Three trends reshaping the market in 2017
In this environment, E&C companies face three major trends that will affect their prospects in 2017 and beyond.
1. Contracting will get tougher. E&C contracting is changing in multiple ways, creating new challenges for management teams. One clear shift is the migration to lump-sum, turnkey (LSTK) contracts — in which E&C firms bear the project and cost risk (lump sum) and guarantee operational readiness (turnkey). Clients in both the private and public sectors are becoming far savvier about what projects should actually cost, and they are benefiting from greater competition for bids. As a result, they can demand LSTK contracts. We expect this trend to continue and accelerate over the next year.
Some top-performing E&C firms are getting better at working with LSTK contracts, but many others haven’t yet fully adapted. For example, some firms are absorbing the risk but not effectively factoring the additional contingency costs into their bids.
Another challenge is the new approach to project definition: Clients are breaking up larger initiatives into smaller, discrete elements. This tactic garners the client a better price, with a trade-off: Clients must take on a greater share of responsibility for project management and controls. These unbundled contracts also prevent E&C players from subsidizing weaker and less cost-effective areas of their operation with the profits from stronger areas. (Buyers will cherry-pick work from those with the best cost positions.)
Yet another factor making contracting tougher is the industry’s shift to public–private partnerships (PPPs). Government agencies need to make upgrades and repairs to infrastructure — particularly in developed markets — yet they don’t have the capital to fund these projects using traditional deal structures. E&C firms are now being asked to invest their own capital simply to participate, in exchange for a share of operational revenue or some other enticement.
In other parts of the world, the migration to PPPs is old news. However, in the U.S. it is still in the early stages. Several toll roads in the U.S. have been built with contractor funding. Meanwhile, the Trump administration has indicated that it will push harder for PPP projects.
These changes add up to a different way of working, in which firms assume greater financial risks but also gain access to new potential opportunities. Success requires partnering directly with public-sector entities on an ongoing basis, rather than simply for the construction phase of a project’s life cycle.