Source– The post is based on the article “From RIL to L&T and Adani, corporate giants build on EPC rule change” published in the Business Standard on 10th January 2023.
Syllabus: GS3- Investment models
Relevance– Issues related to infrastructure development
News– The article explains the increasing preference of big infrastructure firms for EPC contracts.
Reliance Industries Ltd has decided that it would merge its engineering, procurement and construction (EPC) subsidiary Reliance Projects and Property Management.
Many big infrastructure companies are pivoting towards government EPC contracts in a major way.
What is the reason for major infrastructure companies preferring EPC contracts?
This shift is primarily on account of several initiatives by government agencies in 2022. Most prominent of them are the National Highways Authority of India and the Railways. As a result, new entrants will operate on a low-debt model to build greenfield assets. The government will be responsible for selling the completed projects.
Government agencies are now handing out infrastructure contracts stating that bidders have to separate the project financing plans from the post-construction phase.
The new paradigm for infrastructure projects suits companies like L&T, RVNL, Adani or RIL. They have large reserves of cash for implementing the project.
An EPC project begins life with a 20% upfront payment contract offered by the bidding agency. Subsequent payments are linked to achieving project milestones that can be monitored by technology. Bidders need to hardly raise any debt.
What was the reason behind these decisions?
This change was mainly the result of NHAI’s Rs 3.3-trillion debt burden.
The finance ministry discovered that most of the debt was due to hybrid annuity model-based projects for roads. Under this model, the bidders were offered to build the roads or bridges on a tight budget and timeline. They were allowed to compensate themselves from the returns when the projects became operational by charging tolls.
Many contractors were suspicious about collecting tolls or levying user charges, NHAI offered assured returns of up to 40% of the total project expenditure, payable usually over 10 years. The contractor had to arrange the rest.
Due to assured return, contractors inflated projections. Projects often came up late even as the government’s bill mounted.
As a result of this, NHAI not only now asks the contractors to show project construction cost. It has also begun to use drones and satellites to monitor the pace of the progress.
In June 2022, the finance ministry said the past experience of the contractors has to be checked before issuing tenders.