Critical Path

April 2012

Contacts

Welcome to the April 2012 edition of Critical Path

Editor: James Morgan-Payler

In this edition we look at:

  • Dealing with costs resulting from the carbon pricing mechanism in construction contracts;
  • Responses to the global liquidity problem for infrastructure projects;
  • New case law regarding stays of execution in relation to the payment of a judgment debt obtained under security of payment legislation: Silver Star Construction Pty Limited t/as Genesis Construction Australia v Denham Constructions Pty Limited
  • Improving PPP tender processes and procurement;
  • The road ahead for energy infrastructure development: the Draft Energy White Paper; and
  • Early contractor involvement in preliminary design process.

We hope you find these articles interesting and informative. If you have any questions regarding their content, please feel free to contact us.

Dealing with costs resulting from the carbon pricing mechanism in construction contracts

By Lucy Campbell

At the end of 2011, the federal government’s clean energy future plan was passed into law. The plan, which introduces a carbon pricing mechanism and a number of other clean energy reforms, will have particular implications for the construction industry. Many industry members have been reviewing their financial exposure to the carbon pricing mechanism (Mechanism) since its announcement last year and taking steps to ensure contracts properly deal with the risks identified. Given that the Mechanism kicks into operation on 1 July 2012, it is timely for industry members to again review contracts on foot as well as tenders going forward, to ensure that they have appropriately provided for the impact of the Mechanism.

We have previously summarised what the Mechanism means for the construction industry in our legal update, The carbon pricing mechanism: an industry focus. In this update we highlight contractual regimes for allocating the risk of price variations as a consequence of the Mechanism, with particular attention to what reviews parties should be conducting of contracts for projects already underway and what steps can be taken going forward.

It is obviously essential that parties understand what costs are likely to be passed on to them if they are going to properly minimise their exposure. Although the construction industry will not typically be emitting carbon pollution, and therefore will not be directly liable for reducing emissions or purchasing carbon permits, it will incur increased costs passed down from direct emitters, such as through the purchase of carbon-intensive materials, like steel, cement and aluminium, and increased electricity and fuel costs. The federal government has introduced some schemes to provide assistance to direct emitters, such as the Steel Transformation Plan and Jobs and Competitiveness Program, and consequently some price increases may not be as great as anticipated.

It is also important to understand the mechanism to ensure downstream price increases are accurate. Forecasting indicates that increases in construction and building industry costs due to the Mechanism may be less than 1%, however this is likely to incrementally increases year on year once the government assistance schemes end and the carbon price shifts from fixed to floating.

Contracts

There are three key ways in which the impact of the clean energy future plan may be managed contractually:

  • Pricing structure.
  • Change in law or tax clauses.
  • Specific Mechanism provisions.

Pricing structure

There are a variety of payment structures used in the construction industry, including cost plus, lump sum or schedule of rates (or a combination of them). The payment structure used, and more particularly the means for determining the contract sum, may allow the contractor to pass on price increases resulting from the Mechanism.

For example, under a cost plus contract the contractor is essentially reimbursed for all costs it incurs in performing the work, plus a margin to cover its overheads and profit. Consequently, the contractor is able to pass on any increased costs it incurs as a result of the Mechanism under a cost plus contract. Under this contract structure, it is the principal, and not the contractor, who will be exposed to price increases. Principals who have incorporated a guaranteed maximum price may be able to limit these increases to an extent, in which case the risk of increased prices due to the Mechanism will fall back to the contractor. Where a cost plus contract is subject to a guaranteed maximum price, contractors should ensure that all anticipated price increases are sufficiently provided within the limit of the guaranteed maximum price or that there is an appropriate mechanism by which the guaranteed maximum price can be adjusted for price variations as a result of the Mechanism.

Lump sum and schedule of rates contracts offer less flexibility in price variations than a cost plus structure and generally result in the contractor bearing the risk of managing any price increases. The contract sum under a lump sum or schedule of rates contract will be in effect fixed and will not be increased as a result of the Mechanism, unless specifically provided for in the terms of the contract (see ‘Change in law or tax clauses’ and ‘Specific carbon pricing clauses’ sections below). Similarly, a contractor will bear the risk of price increases resulting from the Mechanism under contracts for domestic building works, as statute significantly restricts the instances where cost escalation is allowed in domestic building contracts.

