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EPC in roads Whats wrong with EPC?

EPC in roads Whats wrong with EPC?
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If you thought only BOT projects were in trouble, think again. The faltering roads sector is increasingly dependent on sentiment, and this dependence is clear from the recent negativity that has crept even into EPC. Bringing back investor sentiment should now be supreme. This as damage control, the model should foster innovation, sustainability and a genuine sense of ownership, writes Sumantra Das.

Indian road sector, hailed as the lifeline of India’s infrastructure growth story, is at crossroads as road developers are looking ways to exit route from the projects than looking for any further investment. A majority of road developers those are aggressively went for bidding in the golden ages between 2007 and 2011, now find it difficult to sustain the business as the sector finds itself up against post-bidding issues, including a threat in projects on PPP mode. Issues range from subdued funding, optimistic traffic estimates and delayed execution stressed the balance sheets of developers.

The balance sheet of these developers went so stretched that even after recent tenders of National Highways Authority of India’s (NHAI) road projects on EPC mode also unable to attract them. The situation went so worst that NHAI told the highway ministry that it won’t be able to award any more projects on toll mode during 2013-14 if the prevailing conditions don’t improve. According to a recent newspaper report, the nodal authority of the road sector has informed the ministry that 33 projects covering around 3,500 km awarded during the past two financial years are yet to take off mainly because dearth of finance, equity, clearances and land availability. Moreover, 17 BOT (toll) and three BOT (annuity) projects did not get any response last year.

BOT: losing ground

In the current circumstance, road developers such as Reliance Infrastructure have become more cautious on future investment into this sector. The company has not chalked out any further investment plan on the sector beyond FY 2013-14 (the year when most of its roads projects will be commercially operational.)

"In the last two years or so, we have chosen very few projects those are viable for the company, but in future too we will take it very, very cautiously," says Lalit Jalan, CEO, Reliance Infrastructure.

According to Venkataraman Rajaraman, Director-Infrastructure and Project Finance, India Ratings & Research, while the æslowdown’ is impacting the credit profile of many BOT-based highway concessions; partly aggressive bidding is also to blame. The traffic projections were extrapolated on a feeble base of a few days’ study combined with an annual traffic growth expectation of around 8-9 per cent; which really is not matching with the actual traffic and revenue. To add to the woes, the economic situation is also negatively impacting traffic. Besides, there are structural issues like compressed loan tenors relative to concession tenor, etc. "For under construction projects, delays in handover of land and right of way by the grantor have been major constraints," he added.

Given these current circumstances, it seems natural that the developers are losing interest in the BOT space. Some developers have decided to stop bidding further on BOT concessions. Many bids went unclaimed last fiscal. The Ministry of Road Transport and Highways (MoRTH) was unable to award 13 projects worth over Rs 160 billion in FY13. During the year, NHAI has only been able to award 1,933 km of projects, constituting a mere 20 per cent of the targeted 9,500 km.

EPC a solution, but…

However, in order to reduce the uncertainty in the road sector, NHAI took some steps to come out with projects in EPC model, understanding that EPC model has a better chance than BOT of attracting contractors for taking up road projects right away and also because there is a limited financial commitment required and to that extent they (developers) will have a faster financial return.

However, there are hardly any takers for those projects as well. As in the EPC model road projects the issue of land acquisition, availability of approval still remains valid. If those issues are there, even in the EPC mode, the contractor expects project delay, which means that his margin gets wiped out any way (cost escalation can happen).

Rajaraman believes that at this juncture, the developers will be very cautious and guarded against losses of such nature. The recent increase in the input costs render estimation of costs difficult. Under these circumstances, there will be less interest in fixed-price EPC contracts.

"In EPC also, companies are facing various cha¡llenges. The entire gamut of construction companies are facing challenges due to cost escalation in recent times and they are not getting change orders, affecting their balance sheets. So, I don’t think infrastructure players will prefer more on EPC than PPP," observes Jalan.

