Contracting Strategies for Clean-Tech Projects - Poornima Sharma
The energy industry stands at a pivotal crossroad as it confronts the urgent challenge of Climate change. There is scientific evidence that Climate change is leading to higher temperatures globally and, therefore, decisive measures are needed to reduce CO2 emissions across multiple sectors — including aviation, steel, cement, chemicals and marine industries.
Clean-tech entrepreneurs are driving groundbreaking innovations in sustainable fuels and green chemicals, carbon capture and circularity, to tackle climate change. However, commercializing and scaling these new emerging technologies can take investments exceeding $ 1 Billion, necessitating the involvement of large investment companies to bring these technologies to market.
Many investors lack familiarity with capital and performance risks associated with such novel technologies. Consequently, they will invest only if their risks are substantially mitigated by the Client/Technology provider and/or the EPC contractor who will engineer and execute the commercial sized project.
Various contracting strategies exist for execution of the project, each offering different degrees of risk mitigation for the clients and investors, with varying impact on project schedule and capital investment. What is the most suitable contracting strategy for a clean-tech project?
One option is to use a fully reimbursable engineering, procurement, and construction management services contract. This offers the client complete transparency in all engineering, buying and sub-contracting decisions. It does require substantial resources from the client for active engagement in all decisions alongside the EPC contractor. A fully reimbursable services contract can result in a lower capital investment but places the risk of volatility in the market, and escalation in price of equipment and materials, availability, wages and productivity of construction labor at site, on the client. EPC contractor‘s risk is limited to quality of design and engineering, timely completion of home office services with some limited accountability for overall schedule of the project. It also leaves the risk of performance of the technology and plant operations with the client.
An alternate is a lump-sum turnkey contract where the EPC contractor assumes most of the execution risk, provides greater capital costs certainty, and in some instances, may provide certainty of performance of the technology and operation of the plant. While such contracts are the most sought-after by investors and clients, they do include substantial contingency provisions and premiums for absorption of the project risk by the EPC contractor, resulting in an increase in overall capital cost. It may also limit the project owner’s ability to participate in critical design decisions, procurement strategies and schedule optimization.
For clean-tech projects, the optimal contracting strategy often requires an early engagement and collaboration between the client/owner of the project, investors and EPC contractor to optimize allocation of project risks and optimize overall capital expenditure. Many successful projects employ a hybrid approach, incorporating reimbursable and fixed price elements. A tailored approach can be most beneficial, balancing risk distribution while maintaining sufficient owner involvement in critical project decisions.
As clean technologies mature and their commercial and performance is proven, contracting strategies too will evolve and there will be closer alignment between financial risk management and technical innovation.
Connect with Poornima on Linkedin
