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EPC Industry in India: Issues and Challenges

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Contents Chemtech Foreword

2

KPMG Foreword

3

Executive Summary

4

Acronyms Used

4

Methodology

8

Coverage and Scope

8

Setting the Context

10

Value Creation Strategies

17

Key External Drivers and Issues

22

Key Internal Issues

29

End-Use Industry Views

33

EPC Industry in India Action Agenda for Sustained Growth

48

Acknowledgements

51

About Chemtech

52

About KPMG in India

52

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CHEMTECH Foreword trong infrastructure and industry are critical for India as the country sees leapfrogging growth. As far as both these sectors are concerned, India is in a sweet spot, which has created multitude of opportunities in the fields of engineering, capital goods and construction.

S

Though, India has witnessed significant investments in both industrial and infrastructure space, the growth has remained restricted due to various weaknesses of the Indian EPC industry and difficulties for the foreign players to ply in the market. Jasu Shah Founder & Chairman, CHEMTECH Foundation

At this juncture, it is an imperative to address the challenges, which restrict the growth of this sector in India and will continue to repress industrial development lest addressed. CHEMTECH has made an attempt to address the issues faced by the EPC industry through each edition of its international conference, EPC World Expo. Renowned speakers from world over have deliberated over the topical issues that must be resolved to accelerate the development of India’s EPC sector, which would eventually lead to country’s sustainable economic growth. As we reach another milestone year with 25th edition of CHEMTECH series of expositions and international conferences, Jasubhai Media and KPMG have come together and taken the initiative address these issues through this report. I wish to thank all the members of CHEMTECH Advisory Board for EPC who despite their busy schedules shared their opinions and guided the team to come up with the study report that aims to leverage the Indian industry. We sincerely hope that this report would be a useful information tool for both industry as well as statutory bodies to gear up for the challenges for the Indian EPC sector during this decade.

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KPMG Foreword he Engineering Procurement and Construction (EPC) services industry in India is faced with a large and unique opportunity due to galloping Indian economy, and investments in public and industrial infrastructure. The 11th five year plan has been an inflection point in Infrastructure investments, with them contributing upto 9 percent of India’s GDP.

T Arvind Mahajan Executive Director KPMG Advisory Services Pvt Ltd

The 12th plan envisages a total investment in the region of USD 1 trillion, contributing upto 10 percent of India’s GDP. Similarly, there are large investments expected in industrial infrastructure, whether it be Oil and Gas, Metals and Mining and other industries. This large and fast build out of industrial and plant infrastructure requires a robust and growing engineering, procurement and construction services industry for spreading and management of risks, efficiency and productivity in engineering and construction and supplementing the management bandwidth of project developers. This report in line with the theme for Chemtech’s EPC conference, takes a forward looking view on the future of the EPC industry in India, based on current issues and challenges identified for the industry. We hope that the collective insights shared in this report contribute towards shaping future business strategies and government enablement that drive India’s long term growth in this sector.

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EXECUTIVE SUMMARY

The EPC industry as defined here is

the performance of a “unit” or the whole

multiple routes, with engineering

different from the pure engineering

plant. The scope of work would include

companies, equipment suppliers,

or construction industry. We define

engineering, supplies, construction or

construction companies and project

the EPC industry as comprising of

construction management, erection

developers morphing in to EPC service

companies who are involved in executing

and commissioning and providing

providers by filling in the gaps.

projects involving multiple engineering

performance guarantees. The EPC

disciplines with overall responsibility for

companies in India are evolving from

Expectations As a fallout of the USD 1 trillion

to benefit from this wave. However, the

Similarly, customers now expect EPC

investment expected in infrastructure

expectations far exceed the historical

service providers to ramp up their

and industrial growth keeping pace,

performance delivered and the EPC

financial and execution capabilities

there is heightened interest among the

service providers need to step up their

to be able to execute larger projects,

investor community from engineering

ability to win and deliver business to meet

in time and with ever improving cost

and construction companies who stand

these expectations.

structures.

Acronyms Used EPC GDP PPP TSR EPCM PMC FEED O&M JV BOP BTG BOT BOOT DBO

Engineering, Procurement & Construction Gross Domestic Product Public Private Partnership Total Shareholder Returns Engineering,Procurement &Construction Management Project Management Consultant Front End Engineering Design Operation & Maintenance Joint Venture Balance of Plant Boiler Turbine Generator Build,Operate & Transfer Build,Own,Operate & Transfer Design Build & Operate

EPC Industry in India: Issues and Challenges

EPC Report New.indd 4

DBOOT ITI MRP PNGRB PCPIR Regions MENA CGD ADB JNNURM JICA ULB E&P

Design,Build,Own,Operate & Transfer Industrial Training Institute Material Requirements Planning Petroleum & Natural Gas Regulatory Board Petroleum,Chemicals & Petrochemicals Investment Middle East & North Africa City Gas Distribution Asian Development Bank Jawaharlal Nehru National Urban Renewal Mission Japan International Cooperation Agency Urban Local Body Exploration & Production

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Value Creation Strategies and Routes to Growth EPC companies can improve their wealth

sectors like Water, Roads involving BOT,

creation profile by focusing on performance,

BOOT contracts. International expansion by

prospects and managing risks and financing

EPC companies is likely to be limited largely

costs. While performance is about improving

due to global competitive intensity and the

margins by way of correct estimations,

large domestic demand.

procurement and project management capabilities, and focusing on adding higher

We expect increasing number of acquisitions

margin components to the services provided,

in this industry, as companies look to

prospects is about continuously adding

enter new end-use industries by buying

newer avenues of revenue growth.

qualifications.

The most likely route for diversification

Lastly, risk management and “no-surprises” go

is through penetration in new end-use

a long way in improving investor perception,

industries or taking the developer route,

and materially bringing down financing costs

which in fact is an imperative for growth in

for the EPC companies.

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Key Challenges

External

Internal

The key external challenges faced by the EPC industry are as

The key internal challenges are about managing scale and building

follows:-

capabilities to address issues emanating out of this:-

l

Continuously evolving contracting models and relatively slower

l

adoption of the EPC-LSTK concept, especially where customers are large public sector companies with in-house teams, and large

companies l

private sector developers, who have significant in-house project management capabilities. l

Balancing speed and cost control in the Procurement function

l

Order book uncertainty brought about by purely price based procurement decision making of customers, which has led to

Project Manager Empowerment, especially in Indian

Creating a robust engineering organization and balancing between efficiency and effectiveness

l

Adoption of leading Risk Management practices

the emergence of large number of hitherto unknown companies winning relatively large contracts. While this is essential for capacity

The challenges are accentuated for two sets of companies a)

building, it has led to uncertainty of order book for the incumbent

International entrants and b) mid-size companies looking to scale

service providers. It also makes making investment decisions more

up.

difficult for companies. l

l

Shortage of skilled manpower for managerial as well as site labour.

Policy making can help mitigate some of the issues related to

The country has its task cut-out in terms of creating skill work force

enabling private sector for building a skilled workforce, develoing

for the industry. However, the onus really lies on the private sector

speedier mechanisms for speedier resolution of contractual

and the EPC companies to undertake initiatives to address this

disputes, and clarifying taxation regulations related to the

“supply-chain” issue.

industry.

The perception on the sanctity of contracts remains divergent, especially between Indian companies and International entrants. There is a need to establish faith in our ability to enforce contracts by standardization, following international practices and setting right dispute resolution mechanisms.

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Learnings from the

Korean Construction Industry There are macro level learnings to be derived from Korea’s EPC growth story, which may be replicated by the Indian industry l

Government support in terms of ministerial oversight for the industry, followed by active promotion of the industry overseas

l

Capacity building initiatives in terms of institutions for developing construction industry talent

l

Engineering firms working in collaboration with construction majors, facilitated by not-for-profit engineering industry associations

Apart from the above, the report discusses specific end-use industry issues and demand outlook for Power, Oil and Gas and Water, bringing out nuances in terms of differences in contracting models, profile of service providers and key challenges.

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Methodology

Coverage & Scope The report has been prepared by KPMG Advisory Services

many of the generic EPC industry issues identified in this report

Private Limited in association with Chemtech. Leading

would also apply to EPC services for these other industries.

executives from the industry were interviewed to seek inputs for the report. The representation included project developers, EPC companies, engineering consultants and construction companies. We have collected insights based on numerous engagements with nodal agencies, infrastructure companies, engineering and construction firms, and foreign players looking to enter India and equipment suppliers. Secondary research was conducted using published reports, news analysis and usage of standard financial databases subscribed to by KPMG. We have leveraged the expertise and relationships of our advisory teams in the area of Infrastructure and Government and Industrial Markets spread across the country. Taxation related inputs have been provided by our Tax team based on their working experience with clients in the area of infrastructure and engineering and construction. The report covers primarily the EPC services industry from the perspective of the following end-use industries - Power, Refining and Petrochemicals, Water and Water Treatment. These industries have large investments planned in the country for the next 5 to 10 years, and involve technological complexity apart from being complex from a project management perspective. Also, they are varied and bring out the nuances of the EPC sector across most aspects. Specific issues related to EPC services for other end use sectors like Roads, Railways, Metals and Mining etc are not detailed as part of this report, though

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Defining

EPC Industry

EPC or Engineering, Procurement and Construction industry

not undertake turnkey construction of a plant or packages

is referred to by various terms like Construction industry,

within a plant are not considered as EPC companies by this

Engineering and Construction, Contracting or just engineering

definition. It is difficult to draw a strict boundary in terms

industry. Here we define the EPC industry as consisting of

of what constitutes an EPC firm vis-à-vis construction or

service providers who are capable of executing projects on a

engineering firms. One way to distinguish between a classical

turnkey basis, including detailed engineering, procurement,

EPC company from a primarily civil construction company

construction, commissioning and performance testing.

is the construction intensity of the end-use sector, defined by Crisil as the percent of construction spend in the overall

We concern ourselves with players who are able to aggregate

investment towards creating an infrastructure or industrial

multiple engineering disciplines like process engineering,

asset. For example, Roads is estimated to be close to 100

mechanical, structural, civil and electrical. Examples of such

percent, while a thermal power plant is 20 percent.

companies in India are Larsen and Toubro, Punj Lloyd, Tata Projects, Essar Projects etc. Players who only operate in the

The rest is towards equipment, mechanical fabrication,

civil construction and structural engineering domain and would

electrical and non-construction engineering spend.

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Setting

The CONTEXT

Route 1

Route 3

Expanding scope from being engineering companies to

Expanding scope from equipment supply to EPC companies.

EPC companies. The most prominent example of this route

This route has been more commonly followed in the engineering

Engineers India Limited, which is India’s leading engineering

and capital goods segment. Companies manufacturing major

company, especially in the Hydrocarbons segment and now

pieces of equipment for a particular manufacturing process

offers EPC services. However, successful instances of this

have upgraded themselves to execute projects around their

route are limited.

equipments. Examples are Elecon, TRF who are suppliers of material handling equipment and undertake projects in Power

Route 2

Balance of Plant packages supplying entire Coal handling

Expanding scope from being construction companies to

systems or in industrial plants involving large material handling

EPC companies. This is the more commonly followed route,

components.

wherein companies have added engineering and procurement capabilities to their existing expertise in mechanical and civil

Route 4

construction. The leading example of this route has been

A relatively new development has been of project developers

Larsen and Toubro, which moved from being a fabrication

backward integrating and setting up their own EPC divisions.

and construction company in to one of the largest and most

This has been motivated by a desire to leverage their in-house

respected EPC companies in India.

project management capabilities, and to capture the margins typically belonging to contractors.

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Relevance of the EPC industry to the India Growth Story

The 11th plan was an inflection point for the Indian infrastructure

policies in various sectors, policies around creating investment

story. The 11th plan laid the foundation for large scale

clusters, land acquisition and environmental clearances.

investments in infrastructure in India. Of the USD 500 billion

However, the chain is only as strong as the weakest link.

planned to be invested in the infrastructure, at the current rate, it is expected that the plan will be met to 94 percent. This would

Achieving this rate of infrastructure build-out calls for massive

amount to 9 percent of India’s GDP and is expected to go up

capacity building down the chain in terms of manufacturing

to 10.25 percent of GDP.

capacities for equipments, raw material and commodity capacities (e.g. steel, cement, fuels etc) and human resources.

