improving contractor (management) capabilities to reduce project risks

Improving Contract (Management) Capabilities

to Reduce Project RisksMatthew Rae

Manager Networks Procurement

Oil & Gas Procurement and Supply

26-27 November 2013

APA Group, November 2013 � 2

Project Risk - what can go wrong?


Mexican President Felipe Calderon ordered an

investigation into the blast, yet 14 months on

the cause has still not been confirmed.

Contractual issues that arise from such an incident:

� Consequential Loss

� direct and indirect

� Public & Product Liability Insurance claims

� Workers Compensation claims

� Warranties

� Liquidated Damages

� Defects Liability


The cause of the incident, a Columbia Gas worker, who

responding to a gas leak, came to the building and began using

a metal probe to make holes, as he tried to measure gas levels.

In the process, the worker punctured a gas line that was

improperly marked. Once the worker realized this, people in

the area were evacuated immediately.

It took Columbia Gas up to thirty minutes to shut off the gas,

but in that time, enough gas had already seeped into the

building, which then led to the explosion.


Agenda

� About APA

� Overcoming limitations and the need for flexibility

� Building risk and reward into contracts

� Your legal department and you drafting governance and dispute resolution

� Challenging the pricing and terms

� Questions


APA asset and investment portfolio


June 2000 June 2013

Infrastructure owner and manager Integrated operating business

Market

capital

$0.49 billion $5.1 billion

S&P/ASX 50

MSCI and FTSE World Indices

Assets

owned /

operated

$1.3 billion $12 billion

7,000 km gas transmission 14,120 km gas transmission

25,000 km gas distribution

Underground and LNG gas storage facilities

430 MW power generation (1)

239 km HV electricity transmission

Transporting 25%

of domestic natural gas

Transporting 50% of domestic natural gas,

70% in east Australia

Employees 6 More than 1,500

Operator External (Agility) Internal

… to Australia’s largest gas infrastructure business

(1) Includes the Diamantina and Leichhardt power stations under development

From IPO in June 2000…


Overcoming limitations and the need for flexibility


� Energy industry is among the most dispute-intensive industries in the world economy

� Oil and gas contracts generate a high volume of disputes

� Type of dispute and stakeholders involved vary

� A contract is an agreement between two parties

The nature of oil and gas contractual disputes

Contract management is aimed

not at finding fault, but rather at

identifying problems and finding solutions together

with all contracting parties involved



� In todays market….majority of companies have

standard form contracts

� Drafted by the party with superior bargaining

power

� Basic PO’s through to complex agreements

� Market power may dictate a ‘take them or leave

them approach’

� Intention is to improve efficiency

Standard form contracts



� There is no one size fits all approach

� Companies usually have a standard contractual position

� End users should understand the acceptable changes

� A starting point for contractual discussions as part of the sourcing process

Flexibility in terms and conditions

The focus when negotiating t’s and c’s should be on

reaching agreement with the other party,

this will require



Building risk and reward into contracts


� Under or over specifying requirements

� Contractor hitting a third party asset

� Late project delivery and impacts

� Major gas leak and potential gas outage

� Environmental incident

� Explosion

� Fatality or serious injury

What risk?

Every risk has a “likelihood” and a “consequence”.

The higher likelihood and the worse the consequence, the higher the

risk rating

What is the appropriate allocation of project risks for a contract?Building risk and reward into contracts


� “Carrot and Stick”

� Risk and reward can mean different things

� Rewarding the contractor for over performing

The reward or carrot

� Needs to be commensurate with value and risk

� Performance based contracting

� Reward types



� To incentivise parties to the contract

� For the appropriate allocation of risk

� Contractors perspective….. more interest in the rewards and less in accepting

risk

� To provide a framework for both contracting parties

� “Back to back” any risks associated with penalties in third party agreements

with the contractor delivering the works

Why build risk and reward clauses into contracts?

Many contracting parties…..“enter into discussions about risk-reward to

reduce the chances of something going wrong, but get scared off the idea by

a sudden realisation about what might happen if something goes right.”

Source: Edward Height, a director at Source Information Services



� Uncommon for standard form contracts to have them

� A successful risk-reward mechanism is often based on predefined KPI’s or SLA’s

� It’s not all about the bonus for exceeding milestones

� Linking risk and reward mechanisms

� Liquidated Damages (LD’s)

� Consequential Loss & Limited Liability

� Transferring too much risk can mean high contingency costs

Representing risk and reward clauses in contracts



Your legal department and you – drafting,

governance and dispute resolution


� Engaging with legal from the outset and throughout

� Majority of companies have standard form contracts

� Talk to your Legal Department re customised or “off the shelf

agreement

� Identify clarifications and/or exceptions to T’s and C’s

� Post implementation reviews - feedback

Contract selection and drafting

Drafting, governance and dispute resolution


Governance and Dispute Resolution

� Most contracts do not deal with the situation in which a dispute arises

� Building these clauses in contracts provides a means of resolving commercial

disputes

� Care needs to be taken in completing schedules that comprise dispute resolution so

that the provision has the effect intended by the parties.