Change in law or tax clauses

Most contracts contain a regime specifically allowing for price increases where there is a change in law or change in tax. Although the Mechanism is not strictly a ‘tax’, many change in tax clauses are drafted to include government imposts and levies more generally, which would consequently include the Mechanism. 

  • The introduction of the Mechanism appears on its face to be a change in law, however the drafting of many change in law clauses can severely restrict an entitlement to claim for price variations due to the Mechanism. Close attention needs to be paid to how the change in law clause has been drafted in order to ascertain whether there is an entitlement to claim for price increases resulting from the introduction of the Mechanism. Key obligations to look out for include:
  • Notification: in most instances the contractor is required to provide notification to the principal within a certain period. This time bar may run from the actual change in law or an impending change in law – the latter is of significance as the clean energy legislation package was introduced into the House of Representatives in September 2011 and assented to in November 2011.
  • Foreseeability: some change in law regimes incorporate a test of whether a reasonable contractor, performing the same type of work as the contractor, would have foreseen the change in law. Even if the notification requirements are from the actual change in law, a contractor may be caught out by this requirement given the announcement of the Mechanism in the middle of last year.
  • Extra work: an entitlement to claim increased costs resulting from the change in law may, in some instances, only arise where the contractor has had to perform extra work as a result of the change in law, in this instance the Mechanism. Consequently, where it is simply the cost of materials required for the original work that increases, the contractor may not be entitled to a similar increase in the contract sum, given that no additional work has been required to be performed as a result of the Mechanism.
  • Direct costs: a contractor may only have an entitlement to claim the direct costs it incurs as a result of the change in law. As mentioned above, the construction industry will principally contribute to carbon emissions indirectly and therefore is unlikely to have any direct obligations under the Mechanism. An example of a direct cost under the Mechanism is the price paid for a carbon permit. The increased price of cement or aluminium is unlikely to be a direct cost as it is a consequence of the Mechanism.
  • One-off cost: a change in law regime typically allows for a one-off payment due to the change in law. The effects of the Mechanism will be ongoing and this will be particularly felt after 2015 when the price for permits is no longer fixed. The contract may not allow for multiple claims. Contractors making a claim under the contract for compensation due to a change in law will need to be careful that such claims are without prejudice to any future claims they may need to make with respect to price increases resulting from the Mechanism.

Specific Mechanism provisions

Some contracts may include provisions specifically dealing with the Mechanism and allocating the risk of any price increases resulting from the Mechanism to the relevant party. Notwithstanding that the Mechanism is not yet operative, parties should already be preparing for the shift from a fixed price for permits to a floating price with a set floor and ceiling. That is, industry members should not only be preparing for the introduction of the Mechanism on 1 July 2012 but also the change from a fixed price per permit to a floating price on 1 July 2015. After 1 July 2015, the price for carbon permits will be determined by the demand for permits under a cap and trade scheme. Although the Government will implement a price floor and ceiling on this floating price, parties will have no real control over the price of permits. Given that after 1 July 2012 entitlements under change in law or tax regimes will be of no relevance, we expect to see a greater use of specific Mechanism provisions in contracts as parties desire greater control over any price increases resulting from the Mechanism.

Going forward

Industry members need to be prepared for both the introduction of the Mechanism on 1 July 2012 and the shift from a fixed to a floating permit price on 1 July 2015. This will require that parties:

  • Understand cost-exposure to the Mechanism and continue to implement measures to mitigate any adverse consequences.
  • Review contracts for projects currently on foot with respect to whether there is an entitlement to pass on any price variations due to the Mechanism and if so what conditions precedent need to be satisfied, particularly in regard to notification requirements.
  • Check whether tenders in the lead up to the Mechanism and contracts entered into after 1 July 2012 expressly state that there is an entitlement for price increases due to the Mechanism, and if so ensure the contractual regime is appropriate.
  • If contracts going forward do not allow for any price increases due to the Mechanism, ensure that any anticipated price increases are appropriately included in the contract sum, being mindful that price increases should not be incurred prior to the Mechanism commences on 1 July 2012.

For contracts involving work being undertaken after 1 July 2015, consider whether an appropriate contractual regime for dealing with increased costs and savings due to the floating price of permits should be included.