Mid-Term Appraisal of 11th Five Year Plan

Similarly, it calls for massive capacity building in the engineering

In order to achieve this plan, various pieces of the puzzle

and construction sector in terms of reasonable number of large

need to come together, and would require all stakeholders,

to mid-size contracting or EPC companies available to be able

the government, public sector undertakings, private sector to

to undertake Lump-Sum-Turn-Key (LSTK) and sub-contracting

contribute their achievements in a co-ordinated manner. It is

jobs in the country.

expected that the private sector would contribute 50 percent by way of financing to achieve this plan. The obvious policy focus

Purely from a construction perspective, investment in

has been on building financing capacity, formulation of PPP

construction is estimated to double to INR 16,809 billion over

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the next five years (2010-11-20114-15), from INR

Projected Infrastructure Investments in 12th Plan

8,895 billion recorded during the last five years1. Within this the infrastructure segment, would

Base Yr (2011-12)

construction investment. The opportunity for EPC

GDP (USD Billion) GDP Growth (%) Infrastructure Investment (% of GDP) Infrastructure Investment (USD Billion)

players varies by industry given the contracting

Total Investments

comprise 85 per cent of the total construction investment. Within infrastructure segment, the roads, power, irrigation and urban infrastructure sectors would contribute around 73 percent of total

models and construction intensity of each class of

2012-13

2013-14

2014-15

1,595 9.00%

1,738 9.00%

1,895 9.00%

2,065 9.00%

9.00%

9.25%

9.50%

9.75%

144 161 (USD Billion)

180

2015-16

2,251 9.00%

2016-17

2,454 9.00%

10.00% 10.25%

201 225 1,019

252 

Source: Planning Commission

infrastructure or industrial asset. CRISIL Resarch estimates that investments in the industrial sector would be 1.2 times in the next 5 years as compared to the previous five years while in infrastructure it would be 1.9 times, bringing the total growth to be 1.7 times.

1

Source: Crisil “Construction-Opinion August 2010”

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Expectations from the EPC Industry

The EPC industry has gained prominent share of media,

largely on account of future expectations. Similarly, the large

investor and entrepreneurial attention in the last 3-5 years.

investment plans have raised expectations of customers from

The stock markets have handsomely rewarded companies

this industry.

operating in the infrastructure, construction and EPC space,

Investor Expectations During the period of 2008-2010, the Total Shareholders Return2

ratios, whereas the CAGR growth demonstrated in the last 3

(TSR) by the EPC companies has been ~31 percent. TSR for

years has been around 28 percent for the set of companies

the more broad-based Infrastructure index in the corresponding

considered below3.

period has been only ~ 9 percent. KPMG analysis indicates that the expectations embedded in the current valuations indicate

Hence the stock market expectation of growth of EPC

that investors are expecting the leading EPC companies to grow

companies appears to be very high. Private equity interest has

their order books and revenues at a rate of ~65 percent if they

also been high in the industry.

continue to maintain current profitability and capital turnover

RECENT EXAMPLES OF PRIVATE EQUITY DEALS CONCLUDED CONSORTIUM OF PRIVATE EQUITY FIRMS, INCLUDING BARING, SEQUOIA CAPITAL, FIDELITY AND DEUTSCHE BANK, ACQUIRED A 16 PERCENT STAKE IN INFRASTRUCTURE-EPC COMPANY COASTAL PROJECTS FOR $54.8 MILLION1 AVIGO INVESTED $14 MILLION IN DELHI-BASED NAFTOGAZ INDIA PVT LTD, AN EPC PLAYER IN l THE O&G SECTOR. DELHI-BASED UEM GROUP, SPECIALISING IN WATER & WASTE WATER COLLECTION, TREATMENT l AND DISPOSAL, MOPPED UP ` 90 CRORE FROM INDIA VALUE FUND CHENNAI-BASED AQUA DESIGNS INDIA, A WATER MANAGEMENT ENGINEERING COMPANY, RAISED l ` 55 CRORE FROM PEEPUL CAPITAL CONCORD ENVIRO SYSTEMS, A WATER MANAGEMENT ENGINEERING COMPANY, RAISED $10 l MILLION FROM SAGE CAPITAL FUNDS IN DECEMBER 2009 A2Z MAINTENANCE & ENGINEERING SERVICES LTD (BACKED BY IEP, BEACON INDIA PRIVATE EQUITY FUND AND MR RAKESH JHUNJHUNWALA), IS PRESENT IN POWER DISTRIBUTION EPC BUSINESS. l

2

TSR computation has been done for last 3 years data for companies which have been publicly listed in the last 3 years and may be classified as engineering and construction companies 3 Source of data for analysis is Prowess, CMIE | 13 |

EPC Report New.indd 13

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TotalShareholderReturnsofSelectEngineeringandConstruction Companies 20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

EraInfraEngg.Ltd.

86.3%

EngineersIndiaLtd.

74.5%

SadbhavEngineeringLtd.

50.7%

JaiprakashAssociatesLtd.

38.9%

McnallyBharatEngg.Co. Ltd.

33.6%

BharatHeavyElectricalsLtd.

32.3%

Larsen&Toubro Ltd.

32.3%

AhluwaliaContracts(India)Ltd.

31.5%

GayatriProjectsLtd.

23.3%

ThermaxLtd.

23.2%

HindustanConstruction Co. Ltd.

20.3%

PatelEngineeringLtd.

17.1%

AlstomProjectsIndiaLtd.

14.7%

MadhuconProjectsLtd.

14.1%

PunjLloyd Ltd.

13.0%

UnityInfraprojectsLtd.

12.4%

NagarjunaConstructionCo. Ltd.

8.6%

IonExchange(India)Ltd.

8.5%

IVRC LInfrastructures&ProjectsLtd.

7.0%

JMCProjects(India)Ltd.

4.5%

GammonIndiaLtd. SPMLInfraLtd.

100.0%

2.3% 3.7%

EleconEngineeringCo. Ltd. 13.5%

Source: KPMG Analysis, financial data from Prowess, CMIE

In summary, the expectations from the investors are much higher than the pace at which companies have delivered performance in the recent past. This is an indicator of the strongly positive expectations surrounding the sector, and hence the need for the industry to deliver a consolidated performance in line with what is expected of them.

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Customer Expectations The value proposition offered by the EPC industry is based

to exectution by the developer organization or the more

on the concept of risk sharing or risk transfer from the

traditional route of procuring equipment, services and

project developer to the EPC Company, at least to the tune of the capital cost of the project and to a limited extent to the initial operating performance of the plant / facility being built. In exchange for that, the project developers are willing to pay a premium for the integration services provided. Over a period

engineering services separately

EPC company takes on a much higher level of real and perceived risks within a project, than other service providers in the pure Engineering, Consulting or Project Management space.

of time, customers have come

the project management. It is important to point out here that given the customer expectations and the consequent EPC business model, an EPC company takes on a much higher level of real and perceived risks within a project, than other

to expect a reduction in the total cost of putting up the plant

service providers in the pure engineering, consulting or Project

and the time schedule through the EPC route, compared

Management space.

| 15 |

EPC Report New.indd 15

and owning the integration and

EPC Industry in India: Issues and Challenges

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EPC game is competitive, The

while

EPCM game

The

pure

Given its business model, an EPC Company hence has to

engineering,

target profitability from each contract, since the value at risk in

is about

consulting or

the case of overruns is very high, in proportion to its expected

relationship & trust

PMC services

margins. Further, the nature of the customer relationship

companies build

continues to be “arms-length” over the period of the contract,

their business

as EPC companies look to protect themselves against time

models around

and effort overruns delays on account of the developer and

profitable

a plethora of other risks that might take them off their initial

c u s t o m e r

estimates. At the same time, customers want to ensure that they

relationships, and

get their plant or facility up and running, with the desired quality

do not necessarily need profitability in each project that they

in time and with no extra claims raised by the contractor.

undertake. However, the services of an EPC contractor are supposed to be based on comprehensive contracts with little room for interpretation and ambiguity, whereas pure engineering or EPCM service providers do not take on most of the project cost or time overrun risks which remain with the developer.

APART FROM THIS BASIC CUSTOMER EXPECTATION, DURING OUR DISCUSSIONS WITH PROJECT DEVELOPERS SEVERAL OTHER EXPECTATIONS FROM EPC COMPANIES WERE COMMONLY MENTIONED l

l

l

l

EPC COMPANIES NEED TO IMPROVE THEIR FINANCIAL AND BALANCE SHEET STRENGTH TO BE ABLE TO TAKE ON LARGER JOBS, AND NOT DEPEND ON ADVANCES AND FAST TRACK PAYMENTS FROM DEVELOPERS TO BE ABLE TO PROGRESS INDIAN EPC COMPANIES NEED TO SIGNIFICANTLY IMPROVE THEIR ENGINEERING CAPABILITIES, ESPECIALLY ON THE FRONT END SIDE. THIS IS ESPECIALLY TRUE FOR THE ENGINEERING COMPANIES WHICH ARE RESPONSIBLE FOR PREPARING THE FEED (FRONT END ENGINEERING DESIGN) PACKAGE SO THAT LSTK BIDDING CAN BE FACILITATED. DEPLOY LATEST CONSTRUCTION METHODOLOGIES AND TECHNIQUES, BOTH MANAGERIAL AS WELL AS TECHNICAL TO EXECUTE PROJECTS FASTER AND TO BETTER QUALITY. DEVELOP EMPOWERED PROJECT MANAGERS, SO THAT THEY CAN ACT AS MORE THAN JUST COORDINATORS, AND CAN INTERFACE WITH THE SENIOR MOST LEVELS IN THE CLIENT HIERARCHY AND TAKE DECISIONS TO RESOLVE PROJECT ISSUES.

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Value Creation Strategies

The “project level” value creation driver in terms of profitability

b) Manage the entire ecosystem of customers, vendors,

for an EPC company is its ability to

regulators, engineers and sub-contractors, to deliver within

a) Correctly estimate the detailed costs and time schedules

those estimates.

of a project and

Sources of Long Term Value Creation However, long term value creation requires EPC companies

customers. Financing component of value creation involves a

to improve in all three aspects that impact the market value

reduction in the risk premium and discount rate associated with

of a company – performance, prospects, and financing. While

future cash flows of the company. This can be achieved by a

performance is enhanced both through revenue and profit

combination of a reduction in actual cost of borrowing and the

growth, future prospects are enhanced when the EPC company

“expected” cost of equity through improved risk management

is positioned well to serve high growth segments and profitable

practices and reduced volatility of revenue streams.

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Scale and other Value Drivers for EPC companies

Performance improves for an EPC company with scale, as

investment in world-class tools and techniques.

it is able to leverage efficiencies in procurement, overheads, relationship building with vendors and sub-contractors. Also,

The other two important aspects for value creation are “Growth

there are scale opportunities created when companies are able

to create future prospects” and Risk Management which are

to invest in standardization of designs, value engineering and

covered subsequently.

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Routes to

Growth

iversification is a key element of

execution capabilities of Tata Projects.

lower risks, it doesn’t provide aggressive

growth, and will be aggressively

There are many other examples, of such

top line growth. Such vertical expansion

pursued in India. It is driven

strategies being followed by companies

into Construction and Project Execution

all over the country.

by publicly listed manufacturing or

D

not only from the point of growth, but also from the perspective of managing

engineering companies, is also driven

volatility in order booking. Presently, the

Route 2

by the higher earnings multiples currently

established EPC companies operating

V E R T I C A L E X PA N S I O N S o m e

associated with such “high potential”

in a limited set of industries in India,

companies are expanding to control

businesses. The market recognizes that

are also perceiving a high risk to their

more of the investment value of the

construction and project management

order booking levels due to the large

project, by becoming system integrators.

service providers will be in short supply

number of new entrants into the EPC

A large proportion of these companies

and high demand in the short to medium

space, as well as a perceived dilution

are equipment vendors, who believe that

term.

in qualification criteria from many

they have the ability to execute contracts

customers that appears to be providing

on a turnkey basis. Examples of this route

As a note of caution, however, it is worth

a level playing field to the new entrants.

being followed being prevalent largely

mentioning that companies who enter

Hence diversification has become a

in the Power Generation equipment

the Projects business from product

popular mode of seeking both growth

side. For example companies like

manufacturing or engineering services

and stability in revenue streams of EPC

Elecon, TRF which were earlier primarily

backgrounds, need to carefully built

companies.

material handling equipment vendors

the required capabilities for project

are now competing for turnkey Route 1

material handling systems

HORIZONTAL EXPANSION Existing

packages. Similarly, there are

EPC companies are diversifying in to

engineering companies like

new end-use industry sectors, inspired

EIL, who are now offering EPC/

by the large investments coming up in

LSTK services to their clients.

