The Chinese EPC Contractor in Power Generation: Strengths, Weaknesses, Risks and Rewards

Chudi C. Egbuna
Professional Mechanical Engineer at Parsons Brinckerhoff Africa (Pty) Ltd, Hobart Square, 23 Hobart Road, Bryanston, 2191, PO Box 41927, Craighall, 2024, Johannesburg, South Africa, Tel: +27-11-514-7200, EgbunaC@pbworld.com.

About the Author

Chudi Egbuna is a registered professional Mechanical Engineer with the Engineering Council of South Africa (ECSA). Chudi has experience in coal and gas fired power plants. His experience spans from Owners, Lenders and Technical advisory engineering services to providing comprehensive thermodynamic optimisation and analyses of cycles, sparing philosophies and complete heat mass balance diagrams as well as economic inputs for financial feasibilities. He is currently employed by Parson Brinckerhoff Africa and works in the Power Generation Division of the company.

The Chinese EPC Contractor in Power Generation: Strengths, Weaknesses, Risks and Rewards
1 Introduction
Chinese EPC contractors are seemingly becoming the Engineering Procurement and Construction Contractors (EPCCs) of choice in the power generation industry especially in Africa and the developing world. Working with Chinese EPCCs offers rewards as well as risks. Being able to manage effectively the associated risks of working with Chinese EPCCs could result in significant gains to project Owners. The following paragraphs define the global trends in the engineering services industry with respect to Chinese EPCCs and associated contract models in practice. The paper aims to provide an objective view of the Chinese EPCC, highlighting their capabilities that motivate decisions to work with them. It further provides evidence of their performance worldwide and then progresses to identify the specific risks while offering ideas for mitigation of the identified risks. This paper provides information in an attempt to improve the understanding of the Chinese EPCC, and perhaps tries to better equip Owners and Owners engineers alike who might be considering taking them on as partners or working with them on projects worldwide.

2 Popularity of the Chinese EPCC

Chinese engineering firms are consistently emerging in the global engineering services market. A description of their relative position within the global engineering services market (with particular emphasis on the EPC contract model) is important for a discussion on the Chinese EPCC. Engineering contracts define the terms under which engineering services are provided. Some engineering contract models include Engineering and Construction (EC), Engineering and Procurement (EP), Procurement and Construction (PC), Engineering Procurement and Supervision (EPS), Engineering Procurement and Construction Management (EPCM) and the Engineering Procurement and Construction (EPC) model. The EPC and EPCM contract models are the main contract models in common practice today in large construction projects. A brief overview of the EPC and EPCM contract models is given below. This overview provides the required reference within which Chinese EPCCs will be discussed.

2.1 Chinese EPC Contractors and the EPC Contract Model

The primary difference between EPC and EPCM is in the C for Construction in EPC and CM for Construction Management in EPCM. The EPC contractor is paid a lump sum price to deliver a complete facility, with all subcontracts under their name. Conversely, the EPCM contractor is an extension of the Owner, executing all contracts and procurement under the name of the Owner and being compensated on either a lump sum or reimbursable basis to perform engineering and management services (Agnitsch, Cooke & Solberg, 2001). Alternatively, an EPC contract is a design and construct contract where a single contractor takes responsibility for all elements of design, construction and procurement. In contrast, an EPCM contract is a professional services contract with a radically different risk allocation and different legal consequences (Loots & Henchie, 2007). The above definitions however subjective implicitly highlight the allocation of risk existing within the contract models. From the contractors view point, EPC contracts are inherently high risk, although also potentially high profit. Due to the associated risk and liability, few engineering firms are willing to execute large projects under the EPC contract model. Henchie (2008) states that recently, in response to market conditions and an improvement in the negotiating position of EPC contractors, there has been a significant increase in use of the EPCM contract module for international infrastructure and major construction works. The above statement suggests a shift from the EPC to the less risky EPCM contract model. Chinese EPCCs show a willingness to assume the risk profile required of the EPC contract, with significantly lower margins and contingencies built into their offers in contrast to their counterparts in Europe and the West. Arguably, this (approach) may be driven by a desire to break into the market or their ability to be more cost effective on processes and delivery than their competition.

