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Introduction
Engineering Procurement and Construction (EPC) is an innovative strategy applicable to big and complex projects. EPC activities are conducted by specialized contractors who undertake actual work on behalf of the owner. The details of engagement are outlined in an EPC contract, including the control, costs and risks. The EPC contractor is tasked with the mandate to design and develop the project, which makes them fully accountable for its success or failure (Abdulkarim, 2020). Therefore, the entity must properly understand the clauses and conditions to ensure the project is completed successfully. This will help to avoid conflicts and disputes with the project owner, who is also required to have full comprehension of the contract articles and terms before the start of the project.
Overview of Saudi Economy and the Need for EPC Localization
Saudi Arabia has traditionally relied on oil and gas resources as the primary source of revenue. Over time the Kingdom realized that the dependence on oil and gas does not provide a long term solution to the economy. The sector is characterized by high price fluctuations in the global market, and the countrys reserves are declining. In addition, the sector alone cannot expand the economy and create more opportunities for the population, including employment. In 2016 the Saudi Vision 2030 was unveiled to support the country in rebuilding its economic foundation (Even and Guzansky, 2017). The Vision provided a plan for developing other sectors of the economy to create new sources of revenue.
In 2015 before the plan was launched, the government had encountered an unprecedented level of a budget deficit. The government had budgeted to spend about $260 billion against budgeted revenue collections of close to $229.3 billion (Even and Guzansky, 2017). However, the government was able to collect just about $162 billion against the spending of $190.7 billion (Even and Guzansky, 2017). The deficit had to be bridged by withdrawing money from loans, monetary reserves, and the sale of assets. It dawned upon the administration that the countrys resources would not sustain the budget shortfall for a longer period. Hence, Crown Prince Bin Salman initiated the urgent measure of enacting an economic blueprint as the foundation to gradually expand Saudi Arabias economic base. The desire was to create supplementary sources of finance for the budget through increasing income generation in sectors apart from oil and gas.
Furthermore, the plan outlined the need to control government spending even as new projects are undertaken to boost economic development and growth. The new era opened opportunities in the hydrocarbon and power generation sectors. Saudi Arabia is privileged by geography and climate to have resources to expand its energy sources to include more renewables that will improve its energy mix. The Vision 2030 plan established the National Renewable Energy Program (NREP) to undertake projects in wind and solar energy and meet the Kingdoms responsibilities toward lowering carbon dioxide emissions. According to Even and Guzansky (2017), the plan seeks to reduce the use of liquid oil and increase the share of renewable energy and natural gas to approximately 50% by 2030.
The desire for the government to increase the use of renewable energy presents a chance for the creation of modern industry. The Kingdom has to invest in renewable energy technology by collaborating with different parties, including the private entities through public-private partnerships. The ministry of energy continues to encourage the private sector to boost investment in the Kingdoms renewable energy sector by creating an active local market and procuring the lowest prices in the world for the projects (Even and Guzansky, 2017). The countrys solar and wind power generation enhances its attractiveness as a destination for foreign investment. Therefore, most of the new projects are being conducted by foreign EPC firms, such as Samsung Engineering from South Korea and JGC Engineering of Japan. This effectively means that payments to the companies are repatriated to the home economies. There is a clear need for the Saudi government to consider creating an In Kingdom EPC (IK-EPC) instead of relying on Out-of-Kingdom EPC (OOK-EPC).
Nature of EPC Contracts
Project developments are commonly undertaken under a triple-constraint framework covering the cost, time, and quality. EPC contracts have to cover a wider scope and detail that aim to ensure the parties to the contract are fully satisfied. The contracts vary in nature from one project to another, but there are main attributes that have to be considered in setting up an EPC contract.
Single Point of Responsibility
EPC contracts are distinguished by the feature that the contractor is singularly responsible for the project. The contractor assumes the responsibility for project engineering, procurement, and construction. These components cover deeper details such as designing, commissioning and testing tasks. Accordingly, any issue arising out of or in relation to the project will be solely addressed by the EPC contractor, who assumes entire liability for any defects and rectifications or compensates the project owner (Eggink, 2020). If the contract covers several EPC contractors, they are assumed to be jointly and severally liable. The main EPC contractor assumes overall responsibility for the works performed by any appointed sub-contractor, including any acts of omission and commission.
Fixed Contract Price
A key requirement of EPC contracts is that work has to be conducted and completed at a fixed price. Therefore, if the EPC contractor does not have proper estimates, it is possible that the company will experience cost overruns or cost savings. If the project owner causes delays in the project, the EPC company can claim additional expenses incurred due to such delays or place a charge order to the works (Abdulkarim, 2020). The EPC contract also stipulates that the price is paid as a lump sum to the contractor, but the parties can negotiate for scheduled payments to cater to recurring expenses, such as milestone expenditures.