PROMISES GROWTH & STABILITY IN

these sectors. For example, Punj Lloyd, a player in the Oil and Gas space,

The vertical expansions have

expanded in to the Power Generation

been driven by the desire to

EPC market and has recently won orders

enhance the top line and to

in the Balance of Plant EPC space.

control a larger share of the

Similarly, Tata Projects has entered in to

investment pie. Engineering

a JV with EIL to form a TEIL, to address

services contribute not more

the investments in the Oil and Gas space.

than 5-10 percent of the total

The JV leverages EIL’s engineering

plant investments, and while

know-how, client relationships in the Oil

engineering services have

and Gas sector and the LSTK contract

higher margins and relatively | 19 |

EPC Report New.indd 19

DIVERSIFICATION

REVENUE STREAMS

EXPANSION MODES l

Horizontal

l

Vertical

l

Backward Integration

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:42 PM

execution, and identify and manage their

strong internal project execution teams.

are few others capable of simultaneously

risk exposure in a higher risk business in

Moreover they believe they can derive

executing a number of full EPC projects in

a calibrated manner. Several traditional

substantial benefits on procurement

the Power Sector. One private developer

manufacturing companies have faced

activities through in-house procurement.

mentioned that the available set of EPC

financial difficulties in managing their

Further, as an executive from one of the

companies does not inspire confidence

project businesses in the recent past.

leading players in the industry pointed out

in their being able to deliver projects on

large business houses making significant

time and with the initial estimated cost.

Route 3

investments believe that there isn’t

Typically in such scenarios, the risk of

BACKWARD INTEGRATION Many

enough expertise and scale within the

both schedule and cost is transferred

Indian entrepreneurs have typically

existing EPC companies for assuming

back to the developer in forms of claims

wanted to control as much of the value

and managing their project risks.

and counter claims on who is responsible

chain as possible. The story is being now

for delays and escalations. As a result,

repeated in the EPC industry - Reliance

In the Power Sector, for example, the

the developer feels compelled to manage

ADAG has Reliance Infrastructure,

only large full service EPC company that

his projects on his own if he has the

while Essar Group has Essar Projects.

comes to mind is Larsen and Toubro,

organization and resources to do so,

GMR has its own EPC division, while

which can offer full EPC, BTG package,

and a large enough pipeline of projects

the Tata Group has Tata Projects. Many

BoP package and also individual

to utilize these in-house resources

other business houses have established

equipments and sub-systems. There

efficiently.

COMPANIES WHO ENTER THE PROJECTS BUSINESS FROM PRODUCT MANUFACTURING OR ENGINEERING SERVICES BACKGROUNDS, NEED TO CAREFULLY BUILD THE REQUIRED CAPABILITIES FOR PROJECT EXECUTION, AND IDENTIFY AND MANAGE THEIR RISK EXPOSURE IN A HIGHER RISK BUSINESS IN A EPC Industry in India: Issues and Challenges CALIBRATED MANNER.

EPC Report New.indd 20

International Expansion International expansion for growth

international level in this field. Hence

has really not been a focus area for

companies like Larsen and Toubro,

most Indian EPC companies given the

Punj Lloyd, Essar Projects have won

growth in the domestic sector, and the

business at the international level

stiff competition posed internationally

and should continue to do well in the

by the global majors. However,

hydrocarbons space. Similarly, sub-

there remain certain sectors where

contractors in this space (e.g. Petron

international expansion is likely. The

Engineering) may also be able to

Indian Oil and Gas plant engineering

compete internationally, as they have

and construction market has all the

been working as sub-contractors to

global majors present in India. Hence,

global companies in India.

Indian companies competing with them have raised their game to the

On the other hand, there are niche

| 20 |

2/20/2011 8:13:42 PM

EPC segments, with limited market size

are quite stringent for entry.

in India, which has prompted Indian companies in these domains to go

Tata Projects acquired Artson

global. Examples of this are to be found

Engineering, while entering into a JV

in Walchandnagar for sugar and biomass

with EIL for its Oil and Gas foray. IVRCL

based power plants, KEC International

acquired Hindustan Dorr-Oliver to

for EPC in transmission and distribution

strengthen its Water Treatment business

space. Some of these expansions have

and gain a foothold in the mineral

been facilitated by global acquisitions

beneficiation plant construction market.

as well – for example the acquisition

We expect the acquisitive activities

of the mineral beneficiation equipment

of Indian EPC companies to intensify

business of cement major KHD Humboldt

over the next 3-5 years. Opportunities

Wedag by McNally Bharat Engineering

for partnering or acquisition will arise

has provided them a foothold in the

as smaller, niche EPC companies find

international market. Similarly, the

it difficult to compete against large

acquisition of Sembawang and its

companies. Additionally, the recent bout

subsidiary Simon Carves has significantly

of aggressive bidding by Indian EPC

improved the international profile of the

companies is likely to throw up winners

Punj Lloyd. KEC International acquired

and losers in the next 3 to 5 years. This

SAE Towers’ business, a leading

will likely lead to consolidation in the

manufacturer of steel lattice structures

industry.

GLOBAL ACQUISITIONS BY INDIAN COMPANIES Mineral beneficiation l equipment business of cement major KHD Humboldt Wedag by McNally Bharat Engineering Sembawang and its l subsidiary Simon Carves by Punj Lloyd SAE Towers’ business, l a leading manufacturer of steel lattice structures for transmission towers with subsidiaries in Brazil, Mexico and US by KEC International

for transmission towers with subsidiaries in Brazil, Mexico and US. This is the most plausible route that Indian companies are likely to take acquiring companies in niche areas globally to create large multi-country EPC businesses. There are no large acquisitions of note in the main plant EPC market, other than Punj Lloyd’s acquisition of Sembawang. In the domestic market, diversification in to newer areas by EPC companies has been accompanied by acquisitions or JVs - particularly in the Hydrocarbons space, wherein the qualification criterion | 21 |

EPC Report New.indd 21

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:43 PM

Key External Drivers and Issues

Contracting Models The demand for the EPC industry is driven by the contracting models adopted by customers. Theoretically, the EPC industry is driven by the need to reduce the risk for the developer, at the same time leveraging the expertise of the EPC player to reduce the overall execution period and cost. Some of the prevalent contracting models are mentioned below:

Contracting Models and their Drivers Model

Role of EPC company

Engineering Procurement and Construction Management (EPCM)

l l l l l

l l

EPC - Lump Sum Turn Key (LSTK)

l l

Package EPC

l

l

Drivers / Highlights

System engineering, optionally detailed engineering Detailed cost estimation Package and sub-contract structuring Managing bid / vendor selection process Quality management ( including drawing approvals of vendors, subcontractors) Supervision of construction, erection, commissioning, performance testing Project Management ( sometimes an additional Project Management agency)

l

Engineering, procurement, construction, commissioning The extent of information provided varies, typically all the drawings and designs are provided to construction companies to bid, while in some cases only the conceptual design may be provided

l

Engineering, procurement, construction and commissioning of a particular unit Most likely to involve mechanical, electrical, instrumentation, utilities civil and structural scope

l

l l l

l l

l l l

l

l

Commonly practiced in process industry Players like Engineers India Limited, Uhde, Foster Wheeler, Technip, Technimont ICB etc Contract values are small as compared to LSTK, however high margin Minimal risk for EPCM companies, however customers now insist on incentives based on project cost and schedule as compared to original estimates Places responsibility of managing risks, cost control and procurement on the project developer Preferred in the Indian context due to in-house capabilities of Indian entrepreneurs and willingness to take risks, and save margins

Complete risk transfer to EPC company Very large contract sizes, equal to the project investment Higher adoption in India of this model in the infrastructure segments ( Roads, Water, Hydro Power etc) Limited adoption in the industrial segment

Project developer splits the project in “system” or unit packages Most commonly used method in Process plants, power plants – especially by the public sector. E.g. NTPC breaks the Power plant in to packages like BTG, Coal Handling, Ash Handling, Water Treatment etc Contract sizes can be as large as INR 2000 Crores

Source: KPMG Research and Analysis, Industry inputs

EPC Industry in India: Issues and Challenges

EPC Report New.indd 22

| 22 |

2/20/2011 8:13:43 PM

The choice of the contracting models are

especially where projects are being

driven by multiple factors

awarded through the competitive bidding

Internal capabilities of the project

in the public sector, is the emergence

CONTRACTS

developer

of a large number of relatively small,

being bagged by

l

Influence of financial institutions

unknown players bagging significantly

l

Availability of enough number of

large contracts.

COMPANIES with LIMITED CAPABILITIES

l

quality LSTK suppliers l

Prevailing market conditions,

While it is important from a capacity

including supplier power. In a capacity

building and competitive stand point,

constrained scenario, contracting

it has led to order book uncertainty for

models move towards shifting the

the incumbents. At the risk of sounding

risks on to the project developers.

anti-competition, a senior management

will affect

executive of a large EPC company

PROJECTS in

However, a few general trends can be

suggested that it is not a healthy trend

drawn based on the above drivers, as

at all. “It is leading to contracts being

follows:

bagged by companies with limited

l

l

In the infrastructure segments, the

capabilities, which will affect projects

contracting models are moving

in the medium to long run”. While the

uncertainty is the appetite for investment

towards transferring more risk to

extent of truth in this prophecy can only

in manufacturing or in-house value

contractors, including operating risks

be borne out over time, it is a fact that this

addition. The BTG manufacturing

in the form of BOT, BOOT models.

phenomenon has increased the order

capacities of private sector companies

In the industrial segment, it is

book uncertainty for the incumbents.

in India like that of L&T, Bharat Forge, Thermax, BGR etc are faced with the

expected that the EPCM or even

l

the medium to long run

lesser risk models will continue to

Strategic planning methods based

prospects of being under utilized as

dominate.

on projected capital expenditure and

most main plant equipment orders have

What will tilt the balance in

historical market shares do not throw up

been won by BHEL and the Chinese

favour of turnkey models in the

reliable revenue projections, and there is

companies.

industrial segment is the entry

scramble to hedge risks by diversifying

of new developers, especially

and being present in as many sectors as

This phenomenon was also seen in the

in the mid-scale segments, who

possible. There are numerous examples

Roads sector, where there is consequently

have limited internal capabilities to

around this; a look at the portfolio of the

now a cap on how many orders can be

execute projects without LTSK type

top 10 construction companies in India

placed on a single company, and also in

contracts.

illustrates this point.

the Balance of Plants in Power space, where multiple companies have sprung

Order Book Uncertainty One significant trend in industry,

up to take advantage of the underAnother ramification of this order book | 23 |

EPC Report New.indd 23

capacity scenario. EPC Industry in India: Issues and Challenges

2/20/2011 8:13:43 PM

Human Resources

workers like carpenters, fitters, welders, but what they lament the most is the

Incremental Human Resource Requirement (including skilled workforce) in 000s

The shortage of skilled manpower is

lack of Project Managers with adequate

Profile of People

most acutely being felt in the construction

experience and skill levels to execute

Incremental Requirement

industry. The construction industry

the ever increasing size and complexity

473

currently employs 32 million people in

of projects.

Project Managers and Engineers Supervisors

473

Foremen

946

Crane Operators

7

Electricians

473

Weleder

473

the country. It is estimated that 1 percent increase in GDP translates to 1 percent

The 11th plan envisages the development

increase in jobs for the construction

of a National plan for Human Resource

industry. With the accelerated investment

development through training and

in infrastructure, this is only going to

certification of construction personnel.

increase. If the 12th plan envisages

However, industry participants feels

doubling of infrastructure investment

that this large capacity building will

from the 11th plan, it calls for doubling

require significant private sector effort,

of requirement for the construction

for establishing training institutes, setting

skilled levels4. Centum Learning, a joint

industry, which indicates a large shortage

course material and reducing trainee

venture between Bharti Group’s Centum

of resources. While mobilization of

career risks by providing absorption.