Furthermore many engineering firms have started focusing on the more traditional Owners Engineering (OE) role where the risk and liability profile is considerably less burdensome with consequently less room for profit making. Original Equipment Manufacturers (OEMs) are arguably also migrating to the EPS contract model rather than EPC contract model, where they are only responsible for supervision of the construction of their supplied equipment and do not have to deal with the added burden of managing subcontracts outside of the OEM facility being supplied. These trends have as a result created an engineering market with only a few engineering firms willing and capable of executing large projects under the EPC contract model. This in turn has led to and promoted the growth of the Chinese EPC contractors who are not afraid to take on the added risk. The following basic schematics depict typical EPC and EPCM contract models as discussed above and indicate the relative risk of each role.

High Risk OE Owner Low Risk Contractual relationship EPC Functional relationship

Subcontractor

Subcontractor

Subcontractor

Figure 1: The EPC contract model and indicative risk

High Risk EPCM Owner Low Risk Contractual relationship Functional relationship

Subcontractor

Subcontractor

Subcontractor

Figure 2: The EPCM contract model and indicative risk

Chinese EPCCs have positioned themselves in the engineering market so as to become attractive to Owners who typically want less risk while maintaining project quality and relatively lower overall project cost. Lenders also generally favor one point of contact (the EPC contractor) instead of multiple contact points (EPCM, Designers, Suppliers, Construction contractors, etc) where scope is less well defined and delays by one contractor tend to affect others. In summary, the predictability of a lump sum pricing structure provided by an EPC contract model lowers risk and appeals to financiers. Figure 2 shows the EPCM contract model in contrast to the EPC model. While most EPC contractors can perform OE and EPCM roles, the subject of this paper is the EPC model where Chinese EPC contractors seem to be flourishing.

2.2 Strengths and Attractiveness of Chinese EPC Contractors

Some characteristic strengths for which the typical Chinese EPCC has gained recognition are: Aggressive pricing and willingness to provide attractive commercial terms such as construction bridging loans; Ability to commit to aggressive project schedules; Willingness to adopt international codes and standards; and Their ability to mobilize Chinese construction labor to site. The above mentioned strengths have promoted the popularity of the Chinese EPCC for large power development projects in Africa and in the developing world, particularly where project budgets or other financial constraints exist, and where aggressive project schedules are required.

2.3 Chinese EPC Contractor Presence Globally

China has been the fastest growing economy in the world over almost three decades (Nicholas, 2007). Along with its economic growth comes a need for energy and better technology to aid its growth for which it is becoming renowned. In 2010, Chinas installed capacity climbed to over 900,000 megawatts. Chinas expertise in power generation and power generation equipment is as such improving with resulting successful exports to the Americas, Canada, Bangladesh, India, Indonesia, Iran, Iraq, Vietnam, and more than twenty countries and regions. In Africa, China Eximbank concessional and non-concessional loans for infrastructural development, excluding projects in the petroleum and mining sectors, were US$12.5bn, as reported by the World Bank. Angola, Nigeria, Mozambique, Sudan and Zimbabwe account for over 80 per cent of these loans, and the power sector makes up about 40 per cent of total commitments (Isaac & James, 2007). This fact further highlights point one of section 2.2 above. Shanghai Electric Corporation (SEC), Harbin Power Equipment Company Limited (HE) and Dongfang Electric Company are the 3 biggest state owned enterprises in China (Parson Brinckerhoff Regional Offices, 2010). These enterprises have their core business in manufacturing power generation equipment and are competing successfully in the global power generation sector. Their footprint within Africa and developing world demonstrates this success.

3 Chinese EPCC Risk Mitigation

Having identified their strengths, Chinese EPCCs also have weaknesses. These weaknesses present themselves as risks to project owners. With these risks mitigated, significant rewards can be achieved by working with Chinese EPCCs. As highlighted above, a certain amount of additional risk is inherently taken on by an Owner when employing the services of Chinese EPCCs outside China. These risks generally are related to the modus operandi of the Chinese EPCCs. The challenges experienced by Chinese EPCCs outside China are typically cascaded onto the Owner, manifesting in the form of risks during project implementation. For the purpose of this paper, these risks have been broadly classified as: Communication Technology Quality control, Health and Safety Codes and Standards

Table 1: Chinese EPCC Challenges and Associated Owner Type Risks Table 1 below presents the challenges faced by Chinese EPCCs. The table also provides a categorization of the mentioned challenges as a function of the associated risks class which an Owner may be exposed to.

Table 1: Chinese EPCC Challenges and Associated Owner Type Risks

S/No. 1. 2. 3. 4. 5. 6. 7. 8.

