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Is the government going slow on PPP projects? More infrastructure projects are being commissioned in the country on EPC, as it has proved overall to be less quarrel-prone and more on-schedule in completion. A Shivkamal says the challenge still remains quality and execution, but EPC may be an important way that international investors see their entry into India.
When the Karnataka government planned to four-lane the congested Bangalore-Mysore state highway eight years ago, it handed over the project to a reputed contracting firm. Scheduled for completion in 24 months, the road widening project took nearly four years and vehicular traffic had doubled by the time it was thrown open for movement of vehicles. A major learning from the government was that unless projects were allotted on a turnkey basis with a specific time-frame, the gestation period of infrastructure works would be longer.
According to a study prepared by Ernst & Young titled "Engineering, Procurement & Construction: Driving Growth Efficiently", the Indian EPC sector, with its rising prominence and changing dynamics, has over 150 participants and hundreds of stakeholders today. Players have carved out a niche for themselves and have developed their reputation, based on their sector focus. Some have also divested their operations in other sectors, thereby segregating the entire EPC space, based on operational segments.
Although Engineering, Procurement & Construction (EPC) is at a highly mature practice in developed countries, it was only in 2011 that the Karnataka government included EPC in major infrastructure works. Now, several important projects, such as power projects, road works and construction of new buildings, have been awarded under EPC to several top firms.
An EPC contractor designs the installation, procures the necessary materials and builds the project, either directly or by subcontracting part of the work and ensures timely completion. The contractor also carries the project risk for schedule as well as budget in return for a fixed price, called lump sum depending on the agreed scope of work. In other words, the burden of the project owner (government in the case of public works) is reduced to a great extent.
The EPC campaign
Reduced risk for project owner, protection against fluctuating prices of raw materials (construction material), protection against labour wages, prevention of cost escalation (project cost finalised at a fixed rate), one-point contact for project owner, and ensuring uniform quality levels are some of the main advantages that experts see in EPC. In addition, before handing over the project to the EPC firm, the project owner has the power to define scope and specifications of the work, project duration, fixed costs and ensuring quality.
"EPC is emerging as a win-win proposition, especially in the government sector, where delays have become the highlight. In an EPC contract, the government (project owner) is empowered to provide litigation-free land or area to implement works, backed by funds released in phases. In return, the EPC firm will be in a position to implement the works on a priority basis. The importance of EPC is gaining significance across important projects these days. In fact, the private sector has adopted EPC in a big way in India," said Anand Sukumaran, Executive Director, Neo EPC Ltd, based at Chennai.
S Mahadevaiah, Retired Joint Director (Town Planning), Government of Karnataka, and now with ASUSE EPC Consultants, has been the champion of EPC in Karnataka. His major victory came in the form of government's decision to award four coal-based power projects on EPC basis in 2011. The question is how much importance would the governments of other states accord importance to EPC in order to speed up infrastructure projects.
"Though experts lobbied for implementation of EPC in large projects sponsored by the governments, it was not taken seriously in India," says Mahadevaiah. "Now, look at the enormous backlog of public infrastructure works across the country. It is heartening to note that a few progressive states have started incorporating EPC in their public works."
EPC has evolved to being a significant component of the award of infrastructure projects in the last one decade. Now, after running parallel to the much pub¡lcised Public-Private Partnership (PPP) projects, it has become important for the central and state governments to include EPC in order to avoid time overruns.
While EPC comes with its own set of risks-political (political stability; new governments in power are known for cancelling big contracts), environmental (projects likely to be cancelled in view of environmental concerns), technical, financial, contractual/legal and force majeure-some contractors are actually welcoming more accountability among contractors post-construction; such is the need for projects in infrastructure today. This is mostly because as the infrastructure contractors and developers gear up their EPC capabilities, they also understand that whatever the risk, it won't be assured cash flow. More accountability, however, may be on its way especially in the highways sector, including commitment to post-completion maintenance.
Influence on project effectiveness
The growth of EPC projects has resulted in better organisation of their execution. Demonstrably, it has led to a growing reliance on contractors' capabilities and project management skills. The onus of project management has shifted from the owner/developer to the contractor. Gradually, the risk of time and cost overruns has been transferred to the contractor, along with the responsibility of designing, procurement of materials and construction. Standard clauses and conditions prevailed, but the EPC contract model has evolved to reflect the shift in balance of risk between owner/developer and the contractor.
EPC has achieved maturity in the private sector with the industry being segmented clearly on the basis of the capabilities of the firms. EPC contracts are segmented into Infrastructure Construction, Building Construction, Oil & Gas EPC, Power EPC, and Specialised EPC. Some of the big names in EPC include L&T, Gammon India, Shapoorji Pallonji, Patel Engineering, Mahaveer Projects, Punj Lloyd, McNally Bharat, Thermax, BHEL, Tata Projects, KEC International, Simplex, ABB, Alstom, and Bechtel.
Among recent project awards, Alstom bagged two contracts, worth approximately Ç450 million in total, by GVK Industries to build two units at the new Jegurupadu III combined cycle power plant in East Godavari District, Andhra Pradesh. These contracts consist of EPC contract and an additional long term service agreement. Under the EPC contract, Alstom will design, manufacture, supply, install, test and commission the two units, each consisting of Alstom's GT26 gas turbine, steam turbine, generator, heat recovery steam generator (HRSG), associated civil works and balance of plant equipment.
