Single-supplier EPC contracting under strain as nuclear project risks grow
As energy security and carbon neutrality have become important challenges globally, the demand for nuclear new builds and life extensions for operating units is rising.
However, it has been more difficult to deliver nuclear power projects on time and within budget due to unexpected variables such as global uncertainties, post-pandemic supply chain disruptions and a stricter regulatory environment.
With growing uncertainties of external factors that hinder the success of the nuclear industry increasing, the concerns over EPC contracts where one supplier is responsible for engineering, procurement and construction are also increasing.
Conflicts of interest between owners and suppliers
To minimise the risks caused by project uncertainties, owners and suppliers often establish their plans independently of each other, but their plans inevitably conflict since they are positioned at the opposite ends of their interest.
Most owners prefer to share risks with suppliers as part of their risk management scheme. The risk allocation strategies that owners often adopt include: sharing risks associated with construction licensing delays with suppliers, request for equity investment to enhance the supplier’s accountability for the project, and pursuing fixed price contracts to minimise the increase of project costs.
On the contrary, nuclear suppliers do not want to assume any of the licensing risks and prefer turn-key contracts without equity investment while preparing for unexpected cost overruns through variable price contracts.
In fact, there are cases where unresolved conflict of interests between owners and suppliers at the negotiation table led to the failure in signing contracts and project cancellation or suspension.
In this article, we will look at a recent project where the owner and suppliers addressed conflicting interests by taking a new approach between fixed and variable prices and successfully signed a contract, exploring meaningful implications from the project.
Solution sought from Romania’s Cernavodă Unit 1
As stated above, suppliers tend to prefer variable-price contracts to conventional fixed price contracts. However, the positions of owners differ from those of the suppliers. When it comes to large-scale and long-term projects such as building new nuclear power plants, variable price contracts can be burdensome from the owners’ perspective, as it is nearly impossible to determine the exact amount of budget required for government support and due to the fact that extreme cost overruns may occur.
Take Finland’s Olkiluoto unit 3 (EPR type reactor) project as an example. For the project, a fixed price contract was signed in 2003. The project was estimated to cost €3.3bn and be completed in 2009. Yet, several factors led to more than 14 years of delay in the construction (completed in 2023), and the final project cost was estimated €11bn, triple the initial cost. The supplier, Areva, who signed a fixed price contract had to bear most of the budget overruns, which prompted EDF’s acquisition of Areva.
The Flamanville-3 project in France, which was under fixed prices, was also delayed more than 14 years. The contract value was reported to have risen from €3.3bn to €19.7bn, a more than 6-fold increase, causing a significant loss to the supplier, EDF.
Take a look at Hinkley Point C project that was based on a variable price contract between the UK government and EDF. Its construction began in December 2018, with the goal of completing the first unit by the end of 2025, but the completion was postponed to 2030 as a result of the COVID-19 pandemic, increased raw material costs, technological challenges and difficulties in the construction process. Thus, the project cost which was £18bn - grew to £34bn.
The basic cost of the project, which adopted a variable price contract as previously mentioned, are covered by EDF, but in case of cost overruns, adjustments can be made with the UK government to a certain extent, while exceeded costs would be compensated through long-term profits from power sales by ensuring power sales price after completion. This contract structure will ensure minimizing the risk of cost increase for EDF.
On the other hand, a further analysis must be conducted in the UK government perspective, with regards to the overwhelming delays and cost overruns.
First, the UK government is faced with budget management issues as it is difficult to expect the extent of final cost increases due to the variable price contract.
Second, the UK public could see higher electricity prices in the future, since budget overruns are compensated for the supplier by guaranteeing the price of power sales. Power price guaranteed at the initial contract in 2012 was £92.5/MWh, but the current expected price is reported to have increased to £120/MWh.
Third, it is hard to prove whether the supplier makes sufficient endeavors for cost reduction when costs are rapidly rising. While the UK government should monitor the possibility of the supplier’s inefficient operation, its negotiation power may not be that influential considering the nature of nuclear projects which have to completely rely on suppliers’ nuclear technologies.
As can be seen from these examples, for large-scale and long-term projects with huge uncertainties like nuclear builds, the interests of suppliers and owners surrounding the fixed and variable price contracts are bound to be in conflict.
