In search of the Optimal Mode of Project Implementation for the Oil and gas Sector in India

Overview

During the past few decades there has been considerable debate as to what is the relevant and the optimal mode of Project Implementation in the Oil and Gas segment in the country. While perceptions on the subject vary considerably, it is important to note that the Mode of Implementation has a direct bearing on the overall Project Schedule and the total Project Cost. While in India, several modes of Implementation have been attempted, and various institutions including Niti Aayog, are of the opinion that directionally the EPC mode of implementation ought to be followed, the tangible data and comparative analysis of various modes of implementation in the Indian context always corroborates the inferences otherwise.

Traditionally, the EPCM Mode of Project Implementation has been pursued led pre-dominantly by the OMCs / Engineering Consultant (EC) operating in the Hydrocarbon segment.?While this mode has been time tested and prevalent for the past five decades and more, it is true that the processes and capabilities have evolved over a period of time. In the 60-70’s, the manufacturing sector in the country was not as developed and consequently project implementation was extremely challenging. Imports were difficult and various restrictive procedures and conditions in general had to be adhered to. This led to a situation where the economies of scale and benefits thereof could not be availed, project schedules were tortuously long, and the dependence on the imports was predominant, not only in terms of hardware but services too. On the relatively positive side, since the projects were not of very significant size, seeds of manufacturing could be sown and a number of fabricators and vendors emerged on the scene. Those were tentative times and the confidence building was actually the focus. Fortunately, this endeavor has continued ever since. It would be interesting to note though that while in the early 60-70’s almost 90% of the hardware required for the Refineries and Petrochemical Complexes had to be imported, the cycle has now been completely reversed as in the early part of the century itself, 90% and above of the hardware utilized in the Refining segment and about 60% of the hardware n the Petrochemical segment is being sourced indigenously! Surely this is a turnaround of sorts!

1991 was the water-shed moment of sorts for the country, wherein several segments of the economy were opened up and private sector companies were allowed to enter the refining segment. Lo and behold, this had a cataclysmic effect on the scale and complexity of projects. Suddenly big is also beautiful became the norm! While the private sector companies Reliance and Essar (Now Nayara) set the trend of setting of mammoth size refineries, the PSUs followed suit and soon the projects began to attain economies of scale and complexity of a very high degree. This apart from the benefits that the accruing to the National Refining Industry in general, provided considerable fillip to indigenous manufacturing where scale and quality level also improved considerably. No wonder that soon enough some of the domestic vendors began to compete aggressively internationally as well, to not only support projects domestically but to make major supplies in various projects abroad.

The fact remains, that manufacturing in India is relatively less expensive on account of availability of low cost manpower and high degree of technical skills also available at relatively low cost vis-à-vis the West. This has led to significant competition in the domestic industry for the benefit of the Owners. Additionally, it has been able to equip itself sufficiently, to effectively serve the industry in terms of timely and high quality supply equipment and hardware for the hydrocarbon sector and several connected industries such as power & chemicals etc. In a way considerable Atma-nirbharta has been long achieved in this segment of the Industry, as compared to the others.

It was against this backdrop that the Hydrocarbon sector flourished in India to quickly help it emerge as a Refining Hub, as well as, gain significant strength in Petrochemicals. With the major Oil Companies including Engineering services operating in the Public sector segment, the operations were extremely well coordinated and well supported by the domestic manufacturing industry. Project Implementation gained strength as delays in mega investments was curbed and with the maturity of the overall implementation practices, what was in the decades of 60’s - 80’s set up in 60-70 months, was now being installed in 36-42 months, this notwithstanding the fact, that the sizes of the projects had grown manifold. This was a remarkable achievement for High Capex – High Technology - High Engineering quotient related Industry.

EPCM or the Stick and build approach

All these significant changes led to the consolidation of the EPCM mode of Project Implementation which surely enables the least overall schedule and the cost associated with the Projects.?The important part though, is the fact that a very high level of project management activity is to be carried out by the Owner/Consultant, to ensure that the projects are delivered on schedule, cost and quality. This process has sustained and emerged as major win for the country. While gaining experience, the important part was to develop niche knowledge not only in terms of rendering engineering and project implementation, but also enable backward integration towards development of Feasibility Reports, Technology development, Licensor Selection and facilitation of Basic Engineering Packages of high quality. These critical aspects of Project Management along with the fact that major supplies and construction could be ensured from the domestic market, project implementation achieved a very serious level of maturity. This became a central theme to enable seeking higher challenges and aims!

Upon liberalization of the economy, a lot of procedures were dismantled and OMCs were accorded Ratna status. Boards of the companies were empowered to take major financial and investment decisions. All the Projects therefore, required that the time schedule and the cost of the Projects must be developed to higher level of accuracy in the initial stages of the Project itself, such that, investment approvals could be accorded by the Board at a brisk pace.

