Limited Recourse Financing – EPC Contracting: Investigations Programs and Risk management? K.I. Candee S. Larson Aqua Energie LLC Aqua Energie LLC 7830 Restmoor Drive 7830 Restmoor Drive Baldwinsville, NY 13027 Baldwinsville, NY 13027 USA USA Introduction “…there has been a definite trend to move towards turnkey or EPC-type contracts, where most, if not all, of the risks associated with design and construction are under a single point of responsibility, namely the EPC contractor.” (Devernay, 2003). Hydropower represents 20% of the energy generated globally, thus is far and away the global leader in renewable energy. Twenty years ago, many emerging countries, burdened with debt and unable to continue financing large infrastructure like hydropower with sovereign debt, turned to the private sector. With the entrance of the private sector, new financing mechanisms were required that limited the exposure of the investor’s balance sheet. The residual technical risks could not be adsorbed on investor’s balance sheets, and was seen as an issue to be resolved between the engineer and the contractor. The engineer-procure-construct (EPC) concept was borne. The basic premise of the EPC concept assumed that the project promoter could define the desired outcome, and carry out a bidding process in which teams of engineers, suppliers and contractors under a single point responsibility of the EPC contractor would develop a fixed cost date certain contract and accept liquidated damages for performance and delays. However, the development of technical investigation for a complex infrastructure project such as hydropower development is a lengthy and costly exercise, for which project promoters often cut corners during project development stage assuming that the issues will be addressed during the project execution. In many cases, the geologic investigation programs were abbreviated leading to failures during construction. In other cases the responsibility was assigned to the EPC contractors to carry out site investigations during an initial phase of the project, often leading to delays ad claims of changed conditions. Abbreviated hydrological investigations led to underestimated flood capacity and sedimentation issues and/or overly optimistic energy generation estimates. By the mid-1990’s, a paradigm shift was occurring in the hydropower industry. Traditional lending sources such as The World Bank were pushing host governments into private sector financing for large infrastructure projects in order to free up funds for other host government priorities. The effort also aimed to bring financial sanity to hydropower projects, well-known at the time for large cost overruns and completion delays. Few private entities had the balance sheet to backstop the full development of hydropower, and thus sought to finance the debt portions of the project with non-recourse or limited recourse to their own balance sheets, where the backstopping of the financing was the strength of the supply contracts for the future energy to be sold. With lenders unable to absorb risk onto their balance sheets, the pipeline of new hydropower projects began to dry up. What was needed was a single point entity that had a balance sheet capable of taking on a large share of project risk, and was in the best position to manage it. The solution was seen as a single contract that encompassed the design, procurement of equipment, civil construction, installation, testing and commissioning, and was given the acronym EPC for Engineer-Procurement-Construction. With the birth of EPC, lenders were able to focus on financing risk, Owners could focus on their core business, and Contractors could focus on getting the facility designed, built and commissioned under a fixed price and guaranteed schedule modality. The pieces of the puzzle would all come together nicely…or would they? What investigations need to be performed prior to EPC bidding? Who should take primary responsibility for the investigations program and who should bear the cost? Are contractors really the party best able to take technical risk, as often thought?