"The entire debate in the road sector regarding BOT projects willing to shift to EPC has happened due to anomalies related to the project structuring. We know the fact that partly it is due to rational bidding and partly due to lack of certainty in policy. Most of the bidders find themselves in a position where they are financially stressed and cannot take further debt. So clearly, moving away from PPP is required. But going with EPC will only solve the issue of financial stress, it does not solve the other issues faced by a common contractor," says Shripad Ranade, Senior Principal, TATA Strategic Management Group, adding "Whether it is the fact that there is no mechanism for review of the contract, financial liability, increment status, some of these things developers are still very uncom¡fortable with.

"Besides, road developers are also finding that the existing NHAI tenders are giving a realistic estimate which can really attract them for bid.

"In most of the EPC contracts by NHAI, we find the estimate very low and they are not realistic estimates. Beside, the EPC contract documents and the payment terms are very stringent. We don’t think good companies will be interested in these contracts anymore," says Sandeep Reddy, Managing Director, Gayatri Projects.

After the worst experience so far on BOT in road sector, the developers want to stay away from further projects (PPP or EPC) at least for some time. But it is more important to bringing back investor sentiments and to do so, it is very important that there has to be a prompt approach. Government clearly has to be one of the largest fund providers across sectors including roads.

Goutham Reddy, Executive Director, Ramky Infrastructure, says, "It is very important to bringing back investor sentiment, be it on BOT or EPC mainly because the sector is going through a tough time now and fundamentally things are not right as what they were earlier.

There were a few assumptions which completely went wrong over the years. Assuming that equity was going to be available, debt will cost reasonable around 9-10 per cent, government will make payments on time and assuming a lot of other positive things that aggressive bidding from bigger developers took place in the road sector. All these have failed due to various reasons and to bring back the sentiment, government should declare its intention clearly on road projects. The government has been talking about towards premium payment for many years but nothing has happened. Road developers now refuse to believe that the government wants to do it for the sector. "I believe if the government start releasing all the overdue payments, most of the issues will resolve there itself. Unless resolving all these issues, some aggressive road developers may look our for overseas ventures which also cannot be ruled out," Reddy says.

Way forward

It would be reasonable to expect coordinated efforts from multiple authorities in order to further streamline and shorten the clearance process even for EPC model which may appear as short term solution which may be able to bring back developer sentiments.

The finance minister’s proposal of setting up of a regulatory body for the road sector is likely to be a saviour.

EPC to clear backlog

The road sector is witnessing waning interest from private participants, and several structural changes in the BOT model and governing policy regime seem necessary. While these changes will take some time to revive the sector, to immediately clear the backlog of road project targets, the government should consider the EPC mode of project execution.

Advantages of EPC

Limited financial commitment required: The lower requirement of capital investment will suit the players already reeling under high debt.

Risk mitigation: EPC contracting will unbundle risks and limits the exposure of private player to only construction related risks. The risks related to regulatory clearance, financial closure, land acquisition, social unrest etc. will be borne by the government

Reduced uncertainty: Factors such as traffic projection, changes in policies, development of competing road etc. lead to very high uncertainly for the private player over the long duration of road projects. EPC mode of project execution will avoid most of these uncertainties for the private contractor. In addition, EPC has inherent advantages for the private bidder, viz:

Faster financial return: Since the duration of contract will be till the completion of road construction and defect liability period, the private players will be able to churn their resources more frequently and thus generate better returns.

Scope for innovation & cost saving: Since the engineering, procurement and construction will be responsibility of the private player, EPC mode will give more rewards for innovation. The players will have an incentive to deploy modern construction techniques to save time and cost of project execution, which will be a winning proposition for both government and private players.

Thus, switching to the EPC mode will immediately revive bidding in the road sector. However, the government has to also take steps to ensure that the projects are not stalled during execution. Some of the key considerations for the project developing authority should be:

  • Ensuring complete land acquisition and availability of all required approvals before the award of project to EPC contractor.
  • Identifying sources for the massive financial investment required by the government
  • Faster decision making at the execution level such as faster design clearance, timely inspection and approval of work etc.
  • Government has to put in place a robust monitoring system to oversee the project execution by EPC contractors and ensure that they meet the quality requirement within the time and cost specified.

-Shripad Ranade, Senior Principal, and Mittal Shah, Project Leader, Tata Strategic Management Group.

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