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Infrastructure update: Responses to the global liquidity problem for infrastructure projects

By Nicole Whitby and Grace McGuiness

The impacts of the 2008/2009 credit crunch are being felt again with a lack of liquidity in the banking sector and renewed economic uncertainty keeping the cost of finance high. In this article we provide a snapshot of the steps being taken in a number of countries to combat the difficulties in obtaining project finance.

Current alternative financing model

One of the Australian responses has been a supported debt model which allows government funding to substitute more costly private finance. The private sector provides all financing for the project (both debt and equity) during the high risk construction phase. The public sector then steps in at the less risky operational phase to provide around 70% of the funding. However, a recent trend has been for public sector contributions to flow even earlier in the project lifecycle, during the construction phase decreasing risk for the private sector.

Financing alternatives

The Infrastructure Finance Working Group, an expert advisory panel to Infrastructure Australia, in its paper, "Infrastructure Finance Reform"1 identified the following six methods for maximising the pool of capital available for financing infrastructure investment:

  • greater investment by superannuation funds;
  • the creation of an infrastructure bond market;
  • the establishment of an infrastructure bank;
  • public sector provision of senior debt;
  • sale of brownfield assets; and
  • provision of insurance against demand.

While the path Australia will take remains to be seen, a number of these initiatives have been, or are in the process of being, implemented by governments around the world as discussed below.

What are other countries doing?

United Kingdom

The UK Government recently released its 2011 National Infrastructure Plan 2 (NIP 2), which targets £20 billion in investment through a range of initiatives including pension funds and cooperation with the Chinese government (through the Chinese Investment Corporation). Details of how the investment by pension funds will be structured are not yet available. 

Canada

Canada has been the leading proponent of the unwrapped bond (bonds that do not have the benefit of a guarantee standing behind them and are instead rated on the project itself) financing model. There has been some discussion of exporting the model into other markets, such as Australia and the UK. However, the biggest hurdle in doing so is investor confidence in markets that are unfamiliar with the model and do not have the risk appetite for unwrapped bonds.

The Netherlands

The Dutch Government has made plans to encourage pension funds to invest in PPP project debt by offering inflation indexing for debt financing and the fees that will service it.

Initial debt financing is to be provided by banks and up to 70% of the debt is to be refinanced by pension funds post-construction. The approach is win-win with the banks provided with a guaranteed short-term exit strategy and pension funds avoiding the construction and inflation risk.

The above is intended as a brief overview of global financing responses only. For more information please see the January edition of Norton Rose LLP’s “Infrastructure Updater” and a local version of that article by James Morgan-Payler, Sefton Warner and Paul Mansouri published in the March edition of the Australian British Chamber of Commerce Quarterly magazine, The Chamber.

1Published in July 2011

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Case summary: Silver Star Construction Pty Limited t/as Genesis Construction Australia v Denham Constructions Pty Limited

By Andrew Hopkins

In a recent unreported judgement of the New South Wales District Court, it was confirmed that a Principal that owes money to a Contractor arising under the Building and Construction Industry Security of Payment Act 1999 (NSW) (the SOP Act) can not attempt to defeat the purposes of the Act and delay payment of the monies owed by requesting a stay of execution because of the commencement of a cross claim.

In Silver Star Construction Pty Limited t/as Genesis Construction Australia v Denham Constructions Pty Limited (unreported, District Court of NSW, Olsson SC DCJ, 25 November 2011), Silver Star (the Contractor) made four payment claims for work carried out at two projects in NSW. Denham (the Principal) either did not serve, or did not serve in time the payment schedules required by the SOP Act. A statutory debt arose and Denham became liable to Silver Star for the whole amount claimed, being a total of $295,811.69 which was awarded at previous judgement.

Denham then commenced proceedings in the NSW District Court against Silver Star, alleging breaches and defaults in the performance of work for each project. Silver Star defended the proceedings. Denham sought a stay of the previous judgements pending determination of the principal proceedings.

In deciding whether to exercise the power and general discretion of the Court to grant a stay of the proceedings, the Judge looked at several issues, particularly:

  • the intention of the SOP Act to ensure prompt payment of payment claims;
  • the ability of the Principal to ‘claw back’ payment claims from the Contractor in subsequent proceedings; and
  • the effect of non-payment of the payment claims on the Contractor’s solvency.