In this context, the experience of the past came extremely handy, as engineering companies developed the expertise of generating very high quality detailed feasibility reports with Capex of the accuracy level of (+/-) 10% variation quality. For major companies across the globe this may be quite a surprise, as majority of them are unable to develop these level of estimates without carrying out a proper FEED. In the Indian context, since a major engineering company operating in PSU regime was itself involved in Project Implementation, it ended up purchasing of hardware and lining up construction contracts of $ 3 - $ 5 billion annually. This enabled it to develop a real time cost data bank which came extremely handy in developing cost estimates of very high accuracy levels with the availability of the Feasibility level of information and with not having the need to secure budgetary quotations from the market. ?This was a significant development as the OMC boards were provided with very reliable estimates in early stages to approve large and significant projects. On an average about 8-9 months on the project schedules were saved on this count itself as no FEED was required to be developed to arrive at +/- 10% accuracy level of estimates as is typical in the West. ?It goes without saying, that high accuracy level estimates are an absolute necessity for the Boards to sanction and approve the projects for implementation.

History is a replete with the fact that Projects ranging from 10,000 crores ($ 1.25 Billion) to Rs.1,00,000 Crores ($12.5 Billion) have been implemented within the cost estimates provided as part of the Detailed Feasibility Reports. It is however also a fact, that on the initial project schedules provided to the Board of 36-42 Months an over run of 3-6 months had been observed in the decade between 1997 through 2007. ?These delays however have been brought down within NIL to 2-3 Months in general barring some exceptions.??This continues to be work in progress. The fact however, is that it does signify the strength of the project Implementation that has been successfully achieved and matured in the country making the EPCM route, surely one of the preferred routes of Project implementation in the country.

Analysis of the various projects and delays thereof reveals that the schedule overruns have essentially come from construction segment, where either on account of poor front management or wanting credentials of construction agencies the project schedules over-ran.?While a lot of efforts have been made to improve the overall construction management in general, the quality of construction agencies active to serve Hydrocarbon sector leaves a lot to be desired. This remains work in progress.

EPC or the Lump-sum Turnkey Approach to Project Implementation

With the Operation- Engineering consultant operating in PSU domain was a strong combination, over a period of time the mode of contracting between OMCs and engineering consultant began to invite public gaze as it was deemed against the competitive spirit of contracting. Negotiated contracts between OMCs and Engineering Company were therefore, put under pressure as they were deemed not to encourage competition and free market operations. In parallel other developments were underway. Along with the liberalization of the Hydrocarbon sector, various engineering companies also began mush room in the country to provide a larger consultant base through whom the project implementation services could be sought by the OMCs.

Additionally, over a period of time the OMCs felt that the EPCM mode of implementation warranted a very large manpower and Management team to implement the projects. Contrary to this, the EPC Mode of Implementation offered an avenue, wherein the risks of implementation could be transferred to the EPC on a single point responsibility basis. This could also enable the Owner the advantage of pruning down their implementation team size and involvement in the implementation.?The OMCs also began to weigh additional benefits of the EPC route, as an avenue to overcome the project procurement and contracting in PSU led projects, which is often cumbersome and challenging.

The EPC Mode of Implementation however, warrants that an appropriate FEED should be developed, wherein all the parameters of the project with respect to the hardware definition is clearly evolved, such that the EPC bidders would have explicit documents based on which, they could provide a firm quote for the project. Evidently, this is a tedious procedure, as award of an EPC contract as per the laid guidelines in the PSU sector can be a very challenging affair from procedural adherence and schedule considerations. These problems get compounded as the projects become larger in size with very few agencies available domestically who can actually undertake proper EPC implementation.

Consequently, the initial advent of the EPC Mode of Implementation in the country was somewhat tentative, and restricted to smaller variety of projects generally not exceeding Rs.1000 crores ( $125 Million) or so. The other problem was that since the projects were to be implemented for PSUs, most of the considerations with respect to FIDIC mode of contracting could not be incorporated in the Indian system of Project Implementation. Procedures had to be stringent and strictly in line with the PSU guidelines, with an extra vigilante being carried out by external vigilance as it was the tax payer’s money at stake! Consequently, most of the clauses in the contracts were/are generally loaded in favor of the Owner. Additionally, the PMC was always under pressure to develop a FEED which was complete in all the respects, such that, upon award of the contract, no extra claims are raised by the EPC contractor. This meant that lot of detailing had to be carried out in the FEED to make it resilient and fool proof against extra claims. ??

Experience revealed that award of the FEED contract has been an extremely tardy and tedious affairs leading to precious loss of time. An experienced Engineering Company is able to dovetail the FEED completion along with Basic Engineering, such that, after availability of BFDEP within 3-6 months the FEED could be brought to a shape in readiness of issuing enquiries.