Security
Most of the contacts involving construction require that the EPC entity provides a performance bond. The security seeks to safeguard the interests of the project owner in the event that the contractor does not meet the stipulated standards (Marcenaro, 2017). There are different forms of performance security that can be provided, including retention security, parent company guarantee, bank guarantee, and advance payment guarantee (if payment is made to the project owner before the project begins).
The guarantees also ensure that the EPC observes quality standards in carrying out the project. It is a usual requirement for an EPC contract to cover a condition stating that the EPC contractor should provide performance guarantees. The guarantees can be backed by performance liquidated damages to be paid by the EPC contractor to the project owner in the event of an under-performance. This is common where sub-standard work or lack of performance may have a substantial influence on the business success of the project owner (Eggink, 2020). The effect may cause the project owners revenue generation activities to be impaired. Hence, the performance liquidated damages are pre-estimated to compensate the project owner for such loss and damages of suffering for the failure of the project to be completed.
Inspections, Testing and Commissioning
EPC contracts have a turnkey component that involves testing and commissioning. This is to ensure that the project end product is functional before the actual handover to the project owner. The EPC contract contains clauses relating to inspection, testing and commissioning that set out the procedure and define when the project owner assumes total control over the project. The scope and detail of inspection, testing and commissioning varies, depending with the complicatedness of the undertaking.
The complexity is usually defined by the project specifications and functionality. For instance, a project involving the construction of an infrastructure is less likely to include detailed inspection, testing and commissioning provisions. However, the construction of hydrocarbon and power plants involves comprehensive inspection, testing and commissioning (Marcenaro, 2017). This is to assess and guarantee the stability of the equipment and its usage by certifying that all components are functioning properly and in accordance to specifications.
Fixed Completion Date
EPC contracts provide a fixed date of project completion or specify a period from when the project begins. The EPC contractor is expected to have completed the project by the date indicated in the contract. If the defined project completion date is not fulfilled, the EPC contractor can be exposed to liability (Marcenaro, 2017). The contractor will then be required to pay some damages even if the project owner is not required to demonstrate that it has sustained actual losses since the damages are predefined.
Benefits Of IK-EPC
A Stable And Healthy Local Economy
Saudi Arabias economy continues to evolve and grow stronger as the government implements economic reforms. The development is supported by sufficient oil reserves, estimated to be about 16% of the total global reserves. The country has one of the highest GDPs in the region. It also is strategically located and has the prospect to play a greater role in supporting regional economic growth and development. The country enjoys political stability that is attractive to foreign investors who provide job opportunities for the local population (Even and Guzansky, 2017). The countrys earnings from oil and gas can support the creation of a local EPC to handle big and complex projects as the country diversifies its economic base.
Demographics
Saudi Arabia has a young and energetic population that provides a ready labor supply that will support the creation of an EPC. The level of education is also high, which provides qualified personnel to work in the EPC, especially in technical areas, such as engineering and construction. The labor will also be deployed to work in the completed hydrocarbon and power plants. The countrys literacy rate is over 78%, and the majority of the people reside in urban areas (Even and Guzansky, 2017). The country also enjoys cheap labor provided by an influx of laborers from different parts of the world. Manual and casual labor can be deployed to support the different EPC projects the country chooses to undertake.
Challenges
Information Technology
The hydrocarbon and power projects are complicated and require the use of modern information technologies. Saudi Arabia has not invested adequately in developing IT resource centers to support the EPC projects that will need to be undertaken. In addition, power and petrochemical plants are usually located in remote areas where there is minimum IT infrastructure to support the projects (Marcenaro, 2017). The EPC undertakings also require highly efficient logistics that need to be supported principally by having high-quality IT networks and systems.
Communication Style, Culture, and Religion
Saudi Arabia is an Arab state, with the majority of people using the Arabic language in communication. EPC projects require diverse and specialized labor that may have to be sourced from outside the country. The environment may create difficult cultural challenges for foreign workers as they find it difficult to communicate with the locals. Moreover, the countrys communication style is different from that in most parts of the world. It tends to be completely indirect and may make it difficult for a foreign worker to understand the message (Even and Guzansky, 2017). People in Saudi Arabia mainly use non-verbal modes, such as body language and change of tone, to communicate. In a professional setup, foreign labor is expected to encounter challenges in communicating project details, which may cause delays in project execution.