Chinese EPC Challenges Poor English communication skills The need to cross reference indigenous standards against international standards (e.g. GB - Chinese against international standards) Inadequate quality control and assurance processes and procedures Poor quality of knowledge transfer such as Operation and Maintenance (O&M) Manuals and Training during project handover Inadequate or non-compliant health and safety measures, and Poor Safety, Health, Environment performance Inability to properly manage interfaces with local construction contractors and applicable local authorities Bids offering technologies without proven track records Difficulty in securing entry and work permits for Chinese construction labor.

Associated Risk Class Communication Codes and Standards Quality Management - Quality Assurance/Quality Control (QA/QC) Quality Management (QA/QC) Health, Safety and Environment Communication Technology Communication

The following sections describe the risks in general terms and proffer measures towards mitigating the risks likely to be encountered by Owners when working with Chinese EPCCs.

3.1 Communication
3.1.1 English Language Barrier The inability of Chinese EPCCs to effectively communicate in English usually puts them at a disadvantage when competing internationally English being the universal business language. The poor English communication skill prevalent in most Chinese EPC contractor organizations is a significant problem which requires proper attention at all phases of a project. Right from contract negotiation and award to financial closure and during project execution, effective communication is important if delays are to be avoided. All these pose significant concerns for the Owner and the Owners Engineer. Chinese communicate less directly and less explicitly, often relying on gestures, facial expressions, eye messages, and other non-verbal signals (Engholm, 1994). It is advisable when dealing with Chinese EPCCs that communication is given the utmost priority and that proper investment in communication channels and processes is made. In most cases, using a translator proficient in technical issues during discussions will help. For most Chinese EPCCs, the design office is located in the home country (China) while the project office will be located in the project host country. In such cases, it is most beneficial to have project coordinators on both the EPCC and Owner teams proficient in English and the indigenous language of the EPC (Mandarin or Cantonese as the case may be) and well-versed in the technical aspects of the project as well as conversant with project teams on either side (Owner/OE and EPC project teams) to facilitate communication between the teams and offices during all phases of the project. This is especially important during the construction phase where the field team will be less knowledgeable of English. The specific number of persons with such designation will of course be dependent on the size and complexity of the project. Whatever the case, the presence of such persons streamlines the flow of communication between the Owner/Owners engineer, the field and project teams and the design office in China during the course of the project. 3.1.2 Understanding the Culture: The hierarchical culture of Far Eastern (FE) countries is reflected in the work environments of FE organizations and firms. The chain of command, seniority and responsibility are important factors when communicating with Chinese EPCCs. Experience with Chinese EPCCs has shown that a large number of project staff is usually involved in technical discussions and meetings, with only a hand full of them having the actual power or discretion to make decisions.

In some instances, the oldest (age wise) are the true power brokers regardless of title, rank or position. Certain mannerisms, gestures and in some cases even arguments are some cultural peculiarities that may be encountered. While it is possible to learn and adapt to the cultural situation during the course of the project, Identifying the prevailing cultural posture of the EPC contractor through a proper due diligence activity and planning puts the Owner in a better position to quickly address issues arising from culture. 3.1.3 Project Management Chinese EPCCs operating outside their element (in countries foreign to them) encounter significant challenges in project management. These challenges manifest as problems for the Owner in the form of project delays and schedule slip. As identified in

Table 1, Chinese EPCCs face challenges when trying to manage interfaces with local construction contractors and the applicable local authorities. This often leads to their inability to provide adequate and efficient project management, cost and schedule control as well as risk management. On the African continent, the norm most often is that the project host country insists on the use of local labor as much as possible. The degree to which this will be possible will depend mainly on the amount of skilled and unskilled labor required by the project that can be sourced locally as well as the ability of the Chinese EPC to secure the required permits for foreign construction labor. Ultimately a mixed labor force comprising local workers and workers brought in from China will be deployed during project execution. Managing this mixed labor force is a challenge and requires proper communication throughout the labor force. The inability of the Chinese EPC to effectively communicate through and between ranks in the labor force puts them at a disadvantage and results in problems which propagate to the Owner. In order to mitigate the risk associated with the inability of Chinese EPCCs to effectively manage the project, it is imperative that the Owner with the help of the Owners engineer be involved with the signing off of all key appointments to the project management team on the EPC side. Key appointees in addition to pertinent skills related to their roles must be capable of the necessary skills relating to communication, organization and liaising with local authorities. In terms of communication, it is important that the key appointees understand the cultures (work and otherwise) of both the project host country and China. Having a project management team with these important characteristics on the EPC team as well as on the Owners team should go a long way in streamlining the challenges that come with a multicultural work force.