Intention of the SOP Act

The Court re-iterated that the underlying intention of the SOP Act is for a claimant to receive a prompt interim decision on a disputed payment and to either be paid that payment or have it secured and set aside. It was held that seeking a stay of execution to prevent this process would not be available except in instances where it was most likely the contractor would be unable to repay any of these payments because of insolvency.

‘Claw back’ of progress payments

Of paramount importance in considering the necessity for a stay is the impecuniosity of the claimant, and therefore, the ability of the respondent to ‘claw back’ the payment in the event that it succeeds in the resolution of a contractual dispute. This was a necessary consideration to “prevent injustice” because of the inability to ‘claw back’ these amounts.

The effect on the Contractor of non-payment

The Court discussed Silver Star’s financial statements to determine the effect that non-payment would have on the business. Whilst Silver Star had little in the way of tangible assets, it had secured preferred tenderer status on several projects that were yet to begin. The Court found that by granting a stay of execution in the enforcement of its statutory debt for the progress claims, it would place Silver Star in a precarious financial position. Further, Silver Star was not deemed to be at sufficient risk of insolvency to warrant the grant of the stay.

The Court dismissed the application for the stay of execution, making it clear that a Court will not grant a stay where it interferes with the intention of the SOP Act (or similar inter-state legislation). Similarly, where a contractor relies on the payment claims to remain in business, and where there is no pending insolvency, the Court will refuse to grant a stay of execution.

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Improving PPP tender processes and procurement

By Luke van Grieken and James Morgan-Payler

Introduction

Recently, there has been much media coverage and public comment on the problems facing distressed Australian PPP projects, including the delays to the Victorian Desalination Plant project and the economic strife facing many road PPPs in the eastern states. 

The spotlight on PPP projects has also brought into question the efficiency and efficacy of the PPP procurement process itself. In particular, the private sector has commented on the increasing costs of bidding on PPP projects. Further, in our experience, PPP tender processes in Australia are becoming more complex and often fall behind the target procurement timelines. 

In this article, we outline how PPP tender processes typically work and some common problems with those processes. We also suggest a number of possible ways to improve PPP tender processes and the PPP model generally given the current economic climate.

How do PPP tender processes usually work?

Expressions of interest (EOI) phase

In this first phase of the formal tender process, the government advises the market about the project, the procurement process and timelines and seeks to confirm the level of interest of the market and other market feedback. Bidders submit EOIs in response to the government’s Request for EOIs. The project team then evaluates the bidders and shortlists those most capable of meeting the project objectives. In recent Australian health and transport PPPs, EOI phases have averaged approximately 5 months1.

Request for proposals (RFP) phase

The government will next issue the RFP documentation to the shortlisted bidders, which will include the government’s output and technical specifications and the commercial and contractual frameworks for the project. The shortlisted bidders will then submit their proposals, usually within 6 months after the RFP was issued. The project team will evaluate the proposals against specified evaluation criteria and carry out a question and answer phase and an interactive tendering process (depending on the jurisdiction). The RFP phase concludes when the government announces its preferred bidder. On recent PPPs, this phase has taken between 8 and 10 months in total.2

Negotiation and completion phase

Typically, following selection of the preferred bidder, the negotiations between the parties commence in earnest. During this phase, all outstanding design, legal, commercial and financing issues are finalised, followed by execution of the contracts and financial close. The length of this phase can depend on resolving financiers’ unresolved issues, but is generally around 3 months.3

What are the problems with the current PPP tender processes?

Common criticisms of PPP tender processes are that they are too long, too expensive and too complicated. On some projects, there have also been concerns about a lack of genuine dialogue and flexibility due to strict probity requirements.

Tender processes take too long

In Australia, the average time from EOI to financial close for social infrastructure PPP projects is in the order of 14 to 19 months, with health projects at the higher end, and 18 months for transport infrastructure projects4. This is less that the average procurement timelines in the UK, but longer than in Canada, which has reduced average procurement times from 18 months to 16 months5.