Learning and NSDC is one initiative,

unskilled labour at construction sites

While the need for upgrading the current

to skill and train 1.2 crore Indians on

may be of relatively lesser concern, the

set of ITIs and vocational training institutes

workskills in sectors like Telecom, Retail,

need for doubling the skilled resources

is felt, more importantly, there is a need

Building and Construction. However,

available in the country is being acutely

to establish training centers with private

there is need for many more, especially

felt. Anecdotal evidences indicate that

participation at major labour centers in

from the Construction Industry itself.

construction managers with 15+ years

the country, in the semi-urban and rural

Hence there is an urgent imperative for

of experience in building high quality

areasThe challenge is accentuated due

collaborative action by the Engineering

roads are now drawing compensation

to the demand centers and the supply

and Construction companies in investing

in the same range as their peers in

centers being different. The supply

in skill building at the supply centers, in

advanced countries, which was unheard

is likely to be driven predominantly

a non-competitive environment. In the

of in the Indian context. Industry leaders

by states like Orissa, West Bengal

meantime, the government may have

are worried about the shortage of skilled

and Bihar, especially at the minimally

to refrain from disallowing the use of

Source: National Skill Development Corporation and IMaCs study on Human Resource skill gaps in Building, Construction and Real Estate

foreign labour for project

“The existing public school infrastructure can be upgraded through private participation with minimal additional expenditure with after-school hours used for providing vocational skills” - Senior Executive at an EPC company 4

execution, till such time as skilled labour shortages are addressed. While, the skilled resource

NSDC report on Human Resource and Skill Requirements in Building, Construction Industry and Real Estate Services

EPC Industry in India: Issues and Challenges

EPC Report New.indd 24

| 24 |

2/20/2011 8:13:43 PM

requirement at the Engineer and

of professionals to act as integrators, who

are few institutes focusing on teaching

Supervisor levels is a constraint as well,

can act as engineering coordinators and

Project Management, especially for

we feel that it is easier addressed as over

are comfortable with various engineering

the construction industry in the country.

a period of time through private sector

disciplines and not just one specific

In the absence of specialist finishing

participation in engineering education,

discipline. It is only with the availability

schools for Project Management, the

as this is financially rewarding even

of such talent, that companies can

industry relies on in-house training, and

with limited or no government support.

innovate, carry out value engineering

on-the-job training programs. While

What may be needed though is more

to improve the overall productivity of a

those are important, there is a need to go

specialized curriculum development

capital project.

beyond the generic project management

(for example Power Plant engineering).

credits introduced in business schools

A second requirement is for cross-

The second of critical challenges apart

or engineering institutions. It is strongly

functional engineering skills and

from technical and skilled labor, lies in

believed that the development mandate

exposure. The EPC industry needs a set

developing managerial talent. There

given to the Construction Industry

“There is a need for building a high profile project management school along the lines of an IIT/ IIM, all we need is some land allocation and the industry can do the rest” – Senior Executive of an EPC company | 25 |

EPC Report New.indd 25

Development Council and the National Institute of Construction Management and Research (NICMAR) needs to be supplemented by the establishment of some such high quality Project Management schools. EPC Industry in India: Issues and Challenges

2/20/2011 8:13:43 PM

Contracts

(i) Ease of doing business in India In the latest rankings5 for ease of doing business, India is ranked 134th in the world.

Ease of Doing Business Ranking for India Ease of Doing Business

Starting a business

Dealing with Registering Getting Protecting Paying Trading construction property Credit investors taxes across permits borders

Enforcing Closing a contracts business

134

165

177

182

94

32

44

164

100

134

Source: World Bank Group, Ease of Doing Business Rankings, 2011

India scores particularly poorly in the

who see the immense potential of India,

design engineering and consultancy

establishment of new business and

as also reflected in the FDI flowing

firms, while evolving it strategy for

construction, closure of businesses,

in to the country. However, for many

emerging markets recently, found these

and enforcement of contracts. While,

global companies contemplating entry

rankings to be particularly forbidding in

one may argue that these rankings

into India, these are not encouraging

its evaluation of India’s attractiveness as

mean little to investors and companies

indicators. One of the world’s leading

a business location.

Risk Assessment of Typical Contracts

aggressive delivery periods, the primary

they will have to accept terms from

reason for such evaluations, we found,

the customer. Interestingly, as a senior

During a recent engagement for an Indian

were the typical contractual clauses,

executive in in an EPC firm told us,

EPC client, we studied the risk evaluation

including payment and retention terms

the ability to manage within a weakly

frameworks in use by international

which detract international companies

enforced regulatory framework is a

majors. We found that many international

from taking up large contracts in India.

competitive advantage for Indian EPC

companies would rate typical Indian

Moreover, many EPC companies find

companies who have learnt to operate

projects as “No-Go”. While the reasons

arbitration as a lengthy process in India,

under these conditions. For example,

would typically also include issues

and hence the risk averse companies

these companies have realized that

related to logistics constraints and overly

assume that in case of any disputes,

Liquidated Damages are rarely enforced by Public Sector clients. Further,

“Managing within a weakly enforced regulatory framework is a competitive advantage for Indian companies” - Senior Executive at an EPC company 5

new infrastructure developers, when dealing with large experienced EPC firms operating in India, find it difficult to prevent extra claims, and costs from escalating.

http://www.doingbusiness.org/rankings

EPC Industry in India: Issues and Challenges

EPC Report New.indd 26

| 26 |

2/20/2011 8:13:43 PM

We feel, the industry requires that nodal

contracts, especially in respect of off-

controversy and litigation. Hence, it

agencies in various government sectors,

shore supply of goods / services under

is advisable to structure contracts in a

take up these issues, to align the project

a composite contract, has become a

tax-efficient manner after taking into

contractual clauses to international

matter of great debate and litigation.

account the peculiar facts of each case.

standards, particularly if they wish to

Equally important is the issue in relation

Further, there as several provisions

receive enough number of bids in the

to withholding tax on such payments.

under the Proposed Direct Taxes Code,

International Competitive Bidding routes,

The onshore supplies and services are

2010 such as General Anti – Avoidance

reduce the number of disputes and raise

normally taxable in India.

Rules, etc. that will have to be taken into

the trust levels in the industry between

consideration while entering into EPC

project developers and engineering and

There has been a lot of litigation in

construction companies.

relation to taxability of offshore supply and offshore services. However, the

Permanent Establishment (‘PE’)

Taxation

controversy in relation to offshore

Issues

Direct tax

services is now rested with an amendment

Deputation of personnel for erection /

A typical EPC contract will have the

in the domestic law and accordingly

installation / commissioning / designing

following scope of work in a single

offshore services are now taxable in

/ training activities is a common

project:

India if they are utilised in India. A general

phenomenon in case of EPC contracts.

Supply of equipment (offshore and

principle which was emerged out of the

The ambit of the domestic law of India is

onshore);

judicial precedents is that profit from

very wide and it tries to tax income from

l

Installation / commissioning

offshore supplies would not be taxable

all the activities which give rise to some

l

Services (offshore and onshore)

in India provided following conditions

business connection in India. Based

l

Software / Technology transfer

are satisfied:

on the tax treaty, the business income

(offshore and onshore)

l

Principal to principal transaction

of foreign companies would be subject

l

Title (i.e. risk and ownership) in the

to tax in India only if they have a PE in

Under a typical EPC contract, a non-

offshore supplies passed to the buyer

India. There are various types of PEs like

resident contractor performs multitude

outside India

fixed base PE, agency PE, service PE or

Sale consideration is received

construction / installation PE.

l

of activities. The scope of work under

l

EPC contract: l

Offshore: Offshore supplies and

outside India l

Sale is at arm’s length

offshore services

Practically, in an EPC Contracts, activities take a long duration to complete, and

On-shore: Onshore supplies and

Although the above rulings suggest that

hence PE clause (especially fixed base,

onshore services (installation,

offshore supply may not to be taxed in

construction / installation PE and service

commissioning, etc.)

India, the taxability depends of facts

PE) comes into play in this industry more

of each case. Further, the revenue

often. This would imply that a foreign

Taxability of payments received by

authorities have not accepted the above

company rendering services in India for

foreign companies in respect of EPC

rulings and hence, it is still a matter of

more than the specified period would

l

| 27 |

EPC Report New.indd 27

contracts.

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:44 PM

be taxed in India in addition to being

and much depends upon the facts and

taxed in the country of residence only

circumstances of each case.

by virtue of the fact that services are

Following are the consequences of

being rendered in India for more than

constituting an AOP:

the specified number of days or they

l

have a virtual presence in India. Hence, it is important for the EPC contractor to

Rate; l

structure their operations and contracts to mitigate PE exposure.

Applicability of Maximum Marginal Issues in relation to carry forward of losses;

l

Issues in relation to Foreign Tax Credit;

Association of Persons (AOP)

l

Taxation at two level due to

Generally, two or more EPC contractors

applicability of Minimum Alternate

come together to bid for EPC contracts

Tax on profit distribution from AOP

in the form of a consortium. In such a situation, an AOP exposure would arise. The term AOP is not specifically defined in the Act. One has to rely on the ordinary meaning and the law emerging out of the judicial decisions to determine what constitutes an AOP. Whether AOP exist or not is a very vexed issue

BROAD PARAMETERS TO ANALYZE CONSTITUTION OF AOP l l l

l

l

l

TWO OR MORE PERSONS VOLUNTARY COMBINATIONS A COMMON PURPOSE OR COMMON ACTION WITH OBJECT TO PRODUCE PROFITS OR GAINS SHARING OF PROFITS AND LOSSES JOINT AND SEVERAL LIABILITY OF THE MEMBERS; AND SOME KIND OF SCHEME FOR COMMON MANAGEMENT

EPC Industry in India: Issues and Challenges

EPC Report New.indd 28

| 28 |

2/20/2011 8:13:44 PM

Key Internal Issues

The key internal challenge facing the

the director of one of India’s leading

Most mid-size fast growing EPC

Indian EPC industry today is issue of

engineering and construction company.

companies in India are facing issues

being able to manage scale and diversity,

The glue that binds all these together

related to empowerment of Project

with the rapid growth in business and

is Project Management. Project

Managers and the primacy of the Project

diversification into new business areas.

Management is a science, with its own

Management function in an EPC firm.

Other issues around improving the

school of tools and techniques, both

quality and value addition of engineering,

in the scientific and the behavioural

As a result, projects are de facto mana-

implementing leading practices in

domain.

ged by Business Unit Heads or other

project management, implementing modern construction methods are

very senior professionals,

“E+P+C is not equal to EPC”

also specific challenges facing the

reducing the designated project managers to co-

industry players, but we believe these

“In our company, project managers

ordination roles, and resulting in senior

will get addressed in natural course

are GODs” is the common refrain

management being involved in day to

as the EPC industry matures in India.

in international EPC or engineering

day project issues.

However, the core challenge facing the

companies. However, this is not the

mid-size, fast growing companies are

case in Indian EPC companies, as

Further, with business growth, senior

around effective project management,

is evident from various perspectives

executive time available for a specific

management of growth and scalability

provided by Indian companies as well

project becomes limited, resulting in

without compromising on project and

as developers. A leading Hydrocarbon

loss of execution control. We suggest

business risks, and developing systems

major, in an industry forum, called upon

that fast growing mid-size companies

and processes to make companies

the EPC companies in India to develop

relook at their organization structures

more scalable and less dependent on

better project management talent, and

and policies to ensure that their project

individuals.

especially requested the Indian offices

managers are empowered. They should

of global firms to rotate local talent

have accountability for project cost and

Project Management

through global assignments to develop

time control, and adequate control over

“E+P+C is not equal to EPC” said

these skills.

decisions related to the project.

RESPECT FOR SENIORITY IN INDIA LEADING TO PROJECT MANAGER EMPOWERMENT ISSUES THE OTHER DIMENSION OF THE CHALLENGE IS THE RESPECT FOR SENIORITY IN THE INDIAN CULTURE. WHILE PROJECT MANAGERS ARE DE-FACTO CEOS OF A PROJECT, THEY MAY NOT ALWAYS BE MOST SENIOR IN THE PROJECT ORGANIZATION’S HIERARCHY. THE PROJECT TEAM MAY CONSIST OF ENGINEERING COORDINATORS, CONSTRUCTION MANAGERS WITH MANY MORE YEARS OF EXPERIENCE – WHO WOULD BAULK AT REPORTING TO THE DESIGNATED PROJECT MANAGER DUE TO THEIR CULTURAL CONDITIONING. | 29 |

EPC Report New.indd 29

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:44 PM

Organization Design & Management: Building the Engineering

ORGANIZATION As we discussed earlier in evolution of

Engineering which being a knowledge

EPC companies, who would like to

EPC companies, most EPC companies

based function requires careful design of

balance efficiency with effectiveness.

are likely to evolve from the construction

organization structures, career paths and

For example, companies tend to

or the developer route. In both the cases,

development strategies, and a different

centralize “end-use / process”

the key capability gaps would remain in

approach to performance assessment

independent engineering disciplines

the domain of engineering. While Project

and management as compared to the

like civil, structural and electrical, while

Management is the execution arm,

other functions in the organization.

the other disciplines are de-centralized.

engineering does and should function as

However, there is no right answer, it

the brain, adding competitive advantage

Also, with rapid diversification, the

needs to be carefully assessed in light

in terms of standardization, value

centralization vs. decentralization

of the company’s portfolio, strategy and

engineering and technology leadership.

question stares at managements of

culture.