3.2 Technology
The reliability of implemented technologies plays an important role in the success of any project. From an Owners perspective, the project specification included with the Invitation to Tender (ITT) should clearly identify the required reliability on all technologies or equipment to be offered by EPCCs. Where Chinese EPCCs are capable of offering the required reliability (or proven technology or equipment) as well as meeting the balance of specification requirements at attractive overall project costs, it becomes easier for the Owner to decide amongst bids. However, where unproven technologies or equipment are offered the following could be requested by the Owner or offered by the EPC to mitigate the risk associated with unproven technology or equipment: additional performance testing extended guarantees liquidated damages in the event of equipment failure additional spare parts On-call technical expertise

In many cases, the Chinese EPCC may include the above without the formal request from the Owner in the Invitation to Tender (ITT) Documents, in order to make their offer more attractive/competitive. The Chinese EPCCs 6

may also offer bridging loans. The risks in the project are as such spread between the Owner and the Chinese EPC, generally making the EPC offer more attractive to the Owner. Typically, it is the responsibility of the Owners engineers to ensure that the Owner is well aware of the risks of unproven technologies. Regardless of the technical and financial completeness and competitiveness of the bids, the Owner through the Owners engineers should be required to perform the necessary risk and financial analysis to ascertain the true worth of the EPC bids.

3.3 Codes and Standards

Experience with Chinese EPCCs showed that their designs are most often based on their indigenous codes and standards, such as the GB (Chinese) standards. In some cases Chinese EPCCs utilize Chinese OEMs with licenses to technologies originating in Europe and the West. Where the technology is reproduced and vetted by European or Western OEMs, the original technology standards are inherited. In other cases, modifications are made to imported technologies with a resulting combination of international and indigenous standards applicable to the equipment. When Chinese OEM equipment are supplied to countries outside China, It becomes necessary to compare their imported codes and standards against internationally accepted codes and standards such as ASME, BS, ANSI, etc. in order to validate their applicability to the particular situation. Similarly where the project host country has defined codes and standards on any project subject, and these standards supersede the relevant international codes and standards, it will be necessary to validate the applicability of the Chinese OEM codes and standards against the local codes and standards. Typically, a list of codes and standards is provided by the EPC during contract negotiations which would be the guiding codes and standards to which their design offer complies. The Owner on the other hand via the Owners engineer in turn provides the required codes and standards to which the Chinese EPCC offer must comply. The Owners list would normally be compliant with the project host country and/or international codes and standards. It may become necessary for the Owners engineer to safeguard the Owner by ensuring compliance of the engaged Chinese EPCCs codes and standards with the project specific codes and standards through a process of validation. It should be noted that this validation process does not absolve the Chinese EPCC from any liability arising from the finally agreed upon and implemented codes and standards but rather serves to streamline the design review process. In most projects where international finance is required, international standards such as World Bank (WB) and International Finance Corporation (IFC) standards have to be complied with in order for financing to be secured. Most often WB and IFC standards do not constitute a problem and can be easily met by Chinese EPCCs. Project codes and standards compliance is not a trivial subject and must be given due consideration by an Owner when employing the services of Chinese EPCCs. As a pre-requisite, a due diligence will have to be performed on the Chinese EPC to ensure that they can comply with any changes and/or additions to their offered codes and standards.

3.4 Quality Management (QA/QC)

China is known to have quality issues with respect to manufacturing. Unfortunately, changes to the quality management systems of Chinese firms is difficult because it often requires not just a change of techniques, but also a change of corporate cultures, systems and practices (Pun, 2001). Quality management as such remains an area which is a major concern when dealing with Chinese EPCCs. The quality management reputation of Chinese EPCCs is generally improving with time. This statement is borne out by the fact that Chinese power stations and related technology continue to attain maturity, and may be judged to be progressively more proven, with the passage of time. These continuous improvements notwithstanding, Chinese EPCC continue to experience shortcomings with performance of effective quality assurance and control. Experience has shown in some cases that while the required performance test may have been carried out correctly, improper or inadequate monitoring and results evaluation most often invalidate the performance tests. As the Owner of a project, this is a major issue if quality is to be ascertained.