However, in our experience, the procurement time for some very recent PPPs has been far greater than these averages, and key procurement milestones are often not kept. For example, the Victorian Comprehensive Cancer Centre PPP Project took over 25 months to reach financial close in December 2011 after release of the Request for EOIs in November 2009. The government had originally intended to reach financial close by the second quarter of 2011. The delay was partly due to the extension of the RFP phase by 6 months to include a “best and final offer” (BAFO) phase. In addition, unusually, a relatively lengthy “exclusive negotiation phase” preceded the official announcement of the preferred proponent. This is contrasted with the procurement time of a recent Canadian PPP, the Humber River Regional Hospital, in which the EOI phase was 5 months and the RFP phase was 7 months, leading to financial close in September 2011, a total of only 16 months.

Bid costs are too high

Private sector PPP participants have also frequently commented on the relatively high cost of bidding for Australia PPP projects6. KPMG has estimated that average bid costs in Australia are 1% to 2% for winning bidders, and 0.8% to 1.2% for losing bidders7. Bid costs are comparatively lower in Canada, being about 0.5% to 1% for winners and 0.35% to 1% for losers, but are higher in the UK8. It is our experience that that design costs comprise a majority of the bid costs, followed by due diligence, legal, financial and other costs. Whilst long procurement processes are expensive, other key reasons for high bid costs include excessive documentation and information requirements during all phases, inconsistent tender documentation and inefficient and protracted government evaluation and decision making processes. It follows that total transaction costs for government are also very high.

PPP procurement is too complex

In our view, the Australian PPP procurement model is perceived to be more complex than in other jurisdictions. This, as well as the high bid costs, is a key disincentive for new entrants, including international entities. Some complexity is due to the Australian focus on design quality, innovation and a tendency for Australian PPPs projects to be much larger than in other countries. In our view, unnecessary complexity also arises from the level of detailed design documentation, operational plans and commercial information required to be provided by all bidding consortia and the exhaustive requirements for the legal documentation and departures schedules.

Lack of dialogue and flexibility due to probity concerns

Since the introduction of Partnerships Victoria’s Interactive Tender Process (ITP) guidelines in 2005, we have seen much greater fruitful interaction between the government’s project teams and the shortlisted bidders. In our experience, the market views ITPs very favourably in Australia as it does in Canada. However, ITPs are used inconsistently across projects and states and with varying levels of success, largely depending on the skills and experience of the project teams. In particular, private sector participants have felt that on some projects, the probity rules were allowed to dominate, resulting in the project team being denied contact with the prospective client9. Similarly, some participants have commented that the terms of the Probity and Process Deed required to be signed by respondents are too onerous and inflexible.

Ways to improve PPP tender processes

In our view, Australian governments should modify their PPP procurement processes to overcome the above problems, in ways which lead to greater market confidence and engagement and ultimately provide better value for money for taxpayers.

To achieve this, governments could look at some of the successful strategies used in other jurisdictions, particularly Canada. At a high level, the strategies used overseas include10:

  • disciplined adherence to procurement schedules;
  • commitment to an outside date to reach financial close (with penalties and remedies as applicable for failure to abide by the timeframe);
  • less focus on design, particularly architectural design;
  • less information and less design development required within bids;
  • greater standardisation of contracts, with contracts being rolled forward to subsequent projects without substantive amendment;
  • less use of further bid stages;
  • use of a two-staged evaluation procurement process (i.e. technical evaluation, followed by financial evaluation);
  • earlier selection of preferred bidder coupled with more reliance on the preferred bidder developing its proposal;
  • common procurement of information requirements (such as geotechnical surveys) on behalf of all bidders;
  • greater disclosure of public sector comparator (PSC) to bidders in order to enhance transparency and understanding of the expectations; and
  • government contributions to bid costs of all bidders, or payment of an honorarium by the successful bidder to the losing bidders towards their bid costs.

Some of these strategies may not be appropriate in the Australian market, given the different drivers and approaches taken by governments here (especially in respect of design development and evaluation). However, in our view it is important for governments to give stronger commitments to procurement schedules and adopt other measures to reduce tender process times and bid costs.

For example, we suggest that wherever possible, the governments should avoid any further stages such as BAFOs. In our experience, additional stages can add significant time, cost and complexity and frustrate the public and private sector participants. They may also result in bidders taking a strategic view not to put their best foot forward at the RFP stage. We consider that BAFOs could be avoided by better genuine dialogue with shortlisted bidders about the government’s technical and operational requirements and greater disclosure to bidders of the PSC, including the risk-adjusted PSC.