For consultants, new in the segment of operations particularly in the Indian context, find it difficult in completing the FEED as fast as perhaps an experienced engineering consultant could. The other significant aspect was that domestically, only one or two EPC contractors were available, and the commercial penalties and liabilities in the contract were such, that participation of global EPC contractors was generally limited.?In the initial phases of EPC Implementation a few Korean Companies and some domestic EPC contractors were in the race. It was of course a learning experience as well for the EPC contractors to work in India, as the contract formulation was guided by principles of higher probity and relative rigidity / compliance. Most of the EPC contractors found it extremely difficult to serve the EPC contracts. A lot of hard burn with respect to the delays and the final payments/penalities led to the Korean companies not evincing much interest in the EPC bids issued for domestic projects subsequently.

Availability of EPC contractors therefore, always remained a concern as both the pre-qualification criteria, as well as the provisions of the bidding document were possibly not flexible enough for the comfort of the EPC contractors. A total EPC approach to project implementation was therefore elusive. ???

The first few large projects therefore attempted a hybrid mode of implementation, wherein the very large and substantive sections of the project(s) was implemented on the EPCM route, while the smaller process facilities ranging between Rs.1000 to Rs.1500 crores ($ 125-150 Million) were conceived to be implemented on EPC route. Some of the process facilities also began to be conceived on the LEPC route, wherein the licensor selection was included as part of the LEPC contract and instead of a FEED the front end definition of the Project was led essentially by functional specifications.

The first few large projects which were implemented exclusively on EPC route were the Naphtha Cracker Complex at Panipat and the Cracker Complex at OPAL. Both these projects had mixed feedback.?While Panipat was a great success as the project was implemented on schedule (overall schedule significantly higher than EPCM Mode of Implementation), the OPAL project suffered on account of serious delays and cost over-runs.

In the various projects of a variety of sizes on the EPC route, it was observed that the EPC margins were extremely high and ranged between 25-40% of the EPCM cost. In fact data collated for several Projects over a couple of decades did suggest that for the EPC contracts up to about Rs.2000 crores( $250 million) or so, the EPC margins range between 20-25%. The Project of high value i.e. more than Rs.2000-Rs.3500 crores ( $250- $440 million) the margins were as high as 25-40%. It was also worthy of notice, that typically the minimum difference in the overall implementation schedule for EPCM Vs. EPC range between 9-12 Months for smaller EPC contracts and upto 15M for large contracts. The difficulty all along was a very long cycle of award of EPC contract and delays by the EPC contractors pre-dominantly on account of short-comings of construction.

Open Book Estimate Mode of Implementation

In view of the foregoing, the OBE mode of Implementation became popular, wherein the benefits of EPCM and EPC together could be solicited by the OMCs. In this mode, based on the DFR cost which invariably was considered as the target cost, a OBE contractor could be lined up to enable implementation without the need of a FEED and transparently ensure that P&M cost ?is shared with the OMC.?This implies that market driven costs were passed on to Owner without any margins ensuring the least cost to the OMC. A nominal percentage of the P&M cost however was additionally paid to the consultant for rendering services. The Owner had the added advantage of securing the shorter?schedule as the OBE contractor agreed to all the stipulations of the contract prevalent for the EPC contractor i.e. in an eventuality of delays beyond the schedule the contractor would be penalized on the lump-sum cost i.e. fee to the contractor + P&M cost = Total Cost. The Owner got single point responsibility, EPC mode of implementation, a very small implementation team at their end, EPCM costs as the entire plant and machinery costs were transparently shared by the OBE with Owner and above all, total compliance to vigilance guidelines!.

While a number of projects were implemented on this route successfully, and continue to be implemented, somehow except upstream operating companies, most of the OMCs found it difficult to pilot this model of implementation in their Boards, as it was treated as a negotiated award in their perception. This is actually a tragedy, as being their least cost, least schedule with all the advantages of EPC accruing to the OMCs, this mode of implementation should actually be universalized in the country, and all PSU consulting companies could be involved in the same for the greatest possible service to the Nation. The significant part is. that for this mode of implementation to be practically implement in the Indian context the consultant/contractor ought to preferably be PSUs, as all procurement and contracting has to be carried out strictly in line with the vigilance guidelines which obviously may not be possible with private companies/consultants.

Reflections

However, with the emphasis on EPC and LEPC mode of contracting country like India has to pay for additional schedule and cost. Recently in a large project where the OMC and Consultant are PSU companies, the Owner decided that all the process units would be implemented on the EPC route and the utilities and offsite segment on the OBE route.

