Are we talking corruption or bad risk management?

Published January 28th, 2016

Cg head

Insight from Christopher Gasson, GWI publisher

Everyone likes stories about corruption – especially if they include hair transplants (see this month’s GWI if you are curious). The problem is that they tend to turn everyone into villains long before the actual facts of the case are sorted out.

That is certainly the case with the current Acumed scandal in Spain. Everyone in the international water industry is now probably convinced that every Spanish water company is rotten to the core, regardless of the fact that what is being exposed there is an immensely complicated situation with quite a lot of room for argument in the courts.

At the heart of the issue is the flooding of the Bajo Almanzora desalination plant after the facility had only been partially signed off by the client. The flood waters ruined the electrical systems and cost around €10-15 million of damage. Who should pick up the tab? Should it be Acuamed, the client who sort of owned the uninsured plant, or should it be the contractor who had contracted to deliver a working plant at a fixed price?

In the end, it seems to have been decided to bump up the cost of another project – the EU-funded Flix reservoir clean-up – in order to cover the deficit. Behind closed doors, it probably looked like a neat solution to an ugly problem which might otherwise have taken years to clear through the courts. The problem is that deals like that don’t really stand up in the clear light of day, especially when there is evidence that people on the client side received sweeteners from the contractors to fix the deal.

My guess is that there is not a single EPC (engineering, procurement and construction) contractor in the world (including the most sanctimonious US engineers) who wouldn’t have tried to forge a better relationship with their client in those circumstances. Making sure that fixed-price contracts aren’t really delivered for a fixed price is very much part of the business model. In our industry, it creates a tendency for unhealthy relationships, which can spill over into corruption.

The truth is that while the lump-sum turnkey contract is supposed to shift all the risks associated with project delivery onto the contractor, it inevitably has the reverse effect. Contractors watch like hawks for things to go wrong which might give rise to the need to depart from the contract. They can then negotiate a change order with the client. As the client has no real idea of the cost of the changes required, these are like blank cheques to the contractors. It is said that in America, the final price of delivering large water projects is on average 30% higher than the initial projected cost, largely because of contract variations.

There are two ways to reduce the scope for funny business with fixed-price contracts. One is to let the contractor own and operate the plant. That way, the contractor has no interest in cultivating expensive change orders which might add to the price of a contract, because the money to pay for them comes out of the contractor’s own pocket.

The other solution is the Australian alliance model, where the client forms a joint venture with the contractor to deliver the project, and shares the pain and the gain if things turn out differently from what was expected.

The problem is that both of these contracting models are considered to be expensive compared to a low-bid EPC-only tender. BOT contracts include a premium to cover the developer’s profit margin, while the alliance model tends to result in higher bid prices because the bidding teams tend to be more realistic about costs in the first place. It is the cost of improved risk management. It is not something that people on the client side tend to calculate until they find themselves stuck behind bars with their ever so accommodating contractor friends.