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The role of contract models in nuclear project risk management

Does the form of contract selected for use in a nuclear project affect the behaviour of participants in the project and the project's performance against schedule and budget? A good deal of academic scholarship answers the question in the affirmative for cases involving large, dynamic, complex projects.

Promoting stakeholder behaviour that is aligned with project completion, schedule and cost objectives is one of the keys to improving nuclear project experience and, by extension, the pace of nuclear new build growth.

Challenges to achieving the nuclear industry's potential

There are sound reasons for sustained growth in the nuclear new build sector. Population growth, electrification, and the increasing urbanization of large rural populations, are driving a global energy demand curve that supports the case for nuclear new build. Climate change science also supports the case for nuclear new build. Pacala-Socolow studies show that meeting the most modest climate change objectives requires tripling of the world's installed nuclear capacity by 2060.

The case for growth was also strong in the 1960's, but in the decades that followed, nuclear underperformed the then projected activity. Nuclear capacity in 1999 was far below 1960's projections, with the United States and global construction measuring, respectively, 10 and six times lower than expectations. Today's less optimistic projections of new build and plant retirements suggest that nuclear generation capacity could remain flat for several decades.

So, what has been holding up growth in the nuclear sector? Nuclear industry insiders typically look to external factors for answers. The thinking is that after Three Mile Island and Chernobyl, nuclear lost political support, especially in the west, with the result that western governments have stepped off project completion risk both in domestic and export markets. This, combined with a materially increased regulatory load, the drive for new technologies, and suboptimal project experience, especially in the west, has materially increased nuclear project risk profile and operated as a barrier to nuclear program entry and growth. Industry has been compelled to step up to project risk, in the role of developers, to drive growth, which limits the economic bandwidth available to support the pace of project development (certainly those involving western vendors).

Newsworthy developments in the nuclear industry oblige us to also consider factors internal to the industry. Two major western nuclear vendors (Areva and Westinghouse) have been effectively ruined by unsuccessful nuclear projects. One obvious inference is that nuclear project and enterprise risks are synonymous and represent existential threats, even to the largest industry players. The nuclear industry has reason now more than ever to critically assess the root causes of what is admittedly a difficult global project experience. This is arguably a necessary precursor to a sustainable industry.

While project management is an understandable focal point for critical self-assessment, the role of contracting models in driving the behaviour of key project participants is a factor of equal importance. It merits greater scrutiny.

The effect of the contract on behaviour and nuclear project outcomes

Nuclear projects are dynamic, complex, and large. It is difficult to know in advance exactly what will go wrong in a nuclear project and fully cover it in contract provisions. Nevertheless, project experience provides ample evidence of the likelihood that something will go wrong during construction or commissioning. Because nuclear projects are capital intensive and front end loaded – arguably the most expensive object on the planet – failure is potentially devastating to vendors and owners alike.

The difference between success and failure is not whether significant problems arise. Problems are the norm. The differentiating factor is in the effectiveness and robustness of the response of the key players in the project and how effectively they can recover schedule after problems arise. Success therefore depends on the behaviour of those involved in delivering the project in the face of problems. That behaviour in turn, is determined in part by the motivations of the key stakeholders acting rationally.

The assumption underlying traditional nuclear project contracts is that efficiency is attained by ensuring that each actor is responsible for managing their own discrete package of risk. The traditional contract model relies heavily on risk and liability allocation and liquidated damages to incentivize behaviour. Rational actors are expected to maximize their individual economic return and minimize individual liability exposure, and, in theory, this would lead to project success.

Nuclear project disputes resolution experience makes it clear that civil liability is not a sufficient cover for nuclear project risk. Even where liability can be affixed clearly, the magnitude of cost overrun arising from project delays, together with the cost to complete, far exceed typical caps on liability and liquidated damages. Moreover, responsibility for delay is often complex and overlapping, not discreet. While it may appear easy to allocate risk at the negotiation and contract drafting stages, it is often extremely difficult to affix discrete liability to individual actors in dispute resolution. In short, liquidated damages and risk allocation are often not useful to the owner, whose interest is served only by completing the project within a time frame that preserves the economic parameters on which the project was premised.

Discrete risk allocation in circumstances where risk and responsibility are overlapping and intertwined invites opportunistic behaviour from rational economic actors. Players are motivated (and often advised by lawyers) not to assume liabilities that can be affixed to others by sharing information against interest or volunteering solutions. When unanticipated problems arise in a nuclear project, traditional contract risk allocation motivates players to manage the risk of liability exposure, rather than managing the project completion risk. Delay multiplies, cost soars, and achievable projects become unviable.

Several UK nuclear practitioners have suggested that the UK's experience with collaborative contract models are the key contractual tool for improving nuclear project performance. The most prominent of the collaborative contract forms, NEC3, is radically different from traditional contracts. It is written in plain English. It is a legal framework for project management procedures intended to provide for all aspects of management of engineering and construction projects. It can be tailored to promote collective project risk management by including the key project delivery players, and to promote collective risk sharing. It can include positive collective performance incentives tied to initial project schedule, performance, and cost objectives, as well as for project recovery when problems arise.

The underlying assumption of collaborative contracting models is that risk is amorphous in dynamic complex projects and can only be effectively managed through collaboration among the key players. In theory, the model aligns individual interest with project objectives, engenders a collaborative culture, incentivises transparency and proactive project management, including in project recovery, and thereby enhances the prospects for success. The British construction industry has successfully used NEC3 in several major infrastructure projects. Oft-cited examples include the London Olympics, the Heathrow Terminal, and BP off shore projects, among others.

For these reasons, several nuclear lawyers in the UK have advocated the adoption of NEC3 in nuclear projects. However, industry and prospective owners outside of the UK have shown little interest in abandoning the familiar forms of traditional contracts (typically FIDIC based). Therefore, a more pragmatic approach may be to adapt traditional nuclear contract forms to include the essential elements of collaborative contracts.

The basic principle that needs to be captured in nuclear project contracts is that alignment between project objectives and contractor interests is the key to project resilience. Three contractual elements serve to promote this resilience and should accordingly improve the prospects of project recovery:

  • Information symmetry and early warning. A comprehensive and commonly shared information base allows all key players to give and receive early warnings of anticipated problems and promotes more timely development of solutions.
  • Coordinated global project management. Having the key players involved in a fully integrated project management system allows key players to manage interfaces, synchronize actions and schedules, and to contribute to solution implementation.
  • Incentivised collective project recovery responsibility. The objective is to incentivise all players who can contribute meaningfully to problem solving and project recovery to be absolutely dedicated to doing this collaboratively with the rest of the project teams.

Nuclear projects are dynamic in nature because of the complexity of the risk matrix, the thousands of tasks that make up the project schedule, the large number of participants, and the high degree of scope interdependency required to deliver the project. Shared risk and financial incentives, together with coordinated risk and project management, have proven successful in aligning the objectives of participants with project objectives in several complex UK infrastructure projects. The resultant collaborative culture means that teams respond to challenges collectively and constructively, rather than behaving opportunistically to avoid liability. There is a palpable probability that adopting the essential elements of collaborative contracting would lead to better results when problems arise in nuclear projects.