� Dispute resolution clauses should be drafted with clarity, precision and to ensure

they meet the intended purpose.

� If contractual disputes do arise, it is important that these are managed in close

liaison with legal counsel to avoid any unnecessary litigation

Poorly drafted dispute resolution clauses may result in delay, expense

and inconvenience

Drafting, governance and dispute resolution

………. the very opposite of the desired result !!


Challenging the pricing decisions and terms


� What is the pricing methodology to be used?

– Fixed Lump Sum Price

– Schedule of Rates

– Cost plus

– Management Fee

� What are the major price drivers?

– Cost of Labour

– Raw Materials Pricing

– Manufacturing and Tooling Costs

– Freight and Logistic Costs

� What is the rise and fall mechanism?

– CPI movements

– FOREX Movements

– Commodity price movements

Types of pricing decisions?

How can we challenge the contractor’s

pricing decisions?………………..in a word:

“transparency”



� Understanding what makes up the cost of a finished product

� Numerous sources of market indicators

Exploring rates for materials

Price of iron ore, directly

impacts the price of ERW

and Seamless Line Pipe

Oil is major component in

the production Pipe and

Fittings

The major raw material

input to meter set pipe

work, valves and fittings

Exchange rate also has an

impact on the imported

content component of

materials



� An example of a typical Schedule of Rates

Exploring rates for labour

Item Trade UOM Normal Time Penalty Rate

1 Trade Assistant $/Hour $53.40 $72.00

2 Crew Hourly Rate $/Hour $1,306.00 $1,633.00

3 Team Leader $/Hour $80.00 $100.00

4Field Operative /

Labourer$/Hour $60.00 $75.00

5 Plant Operator $/Hour $65.00 $82.00

6 Welder $/Hour $160.00 $200.00

7 Gasfitter $/Hour $120.00 $150.00



� Labour rates driven by Enterprise Bargaining Agreement (EBA’s)

� EBA’s can be both union and non-unionised

� Unionised EBA’s are available in the public domain, which allows us to see the

labour breakdown

Exploring rates for labour – rate buildups

Amount UOM Hrly Rate

Base Rate $30.00

Superannuation 9.50 % $0.38

Workers Compensation 4.00 % $0.16

Overtime Meal Allowance 20.00 $ $2.63

Travel Allowance $0.75 $/km $9.87

Leave Loading 17.50 % $0.69

Living Away from Home (Distant Work) $62.70 $/day $8.25

First Aid Allowance (min qualification) $2.61 $/day $0.34

Overhead 7.50 % $0.30

Profit 20.00 % $0.79

Income Tax 15.00 % $0.59

Actual Rate $53.40

Trade Assistant $53.40 per hour

Statutory

Requirements

Meal allowance

payable when required

to work Overtime, e.g.

by more than 1.5hrs

Annual leave payment

paid with Leave loading

of 17.5%

A payment made to a

worker where an

employment event

requires them to use

accommodation other

than their normal

place of residence

Statutory

Requirements

Understand labour cost……for cost avoidance and

to avoid double dipping !!Challenging the pricing decisions and terms


� Total Cost of Ownership (TCO) of the life of an asset

� Include: planning, design, construction and acquisition, maintenance, renewal,

depreciation and cost of finance

� TCO expands the narrow confines of price to a vast field of opportunities

� Price is not only different from cost, in fact it is merely one element of cost

Through life support/TCO

Anyone can get a lower price.

The object of good business is to

attain the lowest TCO.



� Procurement set the pricing structure

� Dependent on the type of good or service

� Rates x Hours = Happiness

� Lump Sum Contracts = high mark-up/contingency for allocation of risk

� Understanding the impact on cost a change in on one or more components has

on total cost

� Using mutually agreed rise and fall mechanisms

Challenging the contractor’s pricing/costing decisions



� Be clear on the outcome you are driving to achieve

� Focus should be on reaching agreement with the other party - stay

flexible

� Own and understand your contract

� Spend your companies money as if it were your own….seek

transparency, ask questions

� Avoid Mexico….its far too dangerous there !!!

Some key takeaways…


Questions


For further information contact

Matthew Rae

Manager Networks Procurement, APA Group

Tel: +61 8 8113 9029

E-mail: [email protected]

or visit APA’s website

www.apa.com.au

Delivering Australia’s Energy

improving contractor (management) capabilities to reduce project risks

Documents