Governments should consider reducing the amount of information required in competitive bids, to only require certain information from the preferred bidder. There may be limited benefit to the government in conducting a lengthy evaluation and clarification process in respect of all detailed design and service requirements with two or more bidders. To speed up the process, the issues which have no price or time impact should be left for discussion with the preferred bidder only.

Finally, we note that a common thread to feedback from private sector PPP participants is that the skills, experience and confidence of the government’s project team is critical to the efficiency and timeliness of the procurement process, especially the ITPs. This very issue was the subject of the Victorian Parliamentary “Inquiry into Effective Decision Making for the Successful Delivery of Significant Infrastructure Projects” held in March 2012. The submissions clearly show strong support for continued improvement of competencies and skills within the public sector. This echoes other market commentary emphasising that governments should prioritise recruiting and retaining high quality project team members for PPP projects.

Other improvements to the PPP procurement model

In addition to improving the PPP tender process itself, we consider that governments could make other changes to the PPP model to benefit the public and private sectors.

Governments should retain risks which they can best manage

In our experience, transferring certain risks to the private sector can attract a significant price premium and programming impacts. To avoid those price and time impacts, where appropriate governments should consider retaining responsibility for additional risks which it can better manage, or giving the private sector better opportunities to conduct meaningful due diligence. 

For example, governments (and the National PPP Guidelines) typically seek to transfer site conditions and environmental risks to the private sector, even where bidders are not given sufficient opportunity or access to inspect and test the site to thoroughly assess and price those risks. Accordingly, bidders may include in their bids significant risk premiums and contingencies. 

Similarly, private parties are often required to take access risk, obtain planning and development approvals or to manage user group input during the design development process, even where the public sector is in a better position to manage those processes. In some cases it may also be appropriate for the government to be more involved in managing industrial relations to prevent delays and potential disputes during the construction phase.

Governments should better understand the downstream contracts

Whilst the downstream contracts are based on the risk allocation in the head contract or project agreement, the State ultimately has limited visibility and control of the terms of those contracts. In fact, pressure from the project sponsors and its financiers can force contractors to accept even greater risk than is accepted upstream. This can lead to contractors going into “claims mode” and ultimately a distressed project. We can see benefits in ensuring that both the upsides and downsides of the project agreements end up in the construction and facilities management contracts. Similarly, greater communication and visibility between the government and the builder during the bid phase often assists in better understanding between those parties as to each others drivers and risk appetite.

Consider Dispute Resolution Boards

To avoid particular problems recurring on future projects, we believe that governments should consider including a dispute resolution board (DRB). Its primary function is to prevent disputes, or at least assist the parties to achieve a quick, cost-effective and acceptable resolution. They do this by involving the relevant independent persons at an early stage, as a real project participant. DRBs are particularly useful for projects which are complex, high risk, high profile or have many parties and stakeholders, such as large PPP projects.

Conclusion

As a number of recent Australian PPP projects are distressed, and the PPP model is in the public spotlight, and in an environment where demand for public infrastructure remains high and in order to avoid disincentives for equity investors (particularly superannuation funds going offshore for projects) we believe governments should strongly consider taking steps to improve the PPP procurement process and model generally. 

In particular, governments should closely look at the successful strategies used overseas, especially in Canada, to reduce tender timelines, bid costs and the complexities in the process, as well as improving fruitful communication with bidders. The benefits of addressing the current problems could lead to lower costs, fewer delays, greater public sector engagement and new PPP participants and financiers, all of which could ultimately provide better project outcomes and value for money for taxpayers.

1Based on Norton Rose research of five Victorian and South Australian PPP projects which reached financial close between 2009 and 2011.
2Ibid.
3Ibid.
4KPMG, “PPP Procurement: Barriers to Competition and Efficiency in the Procurement of Public Private Partnerships”, May 2010, commissioned by Infrastructure Australia, pages 27 and 28.
5Ibid, at page 38.
6For example, see the Australian Constructors Association’s comments in its publication “Public Private Partnerships: Putting Guidance Into Action”, available at: www.constructors.com.au
7
KPMG, n. 4 at 36.
8KPMG, n. 4 at 36.
9Australian Constructors Association, n. 6 at 14.
10Refer generally to The Canadian Council for Public-Private Partnerships paper “The Impact of the Global Credit Retraction and the Canadian PPP Market: Deliberations by the industry members of the Canadian Council for Public-Private Partnerships”, published Spring/Summer 2009 and Infrastructure Australia’s issues paper “Infrastructure Finance Reform”, published in July 2011.

