case, as the consequences of combination are fairly obvious. The quality of the process technology is crucial: the whole plant is based on it, and any fundamental error may mean that the whole plant is scrap or uncompetitive in operation. The client therefore needs the most committed participation, and stringent guarantees, that he can get from the technology supplier, and still has to exercise utmost care in ensuring that the technology is based on adequate relevant experience and/or pilot plant tests. The technology supplier’s guarantee obligations seldom cover more than a fraction of the plant cost.

By its nature, then, a process technology package usually has to be negotiated as a specific item with appropriate guarantees, and possibly a form of royalty, which will give the supplier some performance incentive.

Engineering, procurement, and construction management may be structured as a separate contract (‘EPCM services’ or ‘management contract’). The contractor’s task is the engineering and management of the project and in the process competitively procuring the direct field cost (DFC) elements, that is, all the physical plant and its construction, on behalf of the client or on a reimbursable basis. The 80-or-so per cent of the plant costs composing the DFC are thus subject to competitive

purchase, which can be under client surveillance and direction, and only the EPCM services costs need further attention as to how they will be competitively obtained.

These services can be (and are) structured and paid for in a number of ways:

• by the ‘manhour’ (still usually described as such at the time of writing, but surely under threat of conversion to ‘personhour’?);

• by lump sum;

• by percentage of the constructed value of the plant;

• with bonus for good performance, and penalty for poor performance.

There are many variations; we will consider only the major factors which influence the choice.

The performance of the EPCM services impacts directly on the DFC, which is much greater. It is not in the client’s interests to save a relatively small amount on the EPCM cost, and lose a larger amount on DFC and plant performance as a result. This is the principal argument for contracting on a manhour basis: there is no disincentive to the EPCM contractor to spend more manhours when justified. Correspondingly there is no incentive for efficiency, and while various ingenious formulae have been drawn up to give such an incentive, it is difficult to overcome the fundamental antithesis between restricting EPCM costs on the one hand, and ensuring adequate work to get best value out of direct field costs on the other. Another problem is that it is very difficult for the client to compare contractors’ bids. In an hour’s worth of ‘manhour’, how much is included of dedication, of efficient methodology, of truly relevant experience, of real value?

An EPCM contract on a lump sum basis does not solve the problem of antithesis – there is now every incentive for the contractor to mini-mize the EPCM input, but none to promote better EPCM performance.

This goes even further in the contract, where the EPCM contractor is reimbursed by a percentage of DFC; there is now a positive incentive to raise the DFC. If this can be done in ways which reduce the EPCM input, for instance by purchasing large packages or choosing more expensive suppliers and contractors who require less surveillance or expediting, the EPCM contractor scores twice.

One of the most common systems to seek a balance between the conflicting needs is to split the EPCM work into two stages: the feasibility study and the project. For the study work, the contractor is primarily motivated by the need to secure the project work, which will follow the study. Following the execution of the study, the project work should be

sufficiently defined to permit its execution on a realistically motivated basis. There is now a definition of the plant which can be used as a basis for a turnkey contract, and an established project budget which can be used to set up a realistic bonus/penalty incentive for an EPCM contract.

This system also has its weaknesses from the client’s viewpoint. Other than the lure of the eventual project work, there is no inherent incentive to the study contractor to set the most challenging project budgets and schedules. The contractor who does the study work has a considerable advantage over any potential competitors for the project work. He has gained familiarity with the project, and has participated in the compromises and decisions made in terms of the plant design, pricing, and construction schedule; competitors for the project work, if successful, may be expected to challenge the work done and invalidate the commitments.

It should be no surprise that many engineering contractors are prepared to do study work at bargain basement prices! Clients therefore have to exercise great care that the study is conducted competently, that project cost estimates do not include excessive contingencies or leeway for scope reduction, and above all that the best quality of conceptual design and innovation is obtained. This is not consistent with getting the work done cheaply.