Why Our Way To Develop Projects Fails To Minimize Capex—Part 1
In this first of a two-part series, the author describes why the use of lump sum contracts for FEED services contract followed by an EPC contract does not fulfil the requirements to lower oil and gas facilities capex.
In this first of a two-part series, the author describes why the use of lump sum contracts for front-end engineering (FEED) services contract followed by an engineering, procurement, and construction (EPC) contract does not fulfil the requirements to lower oil and gas facilities capex. He proposes an alternate approach, which he sees becoming the future.
Oil and gas facilities projects are developed in two steps: a front-end engineering design (FEED) services contract followed by an engineering, procurement, and construction (EPC) contract.
As companies need to control costs, they resort to lump sum (LS) contracts for the FEED and the EPC.
First of all, when contracting a FEED as a LS, one obtains the bare contractual minimum in terms of studies done, alternatives reviewed, if any, and deliverables. This not only results in lack of project definition but also in missed opportunities to save capex.
The lack of project definition is hard to spot and challenge. How can one tell if enough thought has been put into a drawing? For instance, how do we know if all constraints (Baron 2015) have been duly considered while establishing the plant layout and producing the plot plan drawings?
The missed opportunities result from the fact that the FEED contractor has no interest to spend hours to find alternatives to optimize the design. The FEED contractor also has no interest to propose alternates/deviations to company specifications.
This last aspect is very unfortunate in the current context of low oil prices and due to the fact that companies have, over the past decades, developed very extensive sets of specifications containing stringent technical requirements. As cost was not an issue then, additions of technical requirements to these specifications were not much challenged. This resulted in numerous onerous and sometimes unnecessary requirements which only a joint review between contractor, that is aware of the cost, and company, which is aware of the operational requirements, could discard.
However such exercises, which includes identification of the onerous requirements, development, justification, and validation of alternatives, take much time which cannot be spent by the FEED contractor under a LS contractual scheme.
Under pressure to make a profit, the FEED contractor spends as few hours as it can.
This not only leads to a nonoptimized design, which is already bad enough, but also to the fact that this design will be over-priced. Here is why.
As already stated, under pressure to save man-hours, the FEED contractor will not go too deeply into project definition. The design of utilities is, for instance, usually overlooked.
In addition, the quality of document produced will be low. Rarely will the FEED contractor, for instance, produce project specifications giving clear, synthetic and project-specific technical requirements. Too often it will merely reference the company’s general specifications resulting in a large amount of nonspecific information to be sorted out at a later stage.
The quality of a FEED is difficult to challenge by the client, as it is also to describe in the FEED services contract.
The quality of the FEED documents will directly affect the quality of the EPC bids. FEED deliverables are the basis that will be used by the EPC bidders for their quotations. EPC bidders do not have time to review documents and revise them, as required, before using them as a basis for cost estimation. The cost estimate is therefore based on the FEED documents. As we know: garbage in, garbage out.
Because not enough effort has been spent at the FEED stage to precisely define technical requirements, or some studies may not have been done or are undocumented, the EPC bidder would need to make assumptions. As these assumptions are made by technical personnel, who are not always fully aware of the cost impact and who are chiefly responsible for the technical soundness, assumptions are often made on the safe side.
In spite of the fact that the FEED quality level is unknown to the EPC bidder, and that it has been contracted under a LS scheme fostering low quality, the EPC bidders are required to endorse it, i.e., to take full responsibility for any error or omission. The EPC bidders have no time to thoroughly check the FEED during the bidding period. They therefore include contingencies in their quotations, inflating the project cost for the client.
Even though one readily sees that having the FEED done under a LS contract and demanding endorsement of the FEED by EPC bidders are clearly conflicting, it is the norm today.
At this stage we see that contracting the FEED services contract as a LS creates a conflict of interest between the FEED contractor and the client. It results in a nonoptimized design. In addition, the client will pay more than it should for this design.
It therefore seems quite obvious that a FEED should not be contracted as a LS contract. Only a reimbursable basis allows design and cost optimization, as well as improved project definition and quality.
This article was initially posted on LinkedIn and attracted considerable attention. Please refer to the valuable comments here.
In Part 2, I will explain how to improve the EPC process.
Baron, H. 2015. Plant Layout. In The Oil & Gas Engineering Guide, Chapter 5. Paris, France: Editions TECHNIP.