Proper documentation of processes and activities is essential in all engineering projects. In power generation projects, the successful validation of plant performance as well as operation of the plant is very dependent on the availability of complete and accurate documentation and knowledge transfer in the form of O&M manuals and training and general information management. The quality of O&M Manuals and training are most often affected by poor communication. Translation inconsistencies from OEM language to English; less emphasis on quality of documentation by the EPCC as it is the last few documents being provided; differing training methods and language amongst nationalities (EPCC instructors and O&M staff), etc. are a few other reasons for poor quality O&M manuals and training. For such challenges to be remedied, QA/QC procedures should include requirements for all translations (O&M manuals) to be up to the required certified technical standard. Similarly, training processes should be audited to ensure complete and correct knowledge transfer. In terms of plant operation from a document control point of view, it is expected that all documentation (manuals) from the EPCC should be handed over to the Owner/Operator during the early stages of the defects and liabilities period. Improper and incomplete documentation often leads to ill trained operators or an inability of the operators to effectively resolve problems when they occur. In order to have complete documentation during operation, proper information management systems (document control) should be implemented from preliminary design through to the detailed design phases, to the end of commissioning prior to the defects and liabilities period. Some Chinese EPCCs have very poor quality control and assurance systems for document control, which adversely affects the quality of documents (drawings, memos, emails, etc) that are transmitted during the course of projects. In many instances the documents will be badly worded and will require significantly more time to understand. For the Owner, this means more review cycles and hours required by the OE to approve design documents. Even when translators are used, most processes are drawn out due to ineffective communication between the parties involved. Generally, more effort is required to ensure that all documentation is in a presentable, useable and complete format. Ideally a QA/QC plan covering all the issues mentioned above should be submitted by the Chinese EPC as part of the bid and reviewed by the OE to ensure completeness in the early phases of the project. It is to the Owners advantage if this plan is closely monitored and implemented throughout project implementation. Ensuring that the QA/QC plan is monitored and implemented can be achieved by insisting that the EPCC use an internationally recognized 3rd Party for the complete range of QA/QC management.

3.5 Health, Safety and Environmental Issues

The constantly growing and varied workforce in China makes it difficult to have effective health and safety regulations and labor practices. The International Labor Organization (ILO) estimates that Chinas 2001 workplace fatality rate was 11.1 per 100,000 workers, compared with a rate of 4.4 per 100,000 in the United States (Garrett & Dara, 2003). China has strengthened their national OSH system (ILO, 2011), however, experience shows that the performance of Chinese EPCCs in terms of occupational health and safety is poor. Unfortunately, this poor performance in health and safety is often carried over by the EPCCs to projects outside of China. In order for the Owner of any project to safe guard against issues arising from poor health and safety conditions, it is imperative that when engaging Chinese EPCCs, the tender specification demands the submission of a Health Safety and Environment (HSE) plan. The HSE plan of course is required to be compliant with the Operation Health and Safety Acts and legislations of the project host country. In addition to this, constant monitoring and evaluation of the Chinese EPCCs HSE practices should be performed to ensure that they comply with their outlined plan. Working and site conditions is an aspect during construction which should be monitored closely. As discussed above the Owner/Owners engineer should continuously enforce the HSE plan when working with Chinese EPCCs and as with every construction project, constant training and educating of the work force must be performed and maintained to minimize related HSE risks. Another health and safety issue which may arise when engaging Chinese EPCCs is the living conditions of the foreign labor. As mentioned in section 3.1.3 Chinese EPCCs often bring along with them their own construction labor force. In order to ensure that the working and living conditions are conducive to best HSE practices, it is

common practice to provide a living camp on site where the foreign labor force can reside while working. This has a twofold advantage of keeping the foreign labor separate from local labor (i.e. in order to prevent conflict arising from cultural differences) as well as providing a place of their own (foreign labor) in which they can exist with common lifestyles representative of their home country, especially for the extended project durations characteristic of power plants.

4 Conclusion
While this paper addresses typical risks and mitigations associated with Chinese EPCCs, other risks exist which are not peculiar to the Chinese EPCCs alone and which should be addressed if projects are to succeed. Hence, risk assessment and mitigation are activities which should be performed continuously through the life of a project, from the project feasibility and conceptualization phases, through to operation and maintenance and decommissioning. In conclusion, Chinese EPCCs are yet to be as popular but are quickly gain experience on their counterparts in the West and Europe. There is reward that can be obtained from working with them but these come along with risks. These risks if managed properly can be translated to successful and rewarding projects. It should be emphasized that the status quo existing in the engineering services delivery environment is evolving; especially in the power generation industry. It can be expected that as soon as Chinese EPCCs can compete on the same level playing field and with the same level of expertise and experience of their counterparts in the West and Europe, things are likely to change and they (Chinese EPCCs) will be less willing to offer competitive prices as they do currently or acquiesce to the demands of Owners. It is hoped that the information herein has provided some insight to the Chinese EPCC to aid in making decisions when working with them.

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