Part of a Special Section covering the Nuclear Construction Summit USA 2009, October 26-27 – Washington DC
The Nuclear Construction Summit, USA 2009 was attended by professionals who finance, plan and develop next nuclear projects. Professionals delivered information that will form blueprints for successful financing and construction risk assessment and management at every phase of the construction cycle. From government and regulatory bodies to operator insight and in-depth contractor experience.
- Presented by John Lamberski, Esq., Mercer Thompson LLC –
The attached pdf presentation from the NCS meeting details Turnkey Nuclear EPC Agreement Risk Allocation
Significant Nuclear EPC Agreement
Risk Allocation Provisions
• A. Pricing structure
• B. Schedule guarantees
• C. Performance guarantees
• D. Credit support
• E. Change orders
• F. Limitations of liability
• G. Regulatory Approvals
• H. Vendor/constructor joint and several liability
Price Structure Risk Considerations
• A. Pricing Definitions
– Fixed Price
– Firm (or Indexed) Price
– Target Price
– Time and Materials Price
Pricing Definitions
• Fixed Pricing – means that the stated price is fixed for some portion of the work or piece(s) of equipment or materials throughout the term of the agreement, subject to adjustment based on change orders.
• Firm (or Indexed) Pricing – means that the stated price for some portion of the work is subject to adjustment over the course of the project based on changes in one or more indices (such as the Consumer Price Index or the Handy Whitman Index), or based on fixed escalation percentages, as adjusted by change orders.
• Target Pricing – means that the contractor is reimbursed for all reimbursable costs (direct and indirect) that it incurs to perform the work, plus a fee (profit), subject to a sharing mechanism where such contractor receives a bonus (additional fee) if the final project costs are below a pre-established “Target Price” and where the contractor shares in some portion of the final project costs that exceed the Target Price, as adjusted by change orders.
• Time and Materials Pricing – means the contractor is reimbursed for all costs (direct and indirect) it incurs to perform the work, plus a fee (profit).
Target Pricing Variations
• Key is cost overrun sharing mechanism when Target Price is exceeded, such as:
– Absolute limit on Owner’s cost overrun exposure
– Absolute limit on Contractor’s cost overrun exposure
– Cost overrun shared based on an agreed percentage allocation (with or w/o a limit on either party’s share)– Infinite combinations of the foregoing
• Sharing of cost underruns (bonus fee forcontractor)
The Trouble with Non-Final Designs
• Without design details, the contractor cannot develop an accurate cost estimate
• Uncertainty in cost estimate will result in an increase in contingency amounts in price
– This could make the project uncompetitive
• But, even for non-final designs, there should be some aspects of the project procurement and construction that is susceptible to reasonable cost estimation
Are Phased EPC Agreements the Answer?
• Phase I (development phase)
– Begins with EPC execution
– Includes design finalization, equipment quotations, purchase of long lead items, price finalization
– Regulatory approvals (some if not all)
• Phase II (implementation phase)
– Binding agreement on price
– Full notice to proceed (to the extent permitted by regulatory approvals received)
Phased Agreement Open/Closed Book
• In a phased EPC agreement, all non-final pricing is typically developed on an “Open Book” basis
• All final Fixed and Firm Pricing would be “Closed Book” (except for change orders and escalation adjustments)
• Target Price work would remain subject to Open Book since it is paid on a reimbursable cost basis
Phased Agreement Risks
• Timing Issues
– An extended Phase I period can foreclose the Owner’s opportunity to shift to a different reactor technology (if the parties fail to agree on final pricing). Owner may be forced to fill its capacity needs with a non-nuclear resource alternative
– NRC licensing (COLA) review schedules make it particularly difficult to switch reactor technology horses and stay on schedule for C.O.D.