Risk Management Less than one third of the survey respondents in KPMG-PMI Infrastructure report, had confidence in their risk management capabilities. The EPC business model revolves

risks. Hence it is absolutely critical for

processes for risk identification and risk

around taking ownership of project

EPC companies to establish robust

management. Such a process would address risks identified at both the sales and execution stages of the project. While the ideal situation would be for EPC companies to be able to identify, mitigate or provide for all risks at the tendering stage, this is usually not practical, given the need to complete bids within a specified deadline, and to not rely indiscriminately on additional contingency

Source: PMI-KPMG Study on drivers for success in infrastructure projects 2010 - Managing for change EPC Industry in India: Issues and Challenges

EPC Report New.indd 30

margins that may impair

| 30 |

2/20/2011 8:13:44 PM

the competitiveness of the bids. Hence

based on risk ratings. Similarly, the

help of knowledge and experience that

while key risks are identified and mitigated

portfolio of projects is weighted based

is codified into these tools. These risk

during the bidding stage, a large number

on risk categories as strategic planning

assessment frameworks, customized

of additional or minor unmitigated risks

inputs. Another common element is

and developed with the inputs from

may need to be addressed during

Independent review of risks by personnel

senior management of the company, can

ongoing project execution. Most leading

not directly involved in Project Sales or

flag off critical risks in the tenders, and

international EPC companies, process

Execution. With the rapid growth in

ensure awareness and more informed

all enquiries / tenders through a risk

order books, and a senior management

decision making during bidding. Also,

identification process based on which,

stretched for time, it is essential that

nuanced and differentiated processes of

go-No-go decisions are taken, and risk

Indian companies also rely less on

project execution, monitoring and control

ratings are assigned to each project or

individual or subjective experience

and staffing of projects based on the risk

proposal.

and expertise, and more on agreed

assessment will help in focusing the

risk management tools and objective

best and most careful decision making

The more sophisticated systems also

frameworks which can be used even

capacity towards the most risky of the

have contingencies and margin policies

by less experienced people with the

projects in a company’s portfolio.

strategies are either ‘reduce’, transfer or avoid. While “accept risk” type strategies are used infrequently, ‘exploit’ strategies are rarely used. The industry thus is yet to reach maturity levels at which mitigation strategies are leveraged to exploit project risks and are used as means to maximize project income potential. Risk reporting and monitoring are the remaining links in the risk management Source: PMI-KPMG Study on drivers for success in infrastructure projects 2010 - Managing for change

process that are critical for its effectiveness. Evolving information systems can make timely and accurate

The KPMG-PMI study in 2010 also

that were hitherto unidentified and hence

project information for reporting

highlighted the some concerns on the

not mitigated. Critical improvements are

purposes. The information reported

comprehensiveness of risk identification

also required to acquire a robust level

should comprise early warning indicators

by companies, given the high incidence

of sophistication and maturity in risk

and provide content that facilitates

of projects having suffered due to risks

mitigation. Routinely used mitigation

decision making.

| 31 |

EPC Report New.indd 31

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:45 PM

Procurement

disclose overall project cost budgets

burden of that job has been transferred

for confidentiality and flexibility

to developer or the consultant.

purpose.

Procurement can be a vital element

The constant trade-offs between

This is however, not the case with private

delivery in EPC projects. In projects with

procurement time and procurement

sector clients, especially new entrants.

low construction intensity like Power

costs to meet the often conflicting

EPC companies we believe, would

projects, Refining and Petrochemical

goals of cost control vis-a-vis

benefit significantly from an increased

complexes and other industrial plants, just

schedule control on a project.

focus on vendor development, including

influencing timely and profitable project

l

supporting high quality emerging vendors

the standard “bought-out” components may comprise anywhere between 30-50

It requires companies to evolve strong

in getting themselves accredited with

percent of the project value, apart from

sourcing teams, capable of vendor

PSUs.

other procured items like construction

discovery and price discovery on a

materials and sub-contracted services.

larger scale than would be required

Given this context, we feel Procurement

There are several reasons leading to

in a manufacturing set-up. In most

capability can emerge as a strategic

complexity in the procurement function

manufacturing companies, rate contracts,

differentiator for improving performance

of an EPC company:

differentiated procurement processes for

and winning business in the EPC

minor vs. major items, and MRP based

industry. It requires efforts on the part

Number of individual items to

procurement processes reduce the

of engineering, procurement and client

be procured for a large project,

transactional overhead significantly.

facing personnel to discover, qualify

l

new suppliers and convince customers

within specific and often varying l

deadlines.

Moreover, most public sector units have

to include them in their approved lists or

Cost targets for Procurement are

made, depending on how one looks

allow deviations on the projects. We feel

usually set at individual component

at it, the job easier or more difficult for

however, in the emerging high growth

level, not at an overall Procurement

contracting companies by providing

but hyper competitive scenario for EPC

budget level – since senior

vendor lists. This has resulted in vendor

companies, this would be a worthwhile

management usually does not

development take a backseat as the

investment to make.

EFFICIENCY IMPROVEMENT INITIATIVES FOR PROCUREMENT FUNCTION l

l

l

REDUCE CYCLE TIME, BY DESIGNING THEIR PROCUREMENT PROCESSES FOR INCREASING DECISION MAKING SPEED REDUCING THE NUMBER OF TRANSACTIONS BY STANDARDIZATION AND IDENTIFYING COMMON ITEMS ACROSS PROJECTS EXECUTED IN THE PAST IMPROVE THE COMPETITIVENESS OF THEIR SUPPLIER BASE BY CASTING THEIR NET WIDER, INCLUDING ELEMENTS OF GLOBAL SOURCING IN THEIR STRATEGY

EPC Industry in India: Issues and Challenges

EPC Report New.indd 32

| 32 |

2/20/2011 8:13:45 PM

End-Use Industry Views Power Generation Power Generation Units – especially

term. The thermal power and nuclear

equipment sourcing, engineering and

thermal power plants are likely to be

power units both have relatively lower

integration management as compared to

amongst the largest opportunities for

civil construction component and

other infrastructure classes like Roads,

EPC players in the short to medium

require superior capabilities in terms of

Ports etc.

Demand Outlook By 2015, India would need to increase

significantly across regions and is

additions was conducted based on a

its current generation capacity of 152

estimated as 62 GW in Western Region,

variety of sources such as the CEA

GW to 205 GW (an increase of 53 GW)

62 GW in Northern Region, 54 in the

database for upcoming additions,

till year 2014-15 for meeting the base

Southern Region, 24 GW in the Eastern

industry reports and KPMG’s internal

load capacity requirement to support

Region and 3 GW in the North Eastern

assessment. Only those plants which

growth of economy at 8 percent and

Region of India in the year 2014-15. This

have reached an appropriate state

address unavailability of power in many

projection implies an average annual

of readiness for commencement of

parts of the country. To meet the peak

generation capacity addition at the rate

commercial operations within the period

load capacity requirement, the installed

of 16 GW per year during the period

FY 2010-15 have been considered

capacity requirement would need to be

2007-08 to 2016-17 (covering two 5

for capacity addition. Effective supply

more than 270 GW.

Year Plan periods in India viz. XIth and

addition for each year of the period

XIIth). During the IXth (1997-2002) and

(FY 2010-15) was calculated based on

The generation capacity gap to

Xth (2002-2007) 5 Year Plan periods,

the total capacity addition. We expect

meet baseload requirements varies

the average annual generation capacity

a total capacity addition of 99 GW in

addition in the

this period. Assuming a similar rate,

country has been

this translates in to an approximate

3.6 GW and 4.2 GW

opportunity size of INR 500,000 crore

respectively. The

(i.e. over USD 100 Billion) towards

poor performance in

capital expenditure for these plants.

the past is attributed

The majority of this investment will be

to implementation

towards thermal power plants, of which

Expected Capacity Addition (GW)

6

by the

80 GW are likely to be commissioned by

public sector utilities

2015. The opportunities for EPC players,

coupled with hitherto

equipment vendors are for projects which

limited private sector

are likely to get commissioned beyond

participation.

2012-13 as they are the ones which are

delays

mostly likely yet to be tendered out - for Source: KPMG Research and Analysis 6

balance of plant equipment if not main

of expected plant

plant equipment.

And not necessarily poor planning | 33 |

EPC Report New.indd 33

A bottom up analysis

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:45 PM

End-Use Industry Specific Issues

The thermal power industry has been one of the fastest to adopt the EPC

the entire sector is favourably inclined

generation projects in their planned

towards contracting project execution

portfolio.

model

on a LSTK basis. The current landscape indicates that large public or private

While complete power plant as a single

The Power Generation industry has

sector generation companies like NTPC,

EPC/ LSTK package is still rare in the

seen one of the fastest adoption rates

given their internal engineering and

Indian scenario. Moreover, the trend

in terms of EPC contracting model.

project management talent pool, will

of not awarding the entire EPC job (i.e.

Prior to the reforms in the power sector

continue to buy individual packages,

both BoP and BTG of a power plant) to

and the policies around public private

keeping the integration to themselves.

one single service provider has been driven by:

partnership models, power plants were

Distinct set of competencies required

being constructed by the state level

However, they may combine multiple

generation companies and NTPC. The

power plants in their portfolio, going for

for the BTG and BoP packages.

tariff regime and operating models of

combined bids to get the best prices and

While BTG is technology, equipment

some these power generation entities at

reducing transactional bidding costs.

and manufacturing intensive, BoP

that time did not require utmost attention

NTPC floated a tender for different

requires complex integration

to projection completion on schedule

packages for 11 units of 666 MW each,

capabilities of sub-systems to be

and to cost budgets. However, with the

the award of which is likely by first

sourced, erected and commissioned

competitive power pricing policy PPP

quarter of 2011. With this move, NTPC

from different sources.

bids, - wherein one can participate in

is expecting to bring down the cost/MW

developing power, only if you are the

of setting up power plants, which many

unt to a range of around INR 6000

most efficient on capital cost as well as

experts believe today is at about 5.5

crores for a typical 2X660 MW

7

l

l

A single LSTK package would amo-

operating cost - has led to increased

crore/MW . State level generation

project, requiring EPC companies

focus on executing projects on time and

companies, most of whom are currently

with large balance sheet and risk

within budget. Most projects are being

on the twin package mode (BTG and

bearing capability. It will be difficult

financed by project finance companies

BoP), may continue to procure in that

to find enough number of such

and financial institutions, who demand

manner.

contractors to get a competitive bid.

that developers manage the project budget escalation risks.

