Fluor hosted this conference in Amsterdam. There was a consensus with Paul van Weert of Shell who said that a step change in the way we do projects is needed to secure improvement of 30-50% in cost and 30% in schedule. Clearly that won’t be achieved by squeezing margins of suppliers but needs deeper collaboration and a radical transformation enabled by digital disruption. Andy Brown of ECITB presented on the latest approaches to collaboration and alliancing, and Stephen Mulva from CII in the USA presented on progress with their OS2 ‘Prairie Dog’ research programme in this area which is supported by ECI and which will seek to drive the digital disruption. You can download the presentations by clicking on the links below. A summary report of the conference is available below:
ECI and McKinsey facilitated a roundtable of owner operators in the engineering construction sector which was hosted at Shell’s headquarters in The Hague. Capital efficiency and the need to work together better as a sector to address it remains the number one issue for clients. Compared with ECI’s report 2-3 years previously, issues identified included: the crisis led to incremental improvement but not transformational change; competition for capital has increased while project performance has not; industry-level standardisation could eliminate a lot of waste but remains elusive; banks assert more control and drive risk further down the supply chain, increasing cost; and many companies still fail to capture lessons learned and transfer knowledge to new projects. The discussion identified a number of familiar themes for improvement, which require articulation of a clear road map to go from today to a different way of working, which would feature more collaborative contracting/alliances, harnessing the full power of innovation and digital technology to enable structural transformation of how projects are delivered, and sector-level standardisation of processes and requirements. A summary report is available here. You can view the presentations here.
The oil price is now hovering between USD 70 to USD 75 per barrel. Increases in the market price of other industrial commodities have also occurred. There seems to be a gradual upward trend in the award of new projects across several industry sectors including considerable interest in renewable energy, especially photovoltaic plants. So is this the time for rejoicing? I think not.
Firstly, there does not seem to be any significant increase in margins – if anything they are becoming tighter. EPC businesses are not sustainable on profit margins of 1% to 2%. At the same time project schedules are typically becoming shorter, contract conditions are often more onerous for contractors and they are being obliged to take on greater levels of risk if they want to win new orders.
Secondly, for owners and despite the “squeeze” on contract prices, in order to meet their investment needs the cost of plants remains too high, delivery times are unacceptably long and there is often uncertainty regarding plant start-up and performance – all of which can compromise the business case for the investment. Owner target reductions of 50% in investment costs and 40% in delivery times are not uncommon objectives. Research reveals that 40% of investment costs are in transactional costs. This is where attention needs to be focused to bring down the cost of plants, not the prices paid to contractors. Research also shows that delivery tiems can be reduced. However, there will be no improvement without radically changing the way capital projects are delivered.
In Engineering Construction there has been no real improvement in trading conditions since 2014…and they were not great before 2014!. Continuation of current trends will inevitably build up serious challenges in the future for owners, contractors and the supply network – the trading conditions are simply not sustainable. Many in Engineering Construction are well aware. More importantly, the current trading condition trends will not enable owners to achieve their price and schedule reduction objectives. For Engineering Construction to become healthy and sustainable in the medium to long term it is essential to fundamentally change how capital projects are delivered – ACTION TO BRING ABOUT THAT CHANGE NEEDS TO BE TAKEN NOW! The ECI event ‘Rethinking how capital programmes are delivered‘ in Amsterdam on 21 February 2018 confirmed this.
In the USA there is significant growing interest in and support from owners, contractors and supply network for CII’s Prairie Dog initiative led by CII’s Stephen Mulva. It is also gaining interest around the world. This initiative is designed to achieve three prime objectives: (1) significantly reduce investment costs, (2) substantially shorten delivery times to plant operational start-up and (3) create meaningful improvement in shareholder value for all stakeholders. The underlying philosophy is to deliver the plants the world actually needs at times when they are required by utilising more effectively the available resources to produce results that sustain and develop industry capability and performance. This effectively means delivering more plants with the present levels of resources.
