As a result of the rapidly changing and volatile conditions in the market as well as the regulatory environments they operate in, contracts in the energy industry are growing in complexity as well as volume. The risks to the stakeholders, people, property, and the environment inherent in the operation of the energy industry calls for scrutiny of the risks involved, and how to distribute the risks among the stakeholders and partners involved in projects.
We asked the experts from our speaker panel at the 7th Contract Risk Management in the Energy Sector 2019 about the biggest contract management challenges and risks today facing energy companies and the steps that need to be implemented to mitigate contract risks.
The Deepwater Horizon oil spill (Macondo) in 2010 drew the attention of the industry on the risks inherent to oil and gas exploration and production and the need for risk mitigation that is contractually managed. As a result, the trend of operators seeking to spread their risk to their contractors has been on the rise.
“The biggest challenge in contract risk management is that energy companies face a volatile and fast-changing market, operating with regulatory constraints, political pressures and emerging new competition. To respond, they must become more agile and more commercially creative. The lack of investment in contract management means that they lack the embedded competence to effectively respond and manage these demanding market conditions.”
“The biggest challenge in contract risk management is that energy companies face a volatile and fast-changing market, operating with regulatory constraints, political pressures and emerging new competition. To respond, they must become more agile and more commercially creative. The lack of investment in contract management means that they lack the embedded competence to effectively respond and manage these demanding market conditions.”“High complexity & exponential growth of available data challenges the way we form and monitor our contracts in the future. Automated data aggregation, verification and control need to be implemented to mitigate contract risks.”
“Without being geographic region-specific, I’d like to bring up three of the biggest Contract Management challenges facing energy companies in my opinion.
One is the complexity of contractual arrangements facing them on many projects. E.g. companies that venture on the path of project development of lender financed energy projects (with a view of becoming an owner, designer, builder, and operator) often underestimate the complexity of contracting arrangements involved.
Secondly – information management for the purposes of Contract Management. While some larger energy companies are simplifying and automating their contracting processes and templates to an extent – smaller companies are years behind in that learning curve. The ability of Contract Management automated tools to interface with other software, be used consistently, transparently and accurately throughout the lifecycle of the energy projects, from pre-award to contract closeout, remains a challenge.
Lastly – the often-challenging relationship with lower-tier subcontractors. E.g. smaller civil contractor accepts excessive obligations, liabilities & a high level of risk passed on to them through EPC, it is ill-prepared for it & ultimately goes bust – both EPC and client also suffer as a result. You can shear a sheep many times, but you can only kill it once”
“When it comes to large infrastructure and utility projects where structured finance is involved, a handful number of players have to interact among each other. In this situation, risk mitigation can only be the result of a collective approach whereby each identified risk should be allocated to the most suitable party whose risk preference is higher or who is in the best position to bear that specific risk. Pushing too many risks to the project company, for instance, will only result in an increase in the project costs or, worse, making the whole project unbankable. Asking the EPC contractor to bear unnecessary risks on its shoulders will also make the project more expensive to finance. This is where the off-takers or the various governmental procurers and central banks have a role to play by offering investors and their lenders the most suitable legal and investment framework to attract the largest number of highly skilled players with a view to keep prices at an acceptable level.”
Contractor companies sometimes venture into projects without a complete picture of the risks and complexities involved in the contracts. Adopting systems than can track deliverables of all stakeholders throughout the lifecycle of the energy projects in a transparent manner is key and remains a challenge.
Nicholas Gould – Visiting Professor, King’s College London, UK is of the opinion that energy companies need to do more than passing on all the risks to contractors, “The biggest contract management challenge relates to upfront preparation. More specifically, sufficient and realistic procurement planning and scheduling. Simply passing all risks under EPC contracts does not really focus on the most difficult challenges but relies on the hope that the contractor will deal with the issues.”
In order to mitigate contract risks, he advocates having a “transparent risk schedule and detailed program for sharing risk and defining more clearly the risk and so the financial impact would benefit employers and contractors. Coupled with a risk-sharing mechanism or better still an alliance-based contract creating shared goals and emphasizing information sharing between the parties.”
Transparency among the parties is key to contract management, and technology is making it easier than ever to keep track of deliverables, timelines, risks outlined and the costs for missing deliverables and exceeding the agreed timelines. Stakeholders need to be able to track the obligations outlined in contracts and understand what happens after a deal is finalized. Often the case is that deliverables are not monitored, tracked and sometimes not met. Risk management becomes easier when the stakeholders are updated in real-time as to what has happened, and what needs to be done. Technology has made it possible to automate as well as simplify the process of making contracts; operators, as well as contractors and suppliers, are embracing disruption & seizing technology advances. Modern contract management systems and platforms, streamlined processes, better risk management strategies are the way forward.Greater standardization and automation are critical to reduce fragmentation and enable increased efficiency in anticipating and avoiding typical operational risk. This will allow increased focus on the much bigger challenges of adapting the business to changing market conditions and focusing on the innovations needed to meet the opportunities of the future,” said Tim Cummins –President, IACCM, UK.
In order to reduce contract risks, Marina Mills-Head of Contract Management, Hitachi Zosen Inova AG, Switzerland, recommends having “A user friendly contract risk evaluation & allocation approach used by clients and main contractors together with relative transparency that would identify the risk(s), with which party the exposure lies, whether one party can mitigate it and how, if not – what are the contractual solutions to control and/or reduce this risk.”
The 4th EPC Project & Contract Management for Energy Sector will gather senior decision-makers from Construction, Legal, Contract, Risk & Procurement divisions of leading Energy companies to discuss and benchmark best practices to gain efficiency and increase ROI by tackling project complexity, rising costs and various risks.
