Overview of the Western Australian market
Western Australia (WA) is unique due to its vast size, remote location and diverse economic and environmental factors across its regions. The geographical diversity of the WA landscape requires a forward-thinking procurement approach to project development, particularly regarding labour resources, material transportation and performance (both physical and materials) in harsh climatic conditions and the availability of utilities to construct projects.
Additionally, WA’s diverse ecosystems, featuring unique flora and fauna, add further complexity to project development. Navigating around pastoral requirements and native title rights, including indigenous engagement, are also a critical factor that is often overlooked when embarking on new project developments.
With the strong focus on renewable energy development for decarbonisation, the world is quickly turning its gaze towards the WA market. This newfound interest is driven in part by WA’s abundant land and its exceptional wind and solar resources, considered among the best in the world. These factors are attracting significant investment and fostering growth in the renewable energy sector, supported by WA’s already robust mining sector. As a result, we are seeing an increasing number of new entrants into the WA market that are faced with navigating the nuances of a system that poses some unique challenges.
One such challenge, that is the focus of this article, in the construction market are the contracting models being utilised to deliver projects in WA. Selecting the appropriate type of contract plays an increasingly critical role in the success and timely delivery of construction projects, with approaches to risk allocation between parties changing in recent times. The pricing models being deployed in the market presently, while not altogether new, have changed in recent months and continue to evolve as we see a shift in the balance of power (moving from the developers/operators to contractors).
Contracting models
There are various types of construction contracts that are utilised in the WA market, which will differ depending on the nature of the project, parties involved and specific requirements of the build. The sectors in which the work is being performed will also dictate the type of contracts that are utilised.
In the WA market, we commonly see various types of standard form construction contracts being used for construction works, but these are often heavily amended. While the use of standard form contracts helps to reduce the time and cost of preparing construction contracts and establish a baseline for what is considered to be the market position, they are often out of date and need to be amended to reflect the risk profile of the project being delivered. We see different types of standard form contracts being deployed in different sectors, some of which we touch on below.
In the civil construction sector, the Australian Standards suite of contracts (AS Contracts) are a common starting point for negotiations between parties. The AS Contracts include construction contracts, design and construct contracts, equipment supply agreements and consultant agreements, among others. These contracts tend to have a balanced risk profile, which typically work in a contractor’s favour, but are frequently so materially amended that the final contract does not reflect the model form. The AS Contracts do not include an engineering, procurement and construction (EPC) contract so many of the large Australian firms have developed their own precedent documents. The FIDIC Silver Book is a template EPC contract that is sometimes used in the market, but this is less common (although this template is widely used across Asia and the Middle East).
Bespoke contracting models for civil infrastructure developments are commonly used in the mining and oil and gas sector, particularly given the large scale and often bespoke solutions that are being deployed. However, they are generally quite similar to the AS Contracts. In the energy sector, we often see bespoke EPC contracts being used, while in the major or complex government procurement projects, alliance contracts are now becoming the norm, shifting from the more traditional design and construct procurement approach. This evolution has occurred as contractors have been bearing a disproportional amount of risk, resulting in contractors being unable to deliver projects given the complexity and uncertainty associated with project delivery, particularly in respect of large road and rail projects. Consequently, a collaborative and risk sharing model has more recently been deployed. Alliance contracts promote a collaborative, risk-sharing model, fostering innovation and flexibility essential for successful project delivery. We do not often see alliance contracts being used in the private sector as these models are difficult to finance, given the perceived lack of price certainty with delivery, in comparison with a fixed lump sum contract model.
Often, there is little advance thought put into the delivery model regarding the key drivers for delivery (whether that be time, cost, performance or quality), which can cause misalignment between the parties and may not achieve the desired project outcomes. Each contract model has its advantages and disadvantages, the merits of which should be considered in the context of the project to be delivered. This is a key delivery risk that is often overlooked.
Pricing models
Traditionally, the vast majority of projects were procured on a fixed lump sum contracting basis, particularly in the resources and energy sector. This was also largely the case with a number of social and government infrastructure projects. More recently, the construction sector in WA has experienced several significant challenges, including:
labour shortages due to a thriving mining industry
increased market volatility and supply chain disruptions, particularly post the COVID-19 pandemic
an increase in delivery costs due to inflationary pressures
a higher cost of capital.
This has led to a change in the pricing models used in construction contracts because of a change to the risk profiles and contracting models being utilised.
With a strong preference for fixed lump sum pricing models, particularly in externally financed projects, there is a growing trend to engage contractors on an 'early contractor involvement' (ECI) basis. This approach helps de-risk projects by involving contractors in collaborative planning and risk management from the outset. By doing so, contractors gain a deeper understanding of project delivery risks, allowing them to manage and price these risks more effectively — typically on a fixed lump sum basis.
We have increasingly seen several contractors only willing to bid for contracts on a cost-plus basis, where contractors are paid for all construction-related expenses plus a fixed margin. These contracts provide transparency and allow for flexibility in managing unforeseen costs. This procurement approach has recently been gaining traction in the mining sector, where the competition for labour and reliable contractors is fierce.
The government sector has taken a dramatic turn by now procuring major infrastructure projects utilising alliance contracts (mentioned above), which involve a collaborative approach where all parties share the risks and rewards of the project (however, smaller and less complex projects are still based on fixed lump sum pricing). This model promotes teamwork and is effective in complex projects requiring innovation and flexibility. However, it requires a high level of trust and cooperation among all parties involved and is not commonly used in the private sector.
In the private sector we are seeing hybrid costing models being deployed now with buckets of costs which are fixed, larger advanced payments being made for long lead items to eliminate price volatility and risk, as well as provisioning for escalation into pricing models and using rise and fall clauses. As the balance of power has shifted in the market, given the shortage of contractors and availability of labour, we are seeing contractors being able to leverage their position to negotiate more favourable payment terms, while taking on less risk. However, we emphasise that this type of pricing model is only deployed on the more complex project, with less complicated projects still being priced on a fixed lump sum basis.
Given the traditionally low margins and high risks contractors have shouldered, the change in the contracting models (as more equitable risk allocation is being agreed) and pricing models will hopefully result in better quality projects being delivered on time and on budget (or at least closer to budget). This aligns with the Abrahamson Principles, which advocate for allocating risk to the party best positioned to manage it. This is a positive change in the construction market in WA from a contractor’s perspective and new entrants into the market should be aware of the more recent changes to the approach to contracting in challenging market conditions.
The type of contracting and pricing models mentioned above are only effective where the parties involved adopt the right mindset and are aligned in terms of project objectives and deliverables. We all too often see the scenario where an equitable alliance based contract is being delivered with the mindset of an adversarial fixed lump sum contracting model, so the collaboration and value engineering mechanisms built into the contract are not effectively utilised and deliver the value intended at the outset. It is crucial for the construction market to continue evolving and adapting to changing conditions to ensure an equitable outcome that balances cost certainty with sustainable profit margins. Challenging traditional contracting norms will go a long way to ensuring a robust and competitive construction sector for the future and encourage greater participation in the Australian construction sector domestically and internationally.
This article has been co-authored by AJ Neo of RSM and George Varma of Gibert + Tobin.