In order to ensure the membership has access to and may take benefit from the research outputs from Prairie Dog the ECI has fully endorsed it and will take a small share in the special purposes company set up to develop the operating platform that will ultimately deliver the new approach to capital project delivery. Indeed, the CII is looking to ECI to take the lead in Europe to support and promote Prairie Dog in the research, development and operational phases. This is an opportunity not to be missed if Engineering Construction in Europe is to prosper and develop.
The findings from the ECI Amsterdam event on 21 February 2018 were followed-up in a subsequent event in London on 3 May 2018 which resulted in the formation of three groups to decide upon the research questions on the following topics;
Presentation of these questions is expected by the end of June 2018 and research is expected to commence in September 2018. We need to form research groups comprising academics and industry professionals. This is where YOU and your ORGANISATION can actively contribute to and support the change that needs to take place to the way in which capital projects are delivered. CII and ECI can provide the forum but it is only industry that can make and implement the change. Please email firstname.lastname@example.org to register your interest in participating in a research group and to obtain more details about the research programme and how you can contribute.
The ECI Annual conference will take place on 3 October 2018 and will be hosted by Fluor at their offices close to Schiphol Airport, Netherlands. The Conference topic will be Changing In The Way Capital Projects Are Delivered – Taking Action. It will be preceded on 2 October 2018 by a Client Round Table to be held close to the Conference venue. More details to follow in the next ECI Newsletter.
Recalling JF Kennedy’s sentiments – ask not what your industry can do for you but what can you do for your industry. Let’s work together to make the change that we agree is necessary for a prosperous and sustainable Engineering Construction industry. Your support and contributions are highly valuable and valued.
ECI is reliant upon the continuing support of the current membership and the growth in new members if it is to continue to provide opportunities for Engineering Construction to discuss, determine and implement significant improvement in performance and reward across the industry. It is not only membership fees that are crucial but also active participation in and support of ECI events and initiatives – join-in and help make the difference!
The nuclear theme group of Constructing Excellence has published the first report in its Productivity Series. The report can be downloaded here.
In his Foreword, the chair of the group Adrian Worker writes:
“[Poor productivity] is not just a perception of the nuclear sector but of the wider construction sector… It needs to be urgently addressed by all involved at all levels if such perceptions are to be altered and greater value delivered to clients reliably and with confidence given to potential investors. It is a burning platform issue which is constraining the development and growth of the sector and therefore the national economy. Changes do need to be led by the major clients and without the creation of an environment where all parties can be successful nothing will change.
Productivity must be a high priority in any delivery model throughout the lifecycle. We also know productivity is an outcome of numerous factors including the environment and structures created by clients and the many inputs and constraints that impact the construction processes. There are views that client capabilities need to be strengthened, delivery models revised, the digital environment embraced and the other factors be improved. We are not seeking to address these aspects in this paper but to highlight the change in thinking required using the proven tools from other sectors could create a new mind set where productivity becomes the norm across all parts of the sector.”
Also in the Productivity Series, Simon Flint of Blu-3, another member of the Constructing Excellence nuclear theme group, has written a blog on the investors’ views of financing nuclear newbuild in the UK, highlighting the challenges including productivity improvement that must be addressed in the sector if it is to secure investment. The blog can be read here .
Report of the third conference of the #CEnuclear theme group
The third conference of the Constructing Excellence nuclear theme group was held in London on 10th May 2018. It addressed investors’ views of the sector, which are cautious based on the perceived high construction risk, and this discussion was followed by the launch of the first in the theme group’s Productivity Series. Read the event report here.
Some 30 ECI members got together in London on 3 May to review the proposals developed at the event in Amsterdam on 21 February to support CII’s work programme “OS2” and to consider how best ECI should align to this programme to support the development of better capital project delivery.
John Fotherby, Chair of ECI, opened the meeting, with a call to action for ECI members to deliver meaningful action in the field of capital project delivery. The Executive steering Group had agreed that the existing direction groups should finalise their activities and publish the excellent data and outputs they have been working on, and then dissolve, unless they saw an opportunity to align to the new vision of OS2.