The countrys laws and regulations are based on Sharia law. This may be a challenge to foreign staff who will be expected to embrace specific customs and social obligations as required by Islam. Ignorance of the Islamic way of life could harm a business association with the workforce, suppliers, and customers.
Competition
Saudi Arabia is a strategic location, and good investment policies are attractive to foreign entities. The local EPC contractors will have to compete with more established players from Japan, China, and Korea. EPC companies in these regions have vast experience and specialized equipment and personnel (Marcenaro, 2017). They are likely to offer friendly prices and remain profitable by leveraging their expertise and the systems they have established over time.
Other Limitations
The EPC contracts are costly to implement, and the IK-EPCs will have to find sufficient resources to carry out capital-intensive projects. The situation is further complicated by the nature of EPC contracts that require the contractor to be in charge of design, engineering and construction. The contractor may be inclined to use minimum standards of compliance. The contracts are also time-consuming as they take years to plan and complete (Abdulkarim, 2020). The new IK-EPCs will have to invest in capacity building in labor and finances such that they do not suffer losses due to the risky nature of hydrocarbon and power projects.
Succeeding as an IK-EPC Company in Saudi Arabia
Proactive Approach to Profitability through Cost Management
An aspiring IK-EPC company must take a proactive approach to cost management by balancing costs and profitability. Given that EPC contracts have a fixed price, the company should ensure they have the most viable estimates considering the capital-intensive nature of hydrocarbon and power projects. Different costing techniques that can be used in EPC costing include target costing, whereby the EPC contractor can make savings at the design stage (Eggink, 2020). The company should also implement a cost of production policy to reduce cost speculation. As the demand for hydrocarbon and power projects increases, the company will be able to enhance its project delivery and attain profitability.
Orientation Towards Clients
The success of an EPC company in Saudi Arabia will be defined by its orientation in meeting the clients demands. Project owners invest colossal resources in hydrocarbon and power projects meaning that if the EPC company makes errors, the losses suffered will be massive. The EPC industry is highly reliant on survival zones, hence, a business has to understand the customers fully based on their needs and expectations (Marcenaro, 2017). The understanding will enable the EPC company to design and provide projects that meet the market requirements. Additionally, the IK-EPC company should establish its presence in the country to be able to cope with the high level of competition from foreign players.
Break Down Barriers between Locals and Foreigners
EPC projects involve input from foreign workers either at the top specialized levels or at the casual level. The company should be able to bridge the gap between the locals and the foreign workers considering the strict cultural nature of Saudi Arabia. This will build synergy among the workers, which will enhance project delivery and success (Eggink, 2020). The Kingdoms government plays a facilitating role in ensuring that foreign players are supported.
Conclusion
Saudi Arabia boasts one of the largest oil and gas reserves in the world, amounting to over 16%. The resource, although prized, is characterized by high price fluctuations that impact the governments budget. The trend exposes the government to the risk of relying on the sector for economic growth and development. In 2016, the Vision 2030 was launched to support the government in expanding the economy through other sectors of the economy, including hydrocarbon and power. The plan created huge opportunities for investments, which attracted foreign EPC companies to undertake the basic projects required to support the new sectors.
However, the country is spending a colossal sum of resources on these companies. As the number of new projects increases, there is the desire for the government to consider setting up local EPC companies. The country has a stable economy and can benefit from the current high oil prices to set up IK-EPC companies. Saudi Arabia also is attractive to foreign workers desiring to find opportunities in the country. The workers can be deployed to these sectors to provide the required labor to undertake the new developments. The IK-EPC may face some challenges due to communication and cultural and religious differences among workers. There is also the challenge of competition from established EPC companies in the region. The new IK-EPC contractors will have to develop strategies to manage costs and ensure they generate returns. They should also seek to meet the customers needs and expectations. The methods of EPC contracts can be altered to satisfy the needs and demands of the owner. The EPC corporations can also break down barriers between local and foreign workers to guarantee project success.
Reference List
Abdulkarim, J. (2020). Understanding and negotiating turnkey and EPC contracts. Sweet & Maxwell.
Eggink, E. (2020). A practical guide to engineering, procurement and construction contracts. Abingdon, Oxon Informa Law By Routledge.
Even, S., and Guzansky, Y. (2017). Saudi Arabias Vision 2030: Reducing the dependency on oil. Web.
Marcenaro, E. (2017). Energy contracts at the crossroad between public law and private law: The Relevance of Sustainability Objectives in International EPC Contracts, European Investment Law and Arbitration Review, 2(1), pp.245257.
Order from us for quality, customized work in due time of your choice.