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3.4 Considerations in Developing the Conditions of Contract - Road to Success - IPLOCA WIKI Collaboration Platform

3.4ConsiderationsinDevelopingtheConditionsof
Contract
CreatedbyGuyHenley,lastmodifiedbyMustafaAbusalahonNov20,2014

Traditionally,contractstermstendtobeissuedbyclients,
andmarketforcesand/orfinancialinstitutionstendto
driveintheirfavour.Toooftenriskallocationcontinuesto
bepushedfromonepartytoanotherdependingon
prevailingenvironmentalormarketconditions,withlittle
considerationtothelossofpotentialvalueandearnings
incurredduetoinattentiontoreducingtherisktobegin
with.

3.4.1PipelineProjectSpecifics
3.4.2ClarifyingRiskResponsibilities
3.4.3ProbabilityofRiskandCostOutcome
3.4.4Conclusion

However,asageneralprinciple,theconditionsofcontract(generalconditionsandparticularconditions)should
notbeoverlyfavourabletoonecontractingpartyvisvistheother(s).Indeed,experienceshowsthat
constructionandoperationalrisksarebestallocatedwheretheycanmostappropriatelybemanagedandborne.A
faircontracthelpstosignificantlyreducetherisksofconflicts,delaysanddisruptionswhendifficultiesoccurinthe
performanceofaprojectbyclearlyidentifyingtheagreedriskallocationandprovidingfaircompensationfor
bearingthem.
Several(unsuccessful)attemptshavebeenmadeinthepasttodevelopstandardbalancedcontractconditions,
applicabletoalltypesofmajoronshorepipelineprojects.Thefailureoftheseattemptswaslargelyduetothefact
thatnationalclientsareboundtoabidebythelocalcontractingpracticesandglobalclientshave,overtheyears,
developedtheirowncontractconditionswhich,theyfeel,canadapttothevaryingcontextoftheirprojects.

3.4.1PipelineProjectSpecifics
Whatevertheconditionsofcontractused,therecommendationsaboveacknowledgethespecificitiesofonshore
pipelineprojectsaswellastheuniquenessoftheirsites.Unliketherelativelysmallconcentratedareasofother
constructionprojects(suchasterminals,pump/compressorsstationsetc.),onshorepipelineprojectsoftenextend
overseveralhundredkilometres,crossingstateand/orinternationalboundaries.
Thelikelihood,therefore,ofencounteringconditionsdifferenttothoseuponwhichtheinitialdesignand
constructionprogrammewerepredicatedishigherthaninotherconstructionprojects,hencetherequirementfora
goodFELasthelikelihoodofchangesisinherenttopipelineprojects.Thisrequiresthatthepartiesanalyse
potentialrisksatanearlystage(duringthebidphase)andthatthecontractualbaselineissetaccordinglyto
ensurethatanticipatedrisksarefairlyallocated.Bothpartiescanbenefitfromprudentfrontendloading(see
section2).

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3.4.2ClarifyingRiskResponsibilities
Asdemonstratedhere,thebaselineofagoodpipelineconstructioncontractmustincludeacleardefinitionof
inclusionsandlimitationsforkeyrisks.Thescopeofworksprovidesthebasisforanagreementbetween
contractorandclient.Underidealcircumstancesthiswouldbesufficientforanonshorepipelinecontract.
However,inreality,riskevents,whentheyoccur,leadtocontractualdisputesunlessthecontractaddressesthese
issues.Contractsshouldthereforeincludetermswhichallowsufficientcommercialflexibilitytoaddressthese
inevitablevarianceswhilestillpreservingtheperformanceincentivesinherentinthecommercialtermsforthe
baselineportionofthescope.
Thisrequirestherecommendedspiritoftrustandmutualcooperationbetweenthepartiesandthesituation
wherelackofclearandconcisescopeandengineeringdefinitionleadsonepartytoconsiderexploitationatthe
costoftheothershouldbeavoided.Theclientmayseeunderpricedlumpsumbidsasabenefit,whilstthe
contractormayseetheopportunityforchangeandscopeincreaseduringtheexecutionofthework.Inactualfact
theresultisdisputes,delaysandadditionalcostsseldomtoanypartysbenefit.
Exemplarypreferredconditionsofcontracthavebeenachievedininternationalonshorepipelineprojects.Clauses
ofgeneralinterestforallconstructioncontractssuchasexchangerisk,countryrisk,indemnities,insurance,
paymenttermsetc.arenotfurtherdevelopedhereinastheymaybefoundingeneralcontractliterature.Thereare
certaincontractualtopicsthathaveaparticularimportanceforonshorepipelineprojects.Theguidelinesincluded
inAppendix3.4.4addressthefollowing:
Theweatherconditions/inclementweather
Theenvironmentandarchaeology
Thedefinitionof(andaccessto)thesite
Theprogramme(andadjustmentthereto,includingcompensation)
Therelationswiththirdparties(pipelineprojectsinvolveanunusuallylargenumberofthirdparties)
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3.4 Considerations in Developing the Conditions of Contract - Road to Success - IPLOCA WIKI Collaboration Platform