Stephen Mulva, from CII, provided an overview of the latest thinking on Operating System 2.0 (now named Prairie Dog). Stephen considered how the industry could become more efficient through making better use of both capital and technology in order to unlock a better functioning industry based on a single industry business platform.
The meeting discussed the 16 considerations which had been identified by Stephen in a paper which had been previously circulated – see Appendix 1 – with much lively debate around the many issues and where Europe can really lead and deliver meaningful impact.
It was agreed that the following 3 areas would be focussed upon, with an outline research question to be developed ideally by mid-June.
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On 21st February 2018 over 60 high level representatives of ECI were joined by colleagues at CII at the offices of Fluor in Amsterdam to debate Existential Crisis – Rethinking how capital programmes are delivered.
Delegates were welcomed by John Fotherby, Chair of ECI and Arne Siewertsen, DM Project Controls & Estimating, Fluor our hosts for the day. Paul van Weert, Shell Global EPC Manager and Bernd de Jonge set the context for a sector that needs to change. Paul spoke of the need to halve the costs of capital projects to enable them to do twice as many projects with the same allocated budget, not through putting more cost pressure on supply chains, but through fundamentally rethinking the delivery model. From a client perspective they want to see more continuity and learning across projects, greater standardisation and higher levels of collaboration. Bernd made the case for making capital programmes more affordable, investable and bankable through better utilisation of capital. He proposed that more R&D, greater use of digital technology and more collaboration were the keys to delivering projects more effectively.
There was significant agreement amongst delegates that the sector is facing an existential crisis, with 87% either agreeing or strongly agreeing. On the topic of whether we need to rethink capital programme delivery there was overwhelming support in the room with 96% agreeing or strongly agreeing.
Fitness for Purpose obligations are nothing new in Engineering Construction, especially under Lump Sum Turn Key Engineering, Procurement and Construction contracting arrangements. But how well are these obligations and their implications understood?
Contractors take on Fitness For Purpose obligations with the risk of paying performance liquidated damages in the event that the specified performance guarantees are not met and back up their commitments with contractual warranties, financial guarantees and make good obligations for which the cost is uncapped – this in a business environment where margins can be as low as 2% (or less). Thus, if financial loss is to be avoided it is vital to fully understand the risks be given and taken. Do your sales and project execution teams fully understand the Fitness For Purpose obligations they have committed to? Do your teams awarding contracts really understand what risks they are asking contractors to take?
A decision by the Supreme Court in England in August 2017 highlights some important issues regarding Fitness For Purpose obligations that not only have relevance for contracts governed by the Laws of England and Wales but may also have implications in other jurisdictions. The case was written about quite extensively by legal practitioners straight after the judgement was published but a recent article by Jeremy Winter that was first published by the Chartered Institution of Civil Engineering Surveyors in the Civil Engineering Surveyor last year explores the case from technical and legal perspectives. You may access the full article here it is worth reading!
Overview of Jeremy Winter’s paper:
The dispute between Hoejgaard (contractor) and E.ON (owner) arose out of the parties’ different understanding of the fitness for purpose obligations relating to the design, manufacture and installation of wind turbines for the Robin Rigg windfarm in the Solway Firth. At the heart of this case was the international standard – J101 – and the extent to which this limited Hoejgaard’s responsibility, risk and liabilities, particularly in light of flaws in the standard. The case is also interesting for the bodies responsible for drafting the standards as well as those specifying them in contracts they award.
Hoejgaard contended that because it had complied with J101, it could not be in breach of contract. There was an admitted mistake in the applicable version of J101which led Hoejgaard to overestimate the friction between the steel and the grout, but that was not their fault.
E.ON contended that the fitness for purpose obligation and the requirements to provide wind turbines with a service life of twenty years prevailed over the obligation to comply with J101. Therefore Hoejgaard was in breach of contract, because the wind turbines, with their sliding transition pieces, were not fit for purpose and did not have the required service life.
Hoejgaard commenced the litigation in May 2012 in the Technology and Construction Court and the Supreme Court issued its decision in August 2017 following an appeal by E.ON in the Court of Appeal of the CTT’s judgement. Clearly, both Parties expended a great deal of time, money and resources in the process.