The trends in the private sector are interesting, where a distinction needs to

Internal teams at even established

be made between large business groups

generation companies are stretched,

like Reliance ADAG, Essar Group, JSW

and at the same time, there have been

Group, Sterlite Group, GMR Group,

a large number of new power sector

Lanco etc who are likely to build large

entrants, some with limited background

portfolio of power projects in the future,

in executing large projects. Hence

vis-à-vis smaller players with fewer

7

Source: http://www.sify.com/finance/ntpc-likely-to-float-rs-18-000-cr-tender-news-equity-km4bvDidjib.html

EPC Industry in India: Issues and Challenges

EPC Report New.indd 34

| 34 |

2/20/2011 8:13:45 PM

Typical Outsourced Package Structure by Thermal Power Plant Developer Segments Central Sector PSU

State Sector PSUs

Private Sector

UMPPs

EPC Contract · Not Applicable for Entire Plant (BTG + BOP)

Rajasthan Rajya Vidyut · Companies like GMR, Not Applicable Utpadan Nigam Ltd Jaypee, Essar, Indiabulls (RRVUNL) Projects which have their own Project companies

* Balance of DVC projects to be Plant – EPC tendered as single BOP package· NLC also expected to go for BOP in the NLC TPS – III

· Some state generating companies like Maharashtra, Madhya Pradesh, Chattisgarh are going for the BOP route

The new entrants and small-to-mid size players in the IPP market may go for BoP

BOP route unlikely given the scale of orders and also due to the fact that most large power developers have EPC companies

Coal Handling · N T P C , N L C S t a t e g e n e r a t i n g · Companies going for Plant (CHP) – s e p a r a t e C H P companies going for split split packages have CHP packages have CHP separate package separate

Tata Power Mundra UMPP awarded CHP separately to Krupp: Reliance Infra undertaking Sasan UMPP on EPC basis

Ash Handling · N T P C , N L C Some state generating · Companies going for S e p a r a t e p a c k a g e s Plant (AHP) – s e p a r a t e A H P companies combine AHP split packages have AHP expected from the UMPPs package with Main Plant but that is separate slated to change W a t e r · NTPC and NLC – S t a t e g e n e r a t i n g · Water packages will Water packages will be Packages separate packages c o m p a n i e s o f We s t be split split Bengal, ie, WBPDCL and DPL will give complete water packages; rest will split Source: KPMG Research, News Analysis

The large business houses like Tata,

Company for main plant equipment

to imagine, large private companies

Reliance, JSW, Adani have significant

supply for all its thermal power plants,

wanting to outsource setting up of power

in-house capabilities as far as project

and in the process also getting access to

plants to EPC companies on a turnkey

execution goes. Moreover they have

cheap funds. Estimates put the savings

basis. If EPC companies are looking

substantial leverage with equipment

on financing cost alone at INR 6500 Cr.

to capture this private sector market in

vendors and sub-contractors due to

for just the Sasan UMPP project being

utility power plants, we believe they will

their large portfolios. (Reliance has

8

developed by Reliance Power .

reduces power plant capital expenditure

demonstrated this by entering in to an agreement with Shanghai Electric

have to bring a value proposition which

With that kind of leverage, it is hard

costs by at least 10 – 15 percent over the currently prevailing benchmarks, through

“Do the EPC companies really deliver for us?” - Power Plant Developer 8

project execution capability.

Economic Times, 23rd January 2011 | 35 |

EPC Report New.indd 35

efficient global procurement and strong

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:45 PM

Hence in terms of contracting model,

procurement capabilities, and hence

regarding Chinese supplies have

the following trends are likely to sustain

will place smaller sub-contracting or

been expressed, we understand from

/ materialize

equipment orders.

our interview respondents that there

In the BTG segment, the Chinese

is no conclusive evidence to this

Majority of the public sector projects

companies will likely continue to

effect. In fact a CEA study9 in 2008

or projects of new developers are

have the second largest market

found no material reason to doubt the

likely to be on twin package route

share, after BHEL. It may be difficult

quality or the technology offered by

(BTG and BoP)

for Indian companies in JV with

the Chinese suppliers. On the other

Most large business houses in

foreign partners to make inroads in to

hand, BHEL is the most established

the Thermal Power business will

this market due to the cost advantage

player in Indian with ~60 percent

manage their projects in-house to

offered by the Chinese players due

market share and with recently

leverage their portfolio, faith in their

to overcapacity in their domestic

augmented capacity should continue

internal project management and

market. While quality concerns

to protect its market share.

l l

l

9

Report of the Committee to study Design Features of Boilers and Auxilaries being sourced from Chinese Manufacturers, September 2008 EPC Industry in India: Issues and Challenges

EPC Report New.indd 36

| 36 |

2/20/2011 8:13:45 PM

Refining and Petrochemicals Demand Outlook Oil and gas constitutes about 65 percent

Five year plans Planned Expenditure vs Actual Expenditure

of the global and 40 percent of the the Indian context, the primary energy consumption over the last five years has increased by over 6.5 percent CAGR as compared to global increase of about 1.7 percent CAGR. The overall contribution and pace of growth of oil and gas provides a perspective on the

Investment (in INR thousand crores)

Indian primary energy consumption. In

250

-

200

150 112 67

100 169 50

127

0 VII Plan

importance of this segment to the Indian economy.

VIII Plan

Planned Expenditure

Actual Expenditure

X Plan

XI Plan*

Actual expenditure as % of planned outlay

*XI plan actual expenditure is only up to August 2009 Source: Planning Com m ission

Oil and gas is one of the few sectors which exceed the investment targets as laid out

increase in planned expenditure. This is

and private companies have announced

in the Government’s five year plans.

mainly because of aggressive investment

their investment plans in the various

For instance, in tenth five year plan, the

plans by oil and gas companies in India.

streams of the oil and gas sector such as

actual expenditure was 112 percent of

The actual expenditure during the first

exploration and production, oil and gas

planned outlay at INR 1,08,003 crores.

two years and 4 months of eleventh plan

pipelines, petroleum refineries, liquefied

Similarly, during the midterm appraisal of

(up to August 2009) is INR 1,08,625.91

natural gas, city gas distribution and

eleventh plan, government has to revised

crores which is 47.38 per cent of the

petrochemicals. All these investment

its planned outlay to INR 2,69,461 crores

plan approved Outlay. The Oil and gas

plans would create a robust opportunity

from INR 2,29,278 crores, a 17 percent

sector is poised for growth. Many public

for EPC companies. The total value of the EPC10 opportunity in India for Oil and

EPC Investment opportunity in Oil & Gas Sector

Gas sector can be pegged at USD 60

70 60

21-23

2

60-65

3

USD 18 - 20 billion has been envisaged

40

in the next five years for development

12 30 20

- 65 billion in the next five years. On the upstream side, an investment of about

50

of offshore fields and laying pipelines. 18-20

1

A substantial part of this investment developing the east coast gas discoveries

O

Source: KPMG Analysis

To ta l

0 Re fi n er ie LN s G Te rm in al s CG D N et w or Pe k tro ch em ic al s

is expected to be done by ONGC in il Pi pe li n es G as Pi pe l in es

10

U ps tre am

Investment (in USD Billion)

3-4

and maintaining production from existing discoveries. Moreover, the government is

10

Refers to opportunities for engineering and construction companies as well as equipment suppliers, not restricted to those on offer through the EPC-LSTK model | 37 |

EPC Report New.indd 37

IX Plan

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:47 PM

also planning to offer shale gas blocks

an EPC opportunity of USD 2 billion. In

in first two rounds and plans to have

in second half of 2011, which will create

addition, the Ministry of Chemicals and

offer further 16 cities in next two rounds.

more opportunity over and above the

Fertilisers has approved proposals of

Thus even if one were to assume a

aforesaid investments. The midstream

about USD 35 billion in three regions

conservative spread per city, the EPC

segment would see a spurt in investments

under its flagship Petroleum, Chemicals

opportunity in CGD network is about

given that the PNGRB is in the process

and Petrochemicals Investment Regions

USD 3-4 billion in the next 5 years.

of awarding four key pipelines segments

(PCPIR) policy. These three PCPIRs are

more than 4,000 kms. Further there has

— Visakhapatnam and East Godavari

been plan to launch additional pipeline

districts in Andhra Pradesh, Bharuch

End-Use Industry Specific Issues

such as Asansol-Howrah, Chennai-

in Gujarat and East Midnapore in

The Hydrocarbons industry is unique in

Nellore and other pipeline segments

West Bengal. We have not included

terms of player profiles as the very best

as part of national gas grid. This would

investments in PCPIR in our overall

in the world have a presence in India.

mean an EPC opportunity of about

estimate. City Gas Distribution (CGD)

Here is just a sample list of companies

USD 12 billion in natural gas pipelines.

is another downstream segment which

operating in India, not just by means of

Additionally around USD 1 billion

is set to see a spurt in investment

having offshore engineering centers, but

investment opportunity exists in crude

opportunities, due to new domestic gas

having won & executed projects in India.

oil and petroleum products pipelines.

discoveries and bidding by PNGRB.

Our discussions with these companies indicate that they have at least 20

Further, to meet the domestic gas supply constraint, LNG regasification terminals

The regulator has already completed

percent of their India center manpower

have been planned at Kochi, Mundra

the bidding for 13 geographical areas

deployed on Indian projects.

and Ennore which would require the capex investments of about USD 3 billion

Examples of International Engineering Companies Presence in India in Oil and Gas

by 2015. In the downstream segment,

Company

India Offices11

Examples of India Projects12

refinery sector has seen number of

Chennai, Kolkata and Gurgaon

IOCL Paradip Refinery FEED package

announcements by companies for

Foster Wheeler

expansion of existing plants and setting

Uhde India Mumbai, Pune

up of Greenfield refineries. The new

Jacobs India

Ahmedabad, PMC and EPCM for Manali Refinery Resid Vadodara, Mumbai, Upgradation Delhi

Technip

Chennai

the EPC opportunity can be pegged

Tecnimont ICB

Mumbai, New Delhi EPC for Polypropylene plants at IOCL Panipat

at about USD 21 - 23 billion. Besides

Linde

Vadodara

Hydrogen Plant at IOCL Barauni

this, some companies have announced

Aker Solutions

Mumbai

Engineering, Procurement, Project Management and construction/commissioning assistance for Reliance Polypropylene plant

refineries are expected to increase the India’s refinery capacity by 55 mtpa. Given that refineries are highly capital intensive,

firm additions in their petrochemical production capacity which would mean 11 12

PMC for Refinery Units of BPCL, Mahul,

EPC for Ethylene Storage System of Chemplast Sanmar

Source: Company Websites and News Reports

Including offshore engineering centers supporting global projects Not an exhaustive list of projects, examples provided only to demonstrate instances of work executed in India

EPC Industry in India: Issues and Challenges

EPC Report New.indd 38

| 38 |

2/20/2011 8:13:49 PM

It is a phenomenon very unlike the other

user industry feels that the EPC

FEED, so that it is good enough

sectors discussed like Power Generation

companies are just not willing to

to give it out for LSTK itself takes

or other infrastructure segments. One

take large risks in this sector. While

about a year, followed by bidding

of the differentiating factors is the

L&T and Punj Lloyd are among the

and contracting for another year.

engineering and equipment intensity, put

few Indian companies capable of

This process adds a good two

together as the technological intensity of

taking up large LSTK packages,

years to the 3 odd years of project

the projects. This is an area where the

the international companies do not

execution cycle. Moreover, Indian

relative strengths of the international

have Indian balance sheets of the

user companies seem reluctant to

companies are believed to be superior.

size wherein they can afford to take

spend that kind of man-hours and

Moreover, the qualification criteria

such large risks. The international

cost towards front end engineering.

are stringent and past experience in

parent companies hesitate taking

a particular type of unit / package is

up large projects in India on account

is being done by the state run

demanded. As a result, it has been

of their internal risk assessment

oil marketing companies, ONGC

observed that international companies

policies. Additionally, there is

or Reliance. While the state-run

have established their niches. Amongst

ambiguity related to various taxation

companies have their large in-

Indian companies, the key players

issues, which results in limited

house teams developed over the

include Larsen and Toubro, Punj Lloyd

number of bids being received in an

years to take on the integration

and recently Essar Projects, which has

international competitive bid route.

challenge, companies like Reliance

received large size orders in the recent

One of the state-run refining and

are well-equipped to assume the

IOCL refinery project.

marketing company highlighted the

project risks on their own, given their

lack of enough number of global

entrepreneurial history and esteemed

The industry is also unique in terms

bids received, when they did break

project management capabilities. In

of the prevalent contracting models,

their contracting pattern to attempt

that light, the LSTK model or larger

with very little being given out as LSTK

awarding large LSTK packages.

packages would be possible only in

contracts. The various reasons cited for

KPMG’s tax experts believe there

the event that the internal teams of

this phenomenon are as follows

are ambiguities in Indian taxation

Petroleum companies are stretched

laws related to importing of capital

on account of a large number of

Limited set of LSTK contractors

equipment for projects, and also in

capital expenditure projects ( which it

in the Oil and Gas sector, capable

taxation on work performed in India

appears, is not the case), or there are

or willing to execute large turnkey

for global companies, which force

mid-size refining and petrochemical

contracts. While the EPC companies

these companies to either not bid,

companies setting up plants in India.

believe that process plants are

or bid very conservatively.