Phased Agreement Risks
• Cost Issues
– During Phase I, Owner will be making payments with respect to the Phase I work scope
– Failure to reach agreement on final pricing can saddle the Owner with millions in sunk costs
– PTCs (if in play) will likely be lost as well since pouring of first concrete must occur before Dec. 2013 under current legislation
Phased Agreement Risk Mitigation
• Mitigation Options
– At start of Phase I, maximize the percentage of the Contract Price that is not subject to change
– Include monetary incentive if final contract price meets pre-established criteria
Are Final Designs the Answer?
• Contractors may remain unwilling to take significant construction cost risk
– E.g., if labor availability, qualification and productivity uncertainties exist in the U.S.
• Nonetheless, price certainty in EPC agreements for projects with finalized reactor designs is much more likely than projects with non-final designs
Risk of Exhaustion of Contractor
Responsibility for Cost Overruns
• For Target Price work, once a Contractor’s share of cost overrun responsibility has been exhausted, what incentive does the Contractor have to minimize further cost overruns?
– If LDs for schedule delay are possible, Contractor is still highly motivated; however, LDs may be exhausted
• Further cost overruns will be the responsibility of the Owner
– Contractor may even be motivated to expend extra funds to stay on schedule and avoid LDs
• Incentive Structures/Mechanisms
– Contractor holds a minority equity interest in the project
• Regardless of the exhaustion of LDs and contractor’s share of cost overrun amounts, contractor will be responsible for its equity percentage share of all costs of the project
– Monetary incentives for contractor performance
State Regulatory Risks
• Cost recovery in electric rates is paramount for regulated utilities
• PUCs are unlikely to subject ratepayers to writing a “blank check” for nuclear project construction costs
– E.g., Virginia State Corporation Commission disapproved an IGCC project where it found that the applicant’s cost estimate was not credible. Uncertainty of costs was viewed as greater for the IGCC due to higher capital costs, longer construction and permitting schedules, and untested track record (similar to advanced nuclear designs?)\
• The VSCC found that the applicant “will not obtain actual or firm prices for components of the project until after receiving regulatory approval… has no fixed price contract for any appreciable portion of the total construction costs; there are no meaningful price or performance guarantees or controls for this project at this time. This represents an extraordinary risk that we cannot allow the ratepayers … to assume. This risk is further compounded by the fact that, when [applicant] eventually attempts to obtain a turn-key contract with firm pricing, it likely will be a sole-source contract with one bidder.”
S.C. Decision Re: VC Summer
• Earlier this year, the SC PSC approved the application of SCE&G to construct VC Summer Units 2 and 3 (twin AP1000)
– Certified (for recovery in rates) a specific overnight cost of construction, subject to adjustment for fixed escalation and adjustment by indices, plus separate schedule and cost contingencies
– Target Pricing applies to construction effort, with a minimum profit for Contractor
• SC PSC approval of VC Summer Units 2 and 3
– Should the actual costs of construction exceed the certified amount, further SC PSC approval will be required to recover those costs in rates
Vogtle Units 3 and 4
• In March of this year, the Georgia PSC certified the construction of Plant Vogtle Units 3 and 4 (twin AP 1000)
– Certified (for recovery in rates) a specific in-service cost of construction
– Should the actual costs of construction exceed the certified amount, further Georgia PSC approval will be required to recover those costs in rates
Only Prudent Costs are Recoverable
• For regulated owners, depending on their PUC order approving the project, they may be required to obtain further PUC approval to recover in rates any cost overruns that exceed the original PUC-certified amount of construction costs
• Generally, any such owner will have to demonstrate that such cost overruns were “prudently” incurred
• It is possible that utility owner’s will be denied recovery of such cost overruns where they can be traced to imprudence on the part of the contractor
• In such a case, the utility-owner will be required to absorb such disallowed costs unless the EPC agreement requires the contractor to bear those costs
IRP Considerations
• Utility applicants for certification in Integrated Resource Planning jurisdictions generally are required to demonstrate that their proposed projects are the best cost resource for ratepayers
• A proposed nuclear project, therefore, will compete not only with other nuclear plants but with non-nuclear electric generating resources available to the utility
Click here for the entire presentation in pdf of Turnkey Nuclear EPC Agreement Risk Allocation