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Draft Energy White Paper: The road ahead for energy infrastructure development

By Lucy Campbell

Introduction

The Australian energy landscape is undergoing transformation as demand for our mineral and energy resources increases and as we move towards a carbon price and a greater uptake of clean energy. In order to sustain current levels of development and meet projected growth over the coming decades, an unprecedented scale of investment in developing our energy resources is required.

Australia is the world’s ninth-largest energy producer and constant global demand for coal and liquefied natural gas (LNG) resources in particular continues to make Australia the world’s largest exporter in these areas. The pipeline of energy and mineral resource projects due for completion between 2011 and 2020 that have so far been announced is valued at more than $400 billion. Investment in the electricity sector alone, including generation transmission, distribution networks, pipelines and associated infrastructure, is expected to exceed $240 billion by 20301.

Although it is hoped that the energy industry will see many exciting and substantial developments over the coming decades, such growth inevitably comes with its own challenges. The federal government’s release of the draft Energy White Paper in December last year (Draft White Paper) sets the policy context for ensuring that this significant level of development is undertaken in a manner which ensures energy security and reliability for all Australians.

What is the Draft Energy White Paper?

The Draft White Paper is the result of an extensive consultative process commenced in late 2008. It seeks to establish a long-term energy policy framework for addressing challenges in Australia’s energy sector.

The stated core objective is to build a secure, resilient and efficient energy system that;

  • provides accessible, reliable and competitively priced energy for all Australians;
  • enhances Australia’s domestic and export growth potential; and
  • delivers clean and sustainable energy.

The priority areas identified in the Draft White Paper for enhancing Australia’s energy potential are:

  • strengthening the resilience of Australia’s energy policy framework;
  • reinvigorating the energy market reform agenda;
  • developing Australia’s critical energy resources, especially gas; and
  • accelerating clean energy outcomes.

The overview of Australia’s energy sector provided in the Draft White Paper is comprehensive and examines a range of policy issues, including energy security, developing energy resources, and improving productivity. It identifies particular issues for infrastructure development going forward, some of which are outlined below.

Issues for infrastructure development

Three key issues identified in the Draft White Paper for infrastructure development are:

  • infrastructure reliability;
  • securing investment; and
  • future energy sources, particularly clean energy technologies and LNG.

Infrastructure reliability

Reliable infrastructure is essential to gaining a maximum return on energy resources, maintaining international competitiveness as a supplier and continuing to be an attractive investment destination. One of the greatest issues for infrastructure reliability is inadequate supply chains and ‘bottlenecks’ which severely impact Australia’s ability to meet export demand and threaten energy security and reliability. 

A key feature of Australia’s energy resources is that many are located in regional areas. This presents particular challenges with respect to infrastructure reliability in supply chains, particularly where transportation and access to remote locations is required. To compound the issue of remoteness in supply chains, it is also anticipated that the demand for existing supply infrastructure will increase. By 2050, road transport activity will at least double, water-based transport activity will triple and air transport activity will quadruple.

Consequently, the focus is on supply network expansion and replacement of existing networks. To overcome these issues upgrades are needed to existing infrastructure and new infrastructure is required. This is of particular note for increasing the capacity of our major ports, which will require additions and expansions in order to alleviate these constraints, as well as our rail networks and roads.

Some of these challenges are already being addressed in the National Ports Strategy and National Land Freight Strategy, both of which aim to improve infrastructure planning, pricing, funding mechanisms and regulations.

Securing investment

As stated above, there is a demand for projects that improve energy infrastructure reliability and resilience. However, obtaining funding for such projects faces the challenge of not only securing large-scale investment but also attracting timely investment. Timely investment is required to ensure that infrastructure development is responsive to future growth, aids productivity and keeps pace with demand for resources, both with respect to exports and domestically. To account for planning and construction lead times, investment decisions need to be made years before a project may be delivered. 

Furthermore, given the amount of funds that are required to support the number of infrastructure projects required, it is expected that most funds will be provided by the private sector, and much of these private funds from foreign sources. Consequently in order to be attractive to private investors, infrastructure projects need to generate revenue, provide sufficient certainty about key future cost exposures and otherwise meet expectations of project financiers.