The answer in terms of encouraging

The complexity of the process

mid-sized players to invest in India

front end and basis engineering

industry makes it difficult to prepare

seems to have been found in the

which will provide the solid ground

detailed and comprehensive fixed-

form of PCPIRs being set up in the

for firm estimation is lacking, the

cost bids. The preparation of the

country which will encourage foreign

l

too complex and the quality of

l

| 39 |

EPC Report New.indd 39

l

Majority of the capital expenditure

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:49 PM

as well as domestic investment, with

marks the entry of the famed Korean

Indian EPC companies looking to enter the

the feedstock being supplied by the

EPC companies to India.

Hydrocarbons sector, have to overcome

anchor investor. Though not exactly

the challenge of qualification.

petrochemicals venture, OPaL, being

Contracting Models: Medium Term Outlook

The routes adopted by them to build their

set up in the Dahej PCPIR is a case

As far as the hydrocarbons and the

credentials have included

in point. ONGC has limited in-house

process industry is concerned, it will

a) acting as sub-contractors to

expertise in petrochemicals, and

likely continue to see the dominance

international companies,

hence there is a clear difference

of the EPCM model of contracting.

b) bidding in consortiums or

in the way it has gone about its

However, to reduce the complexity

c) acquiring small companies which

procurement. The EPC order for the

of procurement and integration, the

ethylene cracker has been placed on

individual packages being procured for

a consortium of Linde and Samsung

a Greenfield refinery or similar plant, are

However, as compared to EPC in other

Engineering India. This is one of the

likely to come down from the current 20-

industries or infrastructure segments, it

largest EPC contracts awarded in

25 to may be 10-15 packages and even

is a more gradual process to establish

India in the Oil & Gas sector. Also, it

less going forward.

oneself in the Oil & Gas sector in India.

falling in this bracket, ONGC’s

EPC Industry in India: Issues and Challenges

EPC Report New.indd 40

have partial qualifications.

| 40 |

2/20/2011 8:13:49 PM

Water Demand Outlook Wa t e r R e s o u r c e M a n a g e m e n t

with high demand are not well connected

for industrial purposes in developed

– A Critical Global Challenge and

with regions of high supply. Given

countries as opposed to 80 percent for

Burgeoning Opportunity

the demand-supply mismatch and

agricultural use in developing nations.

The Worldwide Plant market for water

increasing emphasis on sustainability,

Both public utilities and private players

treatment has been estimated at USD

water management is a sector expected

operate in this space with private players

to experience high growth.

accounting for 44 percent of the serviced

13

380 Billion Dollars as of 2009 . Water

water in Europe as opposed to only 12

demand is increasing due to growing levels of industrialization and the spurt

Structure of the Water market

in global population. However regions

Nearly 50 percent of water use is

13 14

percent in South East Asia14.

Techpetro Asia Newsletter (April 5,2010) SAM group – Water - A Market for the future (2010)

Comparison of Global Water EPC Market with India Key Characteristics

Description

India

Industry Structure

Global move towards consolidation has led to the formation of multinational corporations like Veolia, Suez etc having presence in more than a number of nations and latest reported revenues of over 10 billion USD

Growing opportunity in the Indian market has led to the growth of Indian firms in partnerships with global majors, intending to participate in the planned privatization of the water utilities market in India.

Technology

Patented In-house technologies possessed Procurement of technology through tie-ups with foreign by most companies. No one technology majors dominates

End Use Consumers

Industry consumes nearly 50 % of all water Agriculture consumes over 80 % of total water

Domestic opportunity

Historical infrastructural activity surrounding Very little penetration of the Domestic market.Large heavy industry development and emphasis opportunity going forward on sustainability provided the necessary project management experience.

Typical Contract Mode

DBO/BOT (Design Build Operate,Build EPC (Engineering Procurement and Construction). Operate Transfer). Focus on both building Also DBO/BOT basis contracts. and operation of the facility

Source: KPMG Research and Analysis

Indian Scenario: A growing market

during the first decade of the 21st

sanitation, including urban drainage

with a lot of opportunity

century, driven by increased central

and solid waste management16. While

Due to the multiplicity of issues plaguing

government grants made available

private sector interest in the sector

the sector, the Central, State and Local

under Jawaharlal Nehru National Urban

has increased, critical barriers such as

governments are investing significant

Renewal Mission (JNURM) and funding

poorly written contracting documentation,

amounts of money in the sector. Add-

from development agencies such as

large timelines to project award and

15

itionally, funding to the water sector

ADB, World Bank and JICA . The 11th

sub-optimal risk sharing mechanisms

by development banks is increasing

Five-year plan (2007–2012) foresees

continue to hinder the growth of private

manifold. Investment in urban water

investments of INR 127,025 crore (USD

sector investment in the water sector

supply and sanitation has increased

28.6 billion) for urban water supply and

in India17.

15 16

ADB: www.adb.org/India/main.asp; World Bank: go.worldbank.org/E9RO7F96W0; JICA: www.jica.go.jp/india/english/activities/ 17 Planning Commision of India ‘India Infrastructure at crossroads’ Thomas Reuters. September 24, 2010 | 41 |

EPC Report New.indd 41

EPC Industry in India: Issues and Challenges

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Opportunity Drivers and Trends for EPC companies in Water Segment Opportunity Area

Drivers and Trends

Wastewater Treatment

l l l

Water Treatment and Transimission

l

Industrial Water Infrastructure

l

Desalination

l

l

l

l

Water Management

l l

Agricultural Demand

l

Stringent enforcement of sewage disposal norms Shortage of Water for Industrial use Opportunity in building sewage collection infrastructure and Treatment plants Increasing Urbanization Opportunity in the form of EPC / BOOT model including metering and collections Large capacity additions in Power and Steel EPC is the preferred Contracting model Reducing cost of desalinated Water, couple with water shortage Medium term adoption in the industrial sector Leakage reduction programs by Municipal bodies Small projects, opportunity for engineering and equipment suppliers Irrigation projects and driving efficiency of water usage to agricultural consumers. Limited opportunity for EPC players

Source: KPMG Research and Analysis

End-Use Industry Specific Issues Structure of the Indian Private

operations is mentioned below:

Sector A snapshot of some companies operating in the sector along with their area of

Source: KPMG Research and Analysis EPC Industry in India: Issues and Challenges

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Contracting Models for Private Sector Participation in Water Projects Contract

Definition

Duration

Turnkey

Contract to private sector Construction E f f i c i e n c y i n Low to design and build the period construction system for a fixed fee; funded by the public sector

Time & activity linked fixed fee

Design-BuildOperate

Contract to private sector 5 – 10 yrs to design and build the system for a fixed fee, and to operate the system for a few years; funded by the public sector

E f f i c i e n c y i n Medium construction with operation & maintenance e ff i c i e n c y f o r some time

Time & activity linked fixed fee – constructionPerformancebased fee - operation

Design-BuildFinanceOperate

Private sector builds, 15 – 30 yrs finances and operates a facility and sells products/ services to users; could be partly financed by the public sector as well

F i n a n c i n g , High construction efficiency and operations efficiency for a longer time

Performance-based fee – operation post commissioning (revenues from end-users + subsidy from ULBs, if any)

Management Contract

Private sector carries 5 – 15 yrs out the operation and maintenance of some or all components of the water system

O p e r a t i o n M e d i u m Performance-based fee e f f i c i e n c y – High – operation Typically includes a design component

FBC (FeePrivate sector carries out 1 – 3 yrs Based Contract) one or more specified tasks while the public authority remains primary provider

Skills Sought

Skills as sought

Risk Transfer Payment

Low

Fixed fee (per unit)

Source: KPMG Research and Analysis

There is a need to standardize contracts to a limited set of standard models and a

l

general set of services, in order to speed up contracting processes and the speed

l

of award of contracts. In summary, we

JNNURM

the future mode of collaboration will tilt

Increasing urbanization and lifestyle

towards PPP model participation rather

requirements for water

than stand alone EPC contracts18

Major Power Generation and Steel Plant projects.

Going forward, we expect several major

Water treatment can emerge as an

business groups to foray in to the Water

major and attractive opportunity for EPC

additional revenue source & a hedge

sector, and indeed, several of India’s

companies as well Infrastructure players

against declines in other Industrial

largest conglomerates have already

in India, driven by:

markets for domestic EPC firms.

done so. Given the likely preference for

expect the water sector to become a

l

PPP / BOT, BOOT models to emerge in l

l

18

Stricter enforcement of regulations

Further, given the fact that a large number

this sector we are likely to see more EPC

surrounding industrial waste

of contracts in the water space will be

companies becoming project owners

Public sector investment in

awarded by ULBs across the country,

and developers as well in the water

urban renewal programs like the

given the finances of most ULB’s in India,

segment.

Industry Inputs | 43 |

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Snapshot of Some Relevant International Trends

The global plant market was valued at

player participation19.

form the largest portion of the market. A

USD 1.6 trillion dollars as of 2009, of

chart representing the breakup between

which nearly USD 730 Billion dollars

Of this power, water treatment and oil

various sectors in the construction

worth of projects were open to foreign

exploration and production (E&P) activity

industry is given below.

Breakup of Global Plant Market

20

Going forward, the “international bidders

trillion dollars by 2015. Asia Pacific and

expected to contribute to about 58 % of

eligible” component of the global plant

the Middle East in particular will be the

all orders generated globally.

market is expected to increase to 1.11

key growth drivers for this region and are

19 20

Techpetro Asia Newsletter (April 5, 2010) Techpetro Asia Newsletter (April 5, 2010)

EPC Industry in India: Issues and Challenges

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Characteristics of the Global Construction Market21 The global construction market is essentially split into three major segments

Source: KPMG Research and Analysis

21

http://cdiver.net/news/south-korean-firms-taking-work-in-the-middle-east/ | 45 |

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The Growth of the Korean EPC Industry – Some Observations22 The Korean Construction industry

biggest foreign market for construction

the Oil and Gas and Petrochemical

picked up steam after the Korean war in

activities though Korean companies have

space in the Middle East, a result

the 1950s, first by rebuilding essential

diversified into other regions recently.

of decades of project execution and

domestic industries and real estate

growing engineering and technological

destroyed during the war and then by

Middle Eastern contracts accounted

prowess. Some key enablers for the

taking these skills and capabilities to

for 73 % of total international contracts

Korean construction industry have been

international projects. The Middle East

in 2009. Korean companies have

mentioned in the following table, along

with its oil revenues represents Korea’s

increasingly bid and won projects in

with comparison with India.

22

http://www.khl.com/magazines/international-construction/detail/item61017

Key Enablers for Korean Construction Companies and Comparison with Indian Industry Key Enablers

Korean Companies

Indian Industry

Project Management Experience

Large range of projects executed nationally and Only a few Indian companies have broad as well as deep internationally experience in the domestic market. Indian companies have limited foreign penetration

Government Support

Favourable Economic policies and indirect Limited or no direct or indirect governmental support to support through the promotion of research the industry institutes and various infrastructure programs

Domestic Engineering Firms

Korean Firms focused solely on engineering Only one (publicly owned) engineering major which is exist which work in collaboration with the expanding its portfolio to undertake construction projects. construction majors Limited presence of foreign engineering firms in domestic projects. However, a large offshore engineering services sector being built by global majors.

Industry Bodies

Industry bodies exist in a variety of spheres- Labour unions exist , however there are no dedicated technical, economic and labour related providing industry bodies for the EPC construction industry support and engaging with the government on industry issues

Skilled Manpower

Large pool of both labour and engineers Large pool of both labour and engineers available available due to academic support via various related disciplines

Domestic opportunity

Historical infrastructural activity surrounding Large opportunity going forward in the domestic heavy industry development provided the market necessary project management experience. However the opportunity in the domestic market has slowly become saturated

International Leverage

A significant portion of Koreas energy needs are met by the Gulf Cooperation Council (GCC) leading to Korea being an important source of revenue to the GCC

Indian EPC and construction firms presently have limited leverage to win contracts in foreign countries. This may improve along with India’s growing economic importance with its major trading partners

Domestic Equipment often procured from overseas The equipment industry is growing and maturing in India, Ancillary – domestic ancillary industry support has not and can be expected to provide a differentiator in the long Industry Support necessarily been an imperative for Korean run to Indian construction companies construction industry Source: KPMG Research and Analysis EPC Industry in India: Issues and Challenges

EPC Report New.indd 46

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Support from Government and other bodies23 The Korean Ministry of Land, Transport

Institute of Construction Technology etc.

was set up which helped stimulate the

and Maritime Affairs is the primary

Various research bodies like the Korean

domestic engineering services industry.

government body dealing with Korean

Institute of Construction Technology

In addition through the use of various

overseas construction activity through

(KICT), Korean Institute of Construction

treaties and regional agreements,

its arm the International Contractors

Safety Technology (KICST),Korean

the Korean government assists in

Association of Korea. It provides support

Institute for International Economics

promoting business for Korean firms

in the form of providing a forum for the

and Trade (KIET) etc exist to provide

in other nations. Thus Korea posseses

industry to interact with the government

research and other support to the

a skilled set of manpower and has

and through various initiatives like

construction industry. Following the

domestic industries capable of providing

providing dedicated construction training

enactment of the Engineering Services

construction materials like steel, cement

to Koran manpower, the opening of

Promotion Law, the Korean Engineering

at low cost to facilitate the rise of the

educational courses through partnerships

and Consulting Association – a non

Korean construction industry in the

with academic institutions like the Korean

profit group of engineering companies,

international arena.

