Member Article

Mega-projects: Why better contract management is moving centre-stage

A little less than a decade ago, we saw an era when oil and gas resources were relatively abundant and more accessible. Whilst the International Energy Agency (IEA) envisages that fossil fuels will account for 60 per cent of energy generation by 2030, resources are becoming scarcer.

Compared with its heyday, resources are now becoming harder and increasingly expensive to find and develop in an environment that is both geographically and technologically at the frontier.

The Oil and Gas Operators have enjoyed relatively strong return on capital employed and enviable gross profit margins as crude oil prices have remained stubbornly high and global demand shows no sign of diminishing. As recently as 2012, the Organisation of the Petroleum Exporting Countries (OPEC) cashed in on around $1.1 trillion.

Against this background, it is not surprising that despite the many years’ experience often when Oil and Gas Operators have had to choose, they have prioritised “Schedule” over “Budgeted Cost”. A crude paraphrase being “Get to First Oil by the planned date – at any cost”.

The fallout from this is clear when we consider the magnitude and cost of project overruns in this industry. On average, 40 per cent of mega projects exceed budget and cycle time by 10 per cent.

Engineering, Procurement and Construction contract

Traditionally, companies have attempted to mitigate against the risk of project cost overruns by engaging Engineering, Procurement and Construction (EPC) firms in lump sum contracts. Under an EPC contract, the contractor usually has responsibility to produce a detailed design and meet the performance output requirements of the specification.

However when latent errors are found in the pre-tender front-end engineering and design (FEED) studies during the course of that detailed design, claims are invariably made by contractors as a result.

Where the EPC lump sum contract is silent on how this risk should be dealt with, arbitrations, disputes, controversies and cost overruns inevitably ensue. As these capital projects evolve, the likelihood of additional “grey areas” that give rise to change orders and possible claims increases.

The owner contract management team is faced with a flurry of change order requests that need rigorous review, internal consultation, Expert opinion and management attention.

Enterprise Resource Planning systems

Project operators have traditionally relied on a combination of Enterprise Resource Planning (ERP) systems, spreadsheet and paper trails to manage the aforementioned contracts. ERP systems are by design good at handling transaction management such as invoice and purchase order processing. These systems are designed for predictable, repetitive processes.

However in reality mega-projects operate in dynamic environments where new projects can throw up new contractual challenges. The “review” and “approval” or “reject” processes that govern the decision-making around change orders as well as ambiguous interface situations as projects progress from FEED to EPC and operations are not within the ERP footprint.

Capital project contract management systems

Increasingly project operators are adopting “fit-for-purpose” contract management software that integrates with the ERP and other systems to manage the contract execution phase of the project.

Capital project contract management systems introduce a common contract communications platform that connects the parties, such as engineers, legal and finance teams as well as the contractor teams on a contract.

This allows teams to work collaboratively in a predetermined space. Such systems preserve the proverbial “red thread” as to where responsibility lies as the contract is executed, allowing for a single, referential point of truth.

In essence, they synchronise the evolving contractual position with the evolving built environment so that the contract is always a true, real-time reflection of the latter. In turn this helps contract managers move from adversarial relationships to partnerships with contractors.

Context for clarity

Whilst the key is prevention, disputes remain inevitable in these projects. Companies realise that during dispute resolution, accessing the true audit trail of decision making and efficient access to all of the evidence for a case is essential in negotiating the case and minimising the associated cost.

Companies should ensure that their contract management processes and systems are providing this to them - providing them with the “story” and the context at the time a decision was made, rather than providing them access to disparate documents, emails and invoices with no clarity on how these are all tied together.

As projects become increasingly expensive coupled with tighter budgets, stakeholders are placing increasing focus on how these projects are fundamentally managed. Contract management is one way that companies can demonstrate greater accountability, transparency, minimise delays and deliver on budget.

About the author

Clare Colhoun is Chief Executive Officer at 8over8

This was posted in Bdaily's Members' News section by Clare Colhoun .