Last year, Siemens announced its foray into the emerging solar photovoltaic plants in India. Siemens has already executed 160 MWp solar projects as EPC across the world and more than 1,200 MW of equipment supply for solar projects. The Indian market is critical for Siemens as it is one of the fastest growing renewable energy marketplaces in the world today. Taking a cue from Siemens, its competitor ABB too is reportedly planning to enter the solar EPC market in India.
Gateway to Indian market
The government's approval for 100 per cent FDI in infrastructure projects through the automatic route has encouraged various international players to establish their presence in India. These global giants provide the latest technology and quality to domestic contractors through strategic alliances, joint ventures and partnerships.
Global economies have seen extreme contraction in recent years. While some are struggling to survive, India is recording a healthy GDP growth and providing significant opportunities in the infrastructure and construction space.
Due to the shrinking global economy and increasing opportunities in India, several European players are exploring the possibility of an entry into the Indian markets. Four (Bouygues, ACS, Vinci and Hochtief) of the top five European global contractors are evaluating the prospect of entering India and are seeking joint ventures on Indian turf. Several other international players such as Toyo of Japan, Samsung of Korea, Leighton of Australia, Bechtel of USA and IJM of Malaysia have already established their presence in India and undertaken some landmark projects in the country.
So, what is attracting the global EPC players to the Indian market in addition to the interest shown by the private sector? India's Planning Commission has announced infrastructure investments of Rs 40.9 trillion during the 12th Five Year Plan period, and the EPC sector, with its estimated opportunity size of Rs 17.1 trillion investments, will be the largest beneficiary. While the power and highways sectors are expected to continue being the government's main investment focus areas, the urban infrastructure and telecommunications sectors are also expected to witness enhanced investment.
Sectoral prospects for EPC: The government's eagerness to adopt EPC is most evident from the recent announcement that the Union Surface Transport Ministry is intending to increase the number of road projects to be awarded through EPC. In the first phase, the government wants to develop more than 9,500 km of National Highway through PPP model. Of this, 4,000 km of roads will be developed under EPC in the next few years.
"We have entered EPC mode and in that mode we hope to award 4,000 km, and for this budget is available," Union Road Transport and Highways Minister CP Joshi, had said at an investor meet, earlier this year.
National Highways works that are not completed under the PPP model will be undertaken primarily through the EPC mode. The road ministry's biggest imperative to adopt EPC over PPP is warranted by the fact that many PPP projects awarded so far will rake in premium to be utilised as investment in highway development under EPC in the less attractive eastern and north-eastern and central regions, JN Singh, Member (Finance), National Highways Authority of India (NHAI), has told Infrastructure Today. The Union Cabinet Committee on Infrastructure, in August, approved the Model EPC Agreement Document for widening of two-lane National Highways. The government hopes to minimise the time and cost overruns characteristic of the extant Item Rate Contracts. Further, the government believes that EPC will enable a faster rollout of projects with least cost and greater efficiency and flexibility, thereby encouraging contractors to participate in such projects.
According to the Ernst & Young (E&Y) India report, the infrastructure linked EPC sector is set for a big leap in India. The firm expects to see projects in roads and highways go on the fast track, while Mass Rapid Transit System (MRTS), ports, airports and power have already seen increased activity. However, urban infrastructure promises to be the story of the next decade, E&Y says.
Challenges are inevitable in the current EPC market scenario, but the approach to management of such challenges will be the key to continued success for EPC firms. With global giants entering Indian markets, EPC contractors wanting to ride the wave of double-digit growth will have to constantly improvise and improve their modus operandi to maximise value for their shareholders.
"That operating in India where infrastructure projects can be scrapped overnight because of changing political scenario, bureaucratic delays or technical glitches, needs a careful approach. No business is devoid of risks. Therefore, global or Indian EPC firms need to ensure adequate safeguards. We have just made a begin¡ng and pitfalls are common. If the EPC firms are able to withstand these challenges and demonstrate the difference that EPC can make to PPP projects, they will be championing the cause of EPC in a big way," pointed out Mahadevaiah.
The fact that EPC has the potential to change the way infrastructure projects are being commissioned by the private sector is already visible. The biggest challenge for the country now remains in the government sector showing the same level of interest to adopt EPC at every level by legislating such a mandate.
EPC Contract Model as planned by NHAI A Model EPC Agreement, which the Ministry designed in July and put it up for Cabinet approval, derives from international best practices and provides a sound contractual framework that specifies the allocation of risks and rewards, equity of obligations between government and the contractor, precision and predictability of costs, force majeure, termination and dispute resolution, apart from transparent and fair procedures.
For example, the Agreement allows the contractor to design and construct the project using best practices and innovation to optimise on efficiency and economy as compared to the rigidity of the item rate contract that relies on a single design provided by the government. The Contractor also has full freedom to plan the construction schedule for efficient use of its human resources, equipment and other resources while payments are linked to specified stages of construction as compared to payment for individual items/ units under the item rate contracts.
The EPC agreement specifies the dates on which different sections of the land will be handed over to the Contractor.
A provision has been made for damages which the Contractor has to pay to the government for not achieving the prescribed milestones. The government will pay bonus to the Contractor for completion of the project before the scheduled completion date.
Termination payments have been quantified precisely. Political force majeure and defaults by the authority concerned are proposed to qualify for adequate compensatory payments to the contractor and thus guard against any discriminatory or arbitrary action by the government. In the event the government terminates the agreement on account of any of the specified defaults of the Contractor, the Agreement allows the government to forfeit the performance security and retention money of the Contractor.
The EPC contractor will maintain the highway at the rate of 1.5 per cent of the contract amount in the first year and 2 per cent in the second, and assessment will be made on performance to prescribed standards.