Thesupplyofmaterials
Thegroundconditions
Theresponsibilityfordesignandconstructability

3.4.3ProbabilityofRiskandCostOutcome
Manyacontractorhasfallenintoatrapassociatedwithriskpricingwhenclientsinsistinhavingthecontractorto
bearsomeoftheriskimpacts.Thedesiretoachievecommercialadvantagesometimestemptsacontractortobid
alumpsumcontractbasedonacalculationoftheestimatedcostsofinherentrisks.
Thebaselinecostestimateisnormallybasedontheexpectedcostoftheproject.Thiscostincludestherequired
contingencycommensuratewiththeprojectdefinitionatthatstageofthework,wherethecontingencyisaddedto
thebaseestimatetoalevelthatisequivalenttothe50/50(orP50seegraphicbelow).Ontothisabidderwill
addreservethatprovideshiscompanywiththelevelofassurancethattheexecutionoftheworkwithallnormal
riskswillachievehisgoalofprofitability.Thislevelofbidisnormallyassessedatalevelwherethecompanycan
be8090%sureoftheoutcomeoringeneraltermstheP80estimate(thisprocessisdescribedfurtherin
Appendix3.4.5ProjectCostEstimateandContingency)
Whilstsomebiddersmaybesufficientlyconfidentintheirabilitytoexecuteworktoanestimatedbudgetbasedon
the50/50estimate,orwithlittletonoreserveitdoesassumethatthebidderhas100%definitionofallrisksand
unknownsandthathispriceiscomplete.Thisisanunlikelyconditionandnormallyresultsinthebidderplacinga
highrelianceonclaimsorchangestohisadvantage.
Someprojectrisksoccurinacontinuousandincrementalfashion,sothatthedifferingpricepointsconsideredby
differentbidderswillonlyvaryfromtheactualcostoutcomebydegree,leavingthebidderamarginalprofitorloss
intheend.
However,projectsoftenhavediscreteriskswhichresultinanallornothingcostimpact.Whiletheprobabilityof
theserisksisstillvariable,theircostoutcomeisnot.Competitivepressuresoftentemptcontractorstobidsuch
risksatlessthanexpectedcostonthehopethattheunconsumedcontingencywillbecomeadditionalprofitorcan
berecoveredthroughclaims.Whentheriskdoesarriveandisnotsufficientlysupportedwithfunds,theexpected
profitisnotonlylostbutprofitisdrawnfromotheraspectsoftheprojecttooffsettheriskcostimpact.Contractors
feelforcedtorecovertheirincurredriskcostsfromtheirclients,oftencreatinganuneasyrelationshipwiththeir
clients.Thisinevitablyleadstocommercialstressandcanworktounravelthecontractualarrangementsmade
betweentheparties.
Thealternativeadvocatedhereistobeovertinthecontractastohowmuchoftheriskcostimpactisincludedin
thebaselineandhowtheexcessorresidualriskwillbeaddressedcommercially.Clientsareespeciallyurgedto
avoidenteringcontractswhereknownriskshavebeenaggressivelypricedatapointbelowthelikelycostimpact.
Thebetteransweristohavetheclientbeartheriskandavoidthecommercialinefficiencyofpotentiallypayingfor
therisktwiceonceinthebaselineandagaininaclaim!

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Contractsneedtocontainanappropriatecontractualandcommercialmechanismtodealwith(unanticipated)
risksthateventuateduringthecourseoftheworkdespitepartiesbesteffortstocounter,factorin,oreliminate
theserisks.Forrisknotaccountedforinthebaseline,partiescanagree,inadvance,theformofcompensation
andthemethodofcalculationoftheadjustment.
Therefore,thecharacteristicsofonshorepipelineprojectsmakeitmoreimportanttoattainawelldefined
allocationofrisksbetweentheparties.Furthermore,partiesneedtodetermineearlyonhowtheyaregoingtodeal
withresidualexecutionrisk.Thisisfundamentaltoachievingoptimumcontractualcooperationbetweenthe
partiesandminimisingconflictssurroundingeventualcontractadjustments.

3.4.4Conclusion
Thebaselineofaconstructioncontractneedstobeclearlyestablishedincludingscopeofwork,thedetailed
executionplanwitharesourcedMarchchartprogrammeforalllinearactivitiescombinedtoCPMprogrammesfor
allfixedinstallations,thecostelementsandtheconditionsofcontract.
Theremaybecircumstanceswhenthebaselinehasnotbeensufficientlydevelopedattimeofgoingtotenderand
needstobeimprovedthroughearlyworkstoarriveatabettercontract.
Section4willreviewthemainrisksofpipelineconstructioncontractsandproposemitigationmeasureswhichcan
beimplementedatvariousstagesofthedevelopmentoftheproject.

ContinuewithAppendix3.2.1RecommendationsforEstablishingProjectExecutionPlan
ConstructionPhase
Backto3.3ContractPriceInformationtoFacilitateEvaluationofChanges
Backto3.TheBaselineofaConstructionContract

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