The volatile power generation “build” market

For those of us who have been in the Power business for many years building large generation projects, there is one consistent theme, it’s inconsistent. Some people compare our business to the stock market, that is, when companies invest in the market, everyone seems to follow. Likewise, as in the current times, everyone is sitting on the sidelines waiting for the signal that its time to begin reinvesting.

The current times are more complicated than the previous lulls in the Power market due to the impact of the recession.  Utilities have in some instances seen a drop in electric demand, not only in the commercial business, but also residential.  Cost-conscious people are turning off their lights and TVs when not in use.

Although the demand for electricity is down, we all know that it won't last long.  A recent Engineering New Record article noted that the Power market will most likely be the first market to lift itself out of the recession and gather momentum.

So what does all this mean?  It means that the material, equipment and other commodity pricing will start the rollercoaster ride upward, possibly reaching or exceeding mid-2008 pricing.  Currently, pricing is seeing a healthy 12%-15% drop, a sizeable difference for projects that often reach $500 million to $1 billion.  So does a company build today, saving $50 to $150 million or wait until electrical demand requires new generation at the higher cost?

Another significant impact to the project cost is the duration of the construction schedule.  Current times have required owners to participate in competitive generation development, longer internal approval cycles, and extensive permitting.  When a project is ready to proceed, the schedule very often is squeezed to a point that construction costs go up due to excessive overtime and the need to pay higher prices for expediting equipment that have a longer duration for delivery.  Therefore, planning early in getting project approvals, then ordering the primary equipment well in advance to take advantage of lower prices and signing up the engineer, procure and construct (EPC) contractor can greatly improve the chances of project success.

Another way of dealing with volatility is to implement alternative contracting approaches compared to traditional bidding of fixed price work.  These alternative approaches result in a sharing of the risk between the owner and the EPC Contractor.  Although many owners believe that a fixed price contract provides them with the lowest cost outcome, the actual result is often the opposite.  This is due to the EPC contractor adding abnormal contingency to unknown and volatile items.

One alternative approach that has been used successfully is a fixed-target approach.  The owner and the EPC contractor jointly determine the individual project scopes that contain a higher amount of risk, and then determine which company should take that risk based on their ability to mitigate it.

As an example, an EPC contractor is required to purchase some equipment that is highly volatile due to market demand.  Instead of the EPC contractor taking the risk and apply a high amount of contingency costs to cover the risk, the equipment cost is developed as a target.  All the volatile items are placed in the target "bucket" along with a reasonable contingency.  As the project is executed, actual costs are collected.  At project conclusion, the actual costs for the target bucket are compared to the target.  The owner and the EPC contractor share in the savings or the cost overrun.  Since the target cost items are open for review and selection by both companies, this approach also encourages both team members to identify value engineering items to lower cost during the project construction life.

When owners are required to have a fixed price at project financing, other alternative contracts can be implemented to keep the price down.  Some projects require a solid budgetary price to progress through the approval process well in advance of the notice to proceed.  The owner can agree to float the costs for the volatile equipment and then require a firm price for those items at the same time financing is achieved.  Thus, the owner is paying the actual costs, rather than a projected price with contingency, which was developed months, sometimes a year in advance.

CH2M HILL is a leading builder of power plants in the world.  Our company has worked with a number of owners, whether they are utilities, municipalities, or independent power producers.  Assisting our clients to deliver projects on time and on budget, while executing the work in a safe manner, is vital to our future growth.

CH2M HILL has grown from a 5,000 person consulting company to over 25,000 strong by achieving client's needs in literally all areas of engineering and construction business in every continent except for Antarctica.  Current projects we are managing include the expansion of the Panama Canal, the building of a carbon neutral city in the Middle East, development and conversion of the 2012 Olympics in London and the cleanup of the Energy Department's nuclear-waste stockpile in Hanford, Washington.  A feature project in the Power area is our Empire Project, being built for Energy Capital Partners.  The project includes full turnkey scope of a 635 megawatt dual fuel-fired combustion turbine combined cycle plant and also has a number of off-site work including transmission and pipeline work.