23

http://www.koreanewswire.co.kr/?job=news&no=345887, http://www.businessweek.com/investor/content/oct2007/pi20071010_252795_page_2.htm http://www.investkorea.org/InvestKoreaWar/work/journal/content/content_main.jsp?code=4580101

Future Growth Plans of the Korean Construction Industry24 The international growth of the Korean

East. The graph below illustrates the

operating both in the civil and industrial

construction industry has picked up

rise in the international order book

construction space. Large corporations

steam over the last decade with an

of the Korean construction industry

dominate and the Top 5 companies

increasing number of orders especially

over the last 5 years. Most Korean

accounted for over 60% of the total order

in the oil and gas space in the Middle

Construction Companies are diversified,

book as of 2009.

Korean companies overseas plant Contracts ($ Billion)

Source: Techpetro Asia Newsletter (April 5, 2010) 24

Company Annual Reports , http://cdiver.net/news/south-korean-firms-taking-work-in-the-middle-east/ | 47 |

EPC Report New.indd 47

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Advantages of low cost of construction

and are also expanding their activities

concepts – Globalization, Expansion of

and the ability to take up risky fixed price

into other segments like nuclear power,

Profit Pool and Transformation through

contracts have won Korean companies

water treatment etc in addition to their

Innovation and other corporations have

contracts in the plant space in the

presence in civil works. There is also

similar blueprints for growth25.

last 5 years. Samsung Engineering is

a greater focus on the development of

pursuing a strategy of building up a

technological and engineering skills to

Thus the Korean Construction Industry

strong base in the Middle East and then

enable Korean companies to operate in

aims to have a spectrum spanning

further expanding into Northern Africa.

a wide range of business domains and

presence with operations in various

Korean companies are increasingly

industry sectors. For example, Daewoo

industry segments through the buildup

focusing on Sustainable Development

has prepared a long term action plan

of technological ability and a credible

as one of the key goals for the future

called GET which includes three strategic

reputation.

25

Source: Company Websites

EPC Industry in India: Action Agenda for Sustained Growth What follows is a summary of

and contribute in related capability

data on each project executed, so

considerations by various stakeholders

development initiatives,

that more industry knowledge is

EPC industry participants in India

publicly available as case studies

need to enhance the sensitivity

and benchmarks for future planning

and focus on Environment, Health

of projects and improving upon past

Overall Industry Level Actions

and Safety standards, and close

performance.

There are certain elements of an industry

practices in this respect. Most

collaboration and representation in

action agenda which have been pointed

industry participants agree that the

both Government and other for a on

out by various industry participants as the

overall standards on safety need to

issues related to the EPC industry.

need of the hour for the EPC industry.

be raised in India.

While there are broader fora available

The Industry participants, either

for the construction industry, the EPC

The major EPC industry players may

jointly or individually need to develop

industry per se is “under-networked”

need to come together to help in

or invite independent agencies for

and not adequately represented

building a talent pool for the industry,

benchmarking of projects, collect

currently.

for the growth and development of the

l

EPC industry in India.

the gap between Indian and global

l l

EPC Industry in India: Issues and Challenges

EPC Report New.indd 48

l

Need for improved industry

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Policy Agenda In recognition of the critical role played

participation in such contracts,

models, representing opportunities

by the EPC industry and related service

as well as lengthens the contract

and risks of very different types.

providers in enabling the growth of the

bidding and award timelines. Unclear

2. A deep understanding of the local

Infrastructure and Industrial sectors of

and poorly written contracts also

market and regulatory environment is

the country, concerned policy makers

lead to greater levels of disputes

critical to long term success. To this

should take note of the policy and

and litigation, commonly resulting in

end, international companies would

regulatory imperatives for support and

project delays.

find it important to take a medium

strengthening of this industry in India. As

3. Facilitate and encourage PPP models

to long term and patient approach

the Korean example indicates, there is an

in vocational education for this sector,

to building their business in India.

important role to be played by an active

supporting the setting up training

Judicious selection of partners for

and supportive policy environment in the

institutes and capacity building in

specific segments / markets would

success of the construction industry in an

the skilled labour supply market

also help to build local market

economy. Some of the key directions for

for engineering and construction

understanding quickly

action would include:

industry.

1. Addressing the weaknesses of the

4. Clarity and simplification of

market segments within each of

present legal mechanisms in the

taxation policies for EPC service

the major end-use sectors may

area of practical “enforceability” of

providers, which will enhance

be very different for International

construction contracts and setting

global participation, and reduce

companies vis-à-vis Indian players.

up speedier dispute resolution

transactional overheads and overall

International companies would find

mechanisms in the case of

cost of projects

it beneficial to assess in detail, the

infrastructure construction projects.

specific types of projects, packages

This would give confidence to

Some Considerations for International

and customer types where their

more competent global players to

Entrants in the Indian Market

deeper technological and managerial

participate in this sector in India,

While it is well known that India’s

capabilities can be a source of

which in turn would make Indian

need for Infrastructure and Industrial

competitive advantage, as well as

industry more competitive.

capacity build out will represent a

provide sufficient returns to offset

2. Standardization and simplification of

very large market for the foreseeable

their higher cost structures vis-à-vis

EPC and related contracts for some

future, International construction and

Indian counterparts.

of the core infrastructure segments

engineering / EPC companies need to

where Government entities are

be aware of additional considerations as

Some key considerations for Indian EPC

the project owners or franchisors

they evaluate their plans for the Indian

companies:

– for example, the Water sector. In

market:

1. Indian EPC companies planning to

several such sectors there exists

1. While large in aggregate, the Indian

diversify into new segments / end-

today a number of different types of

market is varied and complex. It is

use industries, would need to select

contracts of varying complexity, and

highly segmented in terms of a wide

these industries with care depending

perceived risk, which hinders broader

range of business and contracting

on core capabilities, risk appetite,

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EPC Report New.indd 49

3. The attractiveness of various

EPC Industry in India: Issues and Challenges

2/20/2011 8:13:52 PM

and existing competition and develop

trade offs between centralized vs

a differentiated value proposition to

decentralized reporting of support

compete. Potential routes of such

functions like procurement and

entry have been described in an

engineering can change with scale

earlier section.

and diversity of project types.

2. Mid-sized companies which have growth quickly in the recent past,

Finally, build control, efficiency and

may need to allocate management

standardization into key project

attention and budgets towards

management processes and technology

building core capabilities in the area

platforms, which will allow efficient scaling

of Project Management and Risk

up of the business while managing risks

Management, if they have not done

and gaining from past experience.

so already. 3. To achieve a high degree of scalability of their business in a fast growth scenario, some of the following initiatives should help the Indian EPC companies: Developing an empowered pool

l

of Project Managers, by putting in places systems, processes, and training and appropriate leadership frameworks. Developing a robust Risk

l

Management framework, embedded into the tendering and project execution processes. Continuously and consciously improve the ability to measure, manage and exploit risks over a period of time. An adequate Knowledge management system is a critical enabler for enhancing this capability. l

Revisit the organization structure

as the number and complexity of projects under execution go up – the

EPC Industry in India: Issues and Challenges

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Acknowledgements We would sincerely like to acknowledge and thank the following industry leaders for providing their valuable views for this report (in alphabetical order) l

K Venkataramanan, President, E&C Division, Larsen and Toubro

l

Leja Hattiangadi, Jacobs, Director, Business Development

l

Pothen Paul, India Country Manager, Aker Solutions

l

P D Samudra, Executive Director, Business Development, Uhde India

l

P K Chandra, Chief Operating Officer, McNally Bharat Engineering Company Limited

l

P K Johari, CEO, ONGC Petro additions Limited

l

R Jaishankar, Advisor, SNC-Lavalin Engineering India

l

Rajiv Mittal, CEO, VA Tech Wabag

l

Russel Waugh, Managing Director, Leighton Contractors India

l

SS Gangawati, President Strategic Planning, Walchandnagar Industries Ltd

l

Swarup Mukherjee, President, Projects, Walchandnagar Industries Ltd

Apart from the above, we sincerely thank the members of CHEMTECH Advisory Board for their initial direction, our clients in the Infrastructure and Industrial Markets sectors who provided validation on specific issues in the report. This report also would not have been possible without the commitment and contribution of certain individuals within KPMG. The initiative for this report was led by Vishal Mehta, under the guidance of Biswanath Bhattacharya and was supported by Abhijeet Deshmukh. Finally, we thank CHEMTECH FOUNDATION team for continual support in facilitating and participating in industry interviews.

KPMG Contacts Arvind Mahajan

Biswanath Bhattacharya

Executive Director and Head

Director

Business Performance Services

Business Performance Services

e-Mail: [email protected]

e-Mail: [email protected]

Tel: +91 22 30901740

Tel: +91 22 30902521

Hemal Zobalia

Vishal Mehta

Executive Director

Manager

Tax

Business Performance Services

e-Mail: [email protected]

e-Mail: [email protected]

Tel: +91 22 30902706

Tel: +91 22 39896000 | 51 |

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About CHEMTECH THE CHEMTECH FOUNDATION has connected the Chemical Process Industry in India with a constant focus on innovations and technology. What started as a simple idea of a Trade Fair over 35 years continues to revolutionize the chemical industry today.

Water Management For the entire value chain of water management - industrial, residential or commercial. Event: WaterEx

The Chemtech Group has a presence across all the 6 major industry areas, connecting the entire value chain of the Chemical Process industry.

Shipping, Marine and Ports For those part of the Supply chain logistics and storage Events: Shipping, Marine & Port Expo | Publications: Shipping Marine & Ports World

Its specialised media offerings of Events and Information Services serve as platforms for the exchange of ideas and technology. Chemicals & Process Industries For equipment, services or developing processes for the Chemical and Process industries. Event: Chemtech World Expo | Publications: Chemical Engineering World | Chemical Products Finder Pharma & Biotech For avenues in manufacturing, packaging and formulation services to Pharma and Biotech industry Events: Pharma Bio World Expo | Publications: Pharma Bio World

Oil and Gas For the entire ‘Upstream’ value chain related to Oil & Gas exploration, production and transportation Events: Oceantex | Publications: Offshore World Power and Energy For opportunities in the renewable and non-hydrocarbon energy sector Events: Enertech Industry Automation & Control For the process chain covering Industrial and Process Automation, Instrumentation and Industrial Electronics Events: Industry Automation & Control

About KPMG in India KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 146 countries and have 140,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. Each KPMG firm is a legally distinct and separate entity and describes itself as such. KPMG in India, the audit, tax and advisory firm, is the Indian member firm of KPMG International Cooperative (“KPMG International.”) was established in September 1993. As members of a cohesive business unit they respond to a client service environment by leveraging the resources of a global network of firms, providing detailed knowledge of local laws, regulations, markets and competition. We provide services to over 2,000 international and national clients, in India. KPMG has offices in India in Mumbai, Delhi, Bangalore, Chennai, Hyderabad, Kolkata, Pune and Kochi. The firms in India have access to more than 2000 Indian and expatriate professionals, many of whom are internationally trained. We strive to provide rapid, performance-based, industry-focused and technology-enabled services, which reflect a shared knowledge of global and local industries and our experience of the Indian business environment. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity

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AN ISO 9001:2008 CERTIFIED COMPANY

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26, Maker Chambers VI, 2nd Floor, Nariman Point, Mumbai - 400021, India. Tel: +91-22-4037 3737, 2287 4758/59, Fax: +91-22-2287 0502 Email: [email protected], Website: www.chemtech-online.com EPC Industry in India: Issues and Challenges

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