Since most of the contracts as of now been awarded for the Project, the results are extremely revealing. The Project in the Detailed Feasibility Report, investment to be implemented on the EPCM route, however, the mode of Implementation was altered by the OMC for implementation on the EPC + OBE Mode instead. While OBE component of the Project is essentially a pass through cost, the process units are ones which essentially are worthy of comparison.

As per the final details available, the following interesting data emerges:

From the above, it may be inferred that on an average the Project cost has varied significantly, even considering an additional 10% over the initial provisions of the cost as per DFR. Additionally, the implication on the schedule is even higher for a project which was anticipated to be completed by 2020-2021 is perhaps now heading for completion only by 2023-24 i.e. delay of 2-3 years is anticipated on the project.?While perhaps a year’s allowance can be granted on account of COVID, yet the schedule over run appears to be high. Wither EPC mode of implementation!

The other critical aspect associated with the project is the fact that on account of lack of participation of EPC bidders the pre qualification criteria for the Project

was relaxed substantially to enable new players to find way into the system. This is an additional risk of entering into a domain of uncertainty wherein, untried EPC agencies have made way into the system and have quoted aggressively to win contracts. The results and ramification of this decision can only be weighed with time.

In similar vein, another interesting story has unfolded in the fertilizer segment where typically, most of the fertilizer projects are implemented on LEPC route. The Govt of India sanctioned several fertilizer projects to be revived at least 4 of the project out of the lot were of world scale size with gas as feed stock. Three of these projects were implemented on LEPC basis ( Gorakhpur, Sindri, Barauni) while one project was implemented on EPCM route. (Ramagundam) It is observed that on an average Rs.1200 to Rs.1500 crores more had to be incurred on the LEPC contracts vis-a-vis the EPCM completed cost, with almost similar schedules of implementation, similar capacity and similar feedstock.

All of this suggests that while certain modes of implementation may be relevant for the West, for a country like ours, where resources are limited, it is important that mode of project implementation is recognized as a critical decision. It is understandable that most of large OMCs would not prefer the EPCM route as it involves a lot of involvement and large management teams to be organized by the OMC, it is important that the OBE Mode of Implementation for all such cases where EPC is a necessary preference of OMC, should be considered. Decisions must be taken at the highest level including GOI to emphasis on this.

It is strange that larger costs, longer schedules are being allowed to obviate mis- placed notion that work award from a PSU OMC to PSU consultant on negotiated basis is recourse to lack of competition. This cannot be a good reason to justify loss to the Nation. Project Implementation in the PSU segment necessarily warrants higher level of probity, transparency and adherence to vigilance guidelines. The PSU consultants also operate under the same procedural ambit which has been stipulated as part of procedural requirement. These institutions are actually torch bearers for the country. It would be worthwhile that the Government constitutes a high level committee wherein these aspects are properly discussed to ensure that a broad contour of project implementation is clearly evolved for the country.

For a Nation where the Honb’le Prime Minister himself is involved in plugging the leakages for the larger benefit of the masses, it is surprising that such callous approach to National resources is being permitted. Our personal experience is that for the benefit of a Nation, almost all the countries are protectionist of their skill and expertise, and they better be! It is in India alone, that we seem to believe in over democracy. Look at the way all foreign countries protect themselves, Bhumiputra in South East Asia, Minimum local content in Middle East, difficult conditions as barriers for Indian PSUs to work in the global market, over protective criteria for entry to the developed world. In India we seem to be just allowing anything and everything. High time the GOI has a look at these aspects closely. Domestic Industry and talent has to be promoted and surely the PSUs, who have redeemed themselves times out of number, deserve encouragement, fairer deals, better competition and definitely not suppression under the garb of self anointed procedure.

It must be ensured that Project costs and Schedule are accorded the highest priority and in no way they should be allowed to cross threshold. Accountability has to be fixed on cost and time over-run.?If the Boards clear an investment with (+/-) 10% cost variation, the same should be religiously adhered to and under no circumstances the mode of implementation be allowed to be changed as envisaged in the DFR. It is a general tendency to have the Project provided for at the least cost, which is invariably the EPCM route, but upon investment approval based on individuals and companies own experiences, the mode of implementation is altered and the results are for all to witness. Invariably cost penalty and time overrun is an inevitable result.

While on the subject, Honb’le Minister of Transport Mr. Nitin Gadkari has already demonstrated that all the skills are available within the country, for implementing the projects in a time and cost bound manner. This should become a universal practice and the highly capable and technology incentive projects in the hydrocarbon, power, fertilizer, steel and non-ferrous segment must be engaged to be implemented within strict boundaries of time and schedule.

For the PSU Projects, it is clear that EPCM or OBE route are the correct mode of implementation. The private sector major projects any way are generally implemented through the EPCM route as least cost, least schedule is the priority around which the projects are implemented.

This certainly is a food for thought for the Nation!