The main points of the Supreme Court decision were;
- Clause 3.1 of the Conditions of Contract stressed that it was setting minimum requirements and that it was Hoejgaard’s responsibility to identify areas where works needed to be designed to more rigorous standards, so where there were two inconsistent standards in Section 3 of the Technical Requirements, the more rigorous standard would apply.
- The figure [relating to the height of irregularities on the steel] in the formula [in J101] was wrong, but this (by virtue of clause 3.1) was a minimum requirement, and it was Hoejgaard’s responsibility to identify that there was a more rigorous requirement.
- The Supreme Court rejected Hoejgaaed’s arguments that the onerous obligation of a 20 year service life was not likely to be “tucked away” in the technical documents, and not addressed in the important clause 8.1 of the Conditions of Contract. The Technical Requirements were plainly contractual documents and to interpret them as Hoejgaard suggested would give them no meaning or make them redundant. In any event, section 1.6 of the Technical Requirements, which contained the Key Functional Requirements, included a requirement “for a minimum site specific “design life” of 20 years without major retrofits or refurbishments.
- With reference to a 1986 Privy Council case, the Supreme Court said “the poorer the quality of the drafting, the less willing any court should be to be driven by semantic niceties to attribute to the parties an improbable and unbusinesslike intention”.
The outcome [Supreme Court decision] may be thought to be a tough one. However, English Law does not simply seek out what a court might consider to be a fair conclusion. First and foremost, it applies the wording of the contract, and respects the allocation of risk in a contract, even where that might not seem to be fair.
Just because it is impossible to absolutely ensure a life of 20 years does not mean that the designer cannot allow for all realistically foreseeable risks.
The main difference between Jeremy Winter’s paper and the earlier legal commentaries on the case is that Jeremy has considered the issues that were the subject of dispute from the legal, contractual and engineering / technical perspectives. I suggest that this approach provides useful learning for ECI members – always consider issues that may at first appear to be legal / contractual matters ALSO from the technical perspective and vice versa in order to have a full understanding and appreciation of risks and liabilities BEFORE making contractual commitments.
It is essential to avoid a repeat of the Carillion story in Engineering Construction. We can change for the better the fortunes and destiny of organisations engaged in Engineering Construction by taking action as an industry – NOW.
All ECI members will have by now received their invitations to Existential Crisis – Rethinking Capital Programme Delivery event that is being co-sponsored by ECI & CII and hosted by Fluor in their office in Amsterdam on 21 February 2018. Invitations have also been extended to CII members and guests of ECI and CII. If you have received your invitation then please do register to attend. If you have not received an invitation then please register to attend here. If you have a client or supply chain partner who you believe should attend then please extend an invitation to them.
So far we have received great enthusiasm and support for this event “…What a great subject for this seminar! Such a relevant topic for the industry right now, and pleased to see ECI taking a role in facilitating this discussion…” (Paul van Weert, Shell).
So far 48 people have already registered. If you and your guests would like to attend then I recommend early registration. I hope to welcome very many members and your guests to this event in Amsterdam on 21 February 2018.
This week saw the collapse of Carillion – one of the UK’s largest contractors. It is said that Carillion’s financial problems were due to delays and significant losses on major Government contracts. Whatever the truth of the matter, the mantra for some time in the UK industry press has been that margins of around 2% are not sustainable.
Setting aside Carillion’s profit / loss issues, it is evident that Carillion’s biggest problem in the run-up to its demise was an acute shortage of cash.
While operating in a different market to Engineering Construction, the Carillion case provides salutary lessons for organisations engaged in this industry – owners, contractors and the supply network – current margins are far too low relative to the risks being taken, cash is king – it’s lifeblood, nobody is too big to fail and fall out from a major contractor failing is catastrophic for industry with the brunt of the impact being taken by subcontractors, vendors, service providers and distress for all the people involved and not forgetting that owners are left with incomplete projects and further significant investment to bring their projects to completion. It is in nobody’s interest for contractors to suffer the same fate as Carillion.
Let us all learn from the Carillion demise.