Future energy sources

The federal government is prioritising the development and uptake of clean energy technologies. This will see a shift away from traditional sources of energy such as coal, and a move towards renewable energy sources as well as gas, which is seen as a reliable baseload energy source with low carbon emissions.

The key technology classes for future energy sources are large-scale solar, geothermal, carbon capture and storage and LNG and we will begin to see new developments in infrastructure in response to this change in our energy mix. We are already at the early stages of new types of infrastructure such as floating LNG platforms and going forward other developments will be seen in renewable energy technologies and unconventional energy resources, like shale gas, and unconventional energy technologies, like coal-to-liquids. 

Going forward

The Draft White Paper provides a basis for future discussions on the directions and priorities for Australian energy policy. It is clear that the development of infrastructure is a key factor in ensuring energy security, productivity and resilience and securing reliable and competitively priced energy. Supply networks will be expanded, and we will see a greater focus on infrastructure development that is consistent with a shift towards low-carbon emission energy sources. Furthermore, future infrastructure development is likely to be privately funded and much of these funds from foreign sources. This will affect the manner in which new infrastructure projects come on line and how they are procured.

Following the release of the Draft White Paper, written submissions were invited from the public by 16 March 2012. The federal government anticipates that the final Energy White Paper will be released in 2012.

1Investment Reference Group, Report to the Commonwealth Minister for Resources and Energy, Department of Resources, Energy and Tourism, Canberra, 2011 cited in Draft Energy White Paper 2011: Strengthening the foundations for Australia’s energy future, Department of Resources, Energy and Tourism, Canberra, December 2011 at p xix

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Early contractor involvement in preliminary design process

by Matthew Frazer

The early involvement of the Contractor in the design process of construction projects has shown to provide benefits for Principals. What is noticed in this area is that there are well used models but also possible opportunity for much earlier Contractor involvement on appropriate projects.

The design and construct contract is well understood and has been the traditional solution for Principals requiring the Contractor to develop, complete and be responsible for the design process as well as construction. The preliminary design prepared by the Principal’s designers becomes the Contractor’s responsibility and the designers who prepared the preliminary design are novated to the Contractor.

Although design and construct contracts may contain a value management process and build-ability obligations, there will be limits to the types of decisions made during the preliminary design process that can be later ‘undone’ (for instance, the resultant delay in re-documenting the project may outweigh the saving or may not be able to be accommodated by the program). Therefore, the opportunity to align ‘market’ construction experience with project expectations and have positive impacts at that early stage may have been lost.

In determining when to involve the Contractor in the design process, a Principal will normally decide when design control can be handed over to a Contractor and from when it would like the Contractor to take design, build-ability, time and price risk. Each project will be different but earlier Contractor involvement in the design process can facilitate collaboration and innovation on the project, such as the ability to develop and test material or assemble prototypes before committing to construction. 

Contractors’ involvement in the preliminary design process has so far been uncommon in Australia (particularly on traditional building projects) but it seems it is the ‘final frontier’ of their involvement in this process. Whether the Contractor would take any price or design process risk in their participation in the preliminary design process would be separately answered by the agreement reached on the procurement terms.

Early Contractor Involvement (ECI) contracts are a recent procurement model that has become one possible solution to involving Contractors in the preliminary design process. They usually involve a two stage process. In the first stage, the Contractor is engaged (usually on a time basis) to prepare the preliminary design with the Principal, using the Contractor’s designers. The second stage is essentially a design and construct model but the Principal is not obliged to engage the Contractor and can competitively tender the works to another Contractor.

If Principals have trepidation in giving the design process control to Contractors or the project is not suitable for relinquishing preliminary design control, the ECI model could alternatively be split with the first stage involving the engagement of a Contractor under a consultancy agreement to provide construction advice on the design process being undertaken by the Principal’s designers. This may give Principals an easy inroad into using Contractors more often in the preliminary design phase without the need to hand over design process control or to negotiate and agree the entire construction contract at such an early stage of the project. A design and construct contract could then be used after the preliminary design has been prepared. Given that the ECI model has so far mostly been used on projects involving unidentified risks, this ‘construction consultancy’ alternative may suit a broader range of projects.

On appropriate projects in the future, we may more often see Principals considering the earlier involvement of Contractors in the preliminary design process.

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