Building the Energy Transition – Lessons from the Transport Infrastructure Boom
October 25, 2023
Nicholas Tsirogiannis & Danijela Malesevic
Building the infrastructure to facilitate Australia’s coming energy transition is set to place heavy demand on a construction industry that has already had its capacity significantly stretched by the transport infrastructure boom.
A review of the transport boom highlights important lessons, particularly for those responsible for planning and procuring the next wave of energy infrastructure projects, to ensure that the delivery of those projects is timely, cost-effective, and sustainable for the construction industry.
The following offers a snapshot (and set out in further detail below) of the key lessons learned from the transport infrastructure boom that should be front of mind for all energy and construction sector participants – in particular energy infrastructure planners, investors and those tasked with procurement and delivery (the Australian Energy Market Operator (AEMO), transmission network service providers (TNSPs) and other potential State procurement and delivery agencies).
The key lessons from the transport infrastructure boom are:
- a well-communicated, multi-year pipeline is critical;
- a sustainable and healthy construction industry is required with contractors being able to make a reasonable profit on each project;
- full risk transfer is not acceptable to the market and is not sustainable in the long term;
- collaborative delivery models provide a more balanced approach to risk allocation and have other benefits including facilitating early contractor involvement, providing open-book transparency and creating a more collaborative delivery environment;
- market-sensitive packaging of projects is required; and
- gradual development and ramp up of the domestic supply chain is required to reduce cost escalation and delays.
There are significant demands facing the construction industry in the coming years with several mega transport infrastructure projects across Australia now in delivery and the energy transition driving the next wave of infrastructure investment in electricity transmission and generation infrastructure.
The pace of change and scale of investment in Australia’s energy sector (and in turn the engineering and project delivery investment needed) are already unprecedented and are only set to accelerate.
To date there has (rightly) been a lot of focus on the numerous and complex elements of the energy transition (like the types of government support, funding, regulatory reforms, power systems capabilities and development of new technologies) that will need to be addressed. However, there has been limited focus on the more practical implementation of the energy transition – the actual construction of the record number of infrastructure projects ultimately required and how our construction industry is actually placed to do so.
While the construction industry is not a direct participant in the National Energy Market (NEM) or a traditional NEM stakeholder, it is the sector that will ultimately be required to build the infrastructure needed to transform the NEM.
Given the inherent risks in delivering complex infrastructure projects, the successful delivery of the energy infrastructure projects required is a key risk to achieving the energy transition in a timely and cost effective manner. In turn, the successful delivery of these projects is reliant on our construction industry – an industry that has often been referred to as being at ‘breaking-point’.
The transport infrastructure boom of the last decade holds some valuable lessons for market participants in tackling the next tranche of infrastructure projects.
To enable the delivery of the significant transmission and generation infrastructure required to transition to renewables, we need a healthy and sustainable construction industry and robust engagement between the energy and construction sectors on the planning, procurement and delivery strategies for these projects.
A well-communicated multi-year pipeline is critical
The eastern seaboard transport infrastructure pipeline quickly grew from ad hoc projects moving out of the end of the resources boom, to an instant and unprecedented pipeline without a well-defined and communicated long term roadmap. This had a range of consequences, including the following:
- industry was not prepared and didn’t have sufficient time to plan resources, develop skills and prepare its supply chain;
- in the absence of a well-communicated pipeline, contractors took a win at all costs approach to winning projects – with some notable cases of underbidding occurring on mega projects and inevitably leading to cost blow outs and disputes that in turn led to significant project delays;
- underbidding was seen as a direct consequence of the perception by the contracting industry that projects would ultimately be awarded to the lowest cost bidder rather than the best value for money bid – leading to a ‘race to the bottom’ on costs;
- contractors didn’t have bid team capacity to get properly across the procurement requirements for multiple mega projects being put to market concurrently in multiple states – this situation only got worse as the number of projects in delivery steadily increased concurrently with new projects in procurement and ultimately led to limited bidder interest in new procurements;
- as a result, contractors took on risks which they couldn’t properly evaluate or price and in many instances were arguably not best placed to manage in delivery;
- delivery resources across design and contractor firms were severely stretched – and shortages of specialised skill sets, plant and equipment, particularly in rail, impacted delivery times significantly;
- the supply chain was placed under stress causing price escalation and delay; and
- the above shortages in skills and materials were highly vulnerable to the impacts of the COVID-19 pandemic, and other global events.
Many of the challenges and limitations faced by industry in the past would have been better met with the benefit of a pipeline of work communicated and co-developed with industry. A clear and well-communicated roadmap enables market participants to understand the coming pipeline at a national level. As part of future planning, projects can be staggered to match industry capacity and capability – not the reverse. Such a highly coordinated approach allows:
- proper planning in industry for the workforce and specialist skills required, as well as the supply chain necessary to meet the pipeline;
- contractors to selectively bid for the projects which they are best equipped to deliver and potentially offer scales of economy where multiple projects could or will be delivered in parallel;
- adoption of coordinated programmatic approaches to project packaging (with multiple projects able to be grouped together for streamlined procurement and delivery); and
- industry to attract international capability by way of additional market participants, workforce and technology to bring international experience, capability and lessons learned and to address skills gaps and shortages.