Is there any solution? The refurbishment project of CernavodăUnit 1 pursued by Romania’s Societatea Nationala Nuclearelectrica S.A. (SNN) is in the spotlight as an exemplary model that solved this problem based on a cooperative model which encompasses conflicting interests.
The project valued at €1.9bn is a large-scale refurbishment project which includes engineering, procurement and construction as well as the construction of infrastructure such as a radioactive waste storage facility to extend the unit’s operational life by 30 years.
The owner, SNN, negotiated with Candu Energy and Ansaldo Nucleare, the original suppliers of Cernavodă Unit 1, based on a fixed price contract. Yet, the negotiation reached a deadlock due to the differences with Candu Energy and Ansaldo Nucleare who prefer a variable price contract just like the other suppliers. In particular, Candu Energy had difficulty finding a partner who would take charge of construction at fixed prices.
Under these circumstances, Korea Hydro & Nuclear Power Co., Ltd. (KHNP) joined, proposing to execute the construction on a fixed price basis. The participation of KHNP made it possible to balance the proportions of fixed and variable prices, leading to mutual concessions of SNN and suppliers and providing momentum for contract negotiations.
As a fixed price contract was made possible for the construction, which accounts for one-third of the entire EPC, thanks to KHNP, both Candu Energy and Ansaldo Nucleare were able to reduce the risk of fixed prices in the total project cost. As a result, the two companies could secure SNN’s concession of adopting a variable price contract for procurement (including project management) that includes high risks caused by external factors while accepting the fixed price contract in design/engineering where they have advantages, thus making risk management relatively easier.
It was also a favorable outcome for SNN that engineering and construction would be based on fixed price contracts, considering the additional goal of signing contract in a timely manner.
Consequently, KHNP’s involvement enabled the balance of variable prices (for procurement and project management) and fixed prices (for engineering and construction) in the contract, providing both the owner and suppliers with justification and practical benefits.
In the meanwhile, how could KHNP decide to participate in the project on a fixed price basis, which other suppliers tend to avoid?
KHNP is not just the supplier of nuclear power plants but also an operator of 26 units. It has capabilities to estimate costs and the optimal period of construction based on the experience gained from numerous nuclear power plant construction and refurbishment projects as well as the accumulated data for over 40 years of operation and maintenance from the same position as an utility like SNN.
KHNP was also confident of responding to unexpected events during construction based on its certified supply chains and has the experience of successfully completing the refurbishment project of Wolsong unit 1, the same model at Cernavodă .
With KHNP’s participation, it formed a tripartite consortium which combined individual expertise with Candu Energy, the IP holder of Cernavodă nuclear power plant, and Ansaldo Nucleare, which supplied the Balance of Plant at the time of Cernavodă's construction.
The key takeaway from the Cernavodă Unit 1 is that suppliers established a consortium to effectively share project risks and reach a contract with the balance between fixed and variable prices, creating a solution which satisfy all the owners and suppliers.
The Path to Mutual Growth Through Partnership and Cooperation
As can be seen in the refurbishment project of Cernavodă Unit 1, when a nuclear project becomes large-scale and complex, a single company cannot bear all the risks. Thus, a consortium or a joint venture model where each party takes responsibility of its own specialized area and work together can be an effective solution.
The participation of a company that can gather the capabilities of each supplier and fill the gaps in the project is essential in such a project model. In line with the aforementioned, KHNP's capability in the project management and project delivery skill is noteworthy.
KHNP’s expertise would provide a good solution for suppliers who have the original technology for specific reactor models but are looking for reliable partners in the field of project management and construction.
It is expected that the global nuclear industry will be confronted with three big waves: geopolitical risks, the pressure of carbon neutrality and technological innovation. In this complicated environment, multiple parties of interest can reduce uncertainties and expand opportunities by leveraging their own strengths and working hand in hand. Furthermore, once this cooperative model takes hold, we will be able to turn challenges into new opportunities in the nuclear industry through mutual growth, going beyond mere competition among suppliers.
This article was supplied by Korea Hydro & Nuclear Power. The views and opinions expressed in this article are those of the author
