DESIGN ISSUES

The EPC Contract Process

The idea of using EPC to finance efficiency upgrades originated at meetings between the NSW Sustainable Energy Development Authority (SEDA) and the Area Health Service (AHS).  The AHS established an Energy Management Committee comprising Senior Engineers from each of the Hospitals that decided to proceed with an EPC.  Sites were selected on the basis of their potential for upgrade and cost saving.

An advertisement was placed in the media calling for Expressions of Interest (EOIs) from contractors, to which seven replies were received.  After a detailed evaluation process, three were selected to conduct a walk-through study of the sites and submit preliminary technical and financial proposals.  These proposals underwent an independent evaluation to select a  contractor to prepare a Detailed Facility Study (DFS), This study outlined more accurate details of the technical projects, and full financial and contractual matters.

NSW Treasury has set up a fund specifically  to fund EPCs [NP1] in  NSW Government agencies and this was used to finance the EPC.  Other sources of finance are available for non-NSW Government agencies.

The contract work commenced in September 1999 and was completed in April 2000. The EPC contract period including guaranties concludes in April 2005.  The first quarterly monitoring and verification meeting was held in August 2000 at which progress was assessed against the targets.  The results were satisfactory given the complexity of the projects and changes in the operating conditions; some minor adjustments have been made to account for these changes. .

Financial Structure

EPC contracts are usually assessed using an Internal Rate of Return (IRR) as the measure of financial  viability.  Internal Rate Of Return is effectively the interest rate earned, over a period of time, on an investment  taking into account issues such as:

¨       Capital cost

¨       Cost of financing

¨       Cost savings

¨       Expenses such as maintenance

¨       Inflation

 Because EPCs are long-term contracts, IRR is preferred because it:

¨       Takes account of the time value of money

¨       Allows variable cash flows as different projects are implemented in different years

¨       Provides a simple number (an interest rate) which can be easily compared to other investment options

Preliminary Estimates

The initial IRR calculation was based on:

Initial Capital:      $2,100,000

Initial savings:     $530,126

Term :                  15 years

Discount rate:     7%

Inflation rate:       3%

The financial performance of the project was then estimated to be:

IRR:                                      27%

NPV of Savings:                $5,769,373

NPV Net of Investment:     $3,670,376

Payback Period (years):   3.96

Final Estimate

Between the time the original proposal was developed and the DFS was finished there were a number of changes to the scope, as is often the case.  As a result the final estimate of financial performance was:

IRR:                                      20%

NPV of Savings:                $5,121,634

NPV Net of Investment:     $2,636,804

Payback Period (years):   5.68

While this is not as attractive as first suggested, it is still an excellent investment by any standards and the AHS was happy to commit to implementing it.

Risk Allocation

Another important benefit of EPC is the openness in which the risks associated with any project are disclosed and negotiated.  This is in stark contrast to the more normal adversarial contracts common in the building and services industries, where the contractor tries to ensure all the risks are carried by the client while not actually telling them what they are.

For the Mid Western Area Health Service (MWAHS) EPC a full risk disclosure was made and decisions taken to share the risks depending on who was the most likely party to be able to control it.  As a result the following table was drawn up and included in the contract.

Table 1 Contract Risk Profile