In relation to the energy transition, and specifically transmission infrastructure, the AEMO’s Integrated System Plan (ISP) 2022 identifies transmission projects that it refers to as ‘actionable now’ as well as projects actionable in the future.
The ‘optimal development path’ (ODP) set out in the AEMO ISP 2022 identifies 10,000km of new transmission that will be required to connect new generation and notes that all the projects identified in the ODP are needed. AEMO notes that all ‘actionable projects’ should progress as urgently as possible, noting that in some instances the optimal delivery time for these projects is earlier than what is achievable. These are complex large linear infrastructure projects, with significant risks in procurement and delivery.
In the 2022 ISP, AEMO has correctly identified that some of the key challenges to the delivery of required infrastructure include (amongst other issues) supply chain issues, project sequencing, workforce and skills shortages.
The next ISP is under development and will be issued in 2024. A key piece of the puzzle in ensuring needed transmission and generation projects can be delivered in accordance with the ODP identified by AEMO, is strong collaboration between NEM participants and the construction industry in appropriately planning, sequencing and communicating the project pipeline.
A sustainable and profitable construction industry is key – another profitless boom is not an option
Despite the unprecedented level of investment in transport infrastructure on the eastern seaboard of Australia, the construction industry has been under significant financial pressure. This is particularly true of Tier 1 contractors which have acted as the lead D&C contractor on the delivery of mega transport projects. We have seen contractors move out of the sector or sell their business to international contractors because of the low profit margin or significant losses that they have suffered on these projects. In many cases, contractors have made significant claims against government to seek to recover those losses, resulting in protracted disputes that have caused large delays to the completion of those projects and government ultimately wearing a significant portion of those losses.
Low margins or, even worse, large losses are obviously not sustainable in the medium or longer term as there will be very limited appetite to bid for and ultimately take on these large projects. Contractors cannot assume a disproportionate level of risk on a project and, at the same time, expect to make a reasonable profit.
Without a sustainable and profitable construction industry, the significant infrastructure required to facilitate the energy transition will almost certainly not be built as needed.
Collaborative delivery models enable successful planning and delivery of complex infrastructure
In response to the challenges identified during the transport infrastructure boom, some government delivery agencies chose to go down a full collaborative delivery model path (i.e., alliancing or ITC), while on some other projects collaborative elements were introduced into a traditional delivery model.
For example, on the North East Link Project (NELP) in Victoria, in response to bidder feedback, ITC elements were introduced into the D&C component of the PPP structure by way of a target cost approach instead of the traditional fixed price approach. Either option provides a more balanced approach to risk and assists in significantly reducing the existential threat that these mega projects have posed for contractors in recent years.
In any case, contractors are not, in the current climate (and noting the size and complexity of some energy projects), going to accept the full risk transfer that has occurred in the past. This is particularly the case where there are more projects than contractors and contractors can pick and choose which projects to bid on and the basis on which they bid.
A collaborative delivery model not only provides protection from substantial losses, it provides a number of other benefits. For example, the open book nature of the model allows the owner to see what costs and risks have been allowed for and the amount allowed for each risk. This provides the opportunity before the contract is signed to ensure that risks have been properly addressed and reside with the party best placed to manage them (or alternatively – should be shared). Further, the cost-reimbursable nature of these models should also result in more accurate risk contingencies being allowed for in the ultimate target cost.
In delivery, the shared risk and reimbursable cost principles embedded in collaborative delivery models enable and incentivise the parties to work together to find the ‘best for project solution’ in dealing with the risk when it arises. What practice has shown is that while a shared risk approach or a collaborative delivery model doesn’t mean the project will not run into challenges, it certainly does provide the project participants a better framework within which to solve those challenges together.
Noting the high complexity and high-risk nature of energy infrastructure (a significant part of which will be linear infrastructure), the ability to work within a framework that enables parties to collaborate and focus on ‘best-for-project’ outcomes, as well as solving issues together, will be especially important. Particularly in circumstances where energy sector participants have not previously had to plan, procure and deliver a significant program of complex major projects on a short timeframe in an already heated market (both nationally and globally).
Early contractor involvement to de-risk highly complex projects
Early contractor involvement is a key feature of collaborative delivery models and played an important role in the planning and ultimate de-risking of transport infrastructure projects. For example, during the target outturn cost development stage, the bidder (on an ITC procurement)/alliance worked closely with the relevant government agency prior to contract/package award to:
- progress the design to enable it to be fully priced;
- undertake constructability assessments as the design developed;
- commence stakeholder consultation based on the developed design;
- undertake site investigation activities based on the developed design;
- commence processes to obtain planning, environment and other approvals;
- engage with, and prepare, the supply chain; and
- undertake any early works, for example, utilities relocation.
Given the linear nature of transmission infrastructure it is likely that these projects will also benefit from undertaking the above activities. Not only will it benefit the construction program to undertake them earlier, it should also de-risk aspects of the projects and result in a more fully informed price.
There is already broad recognition in the energy sector of the benefits of undertaking increased preparatory activities as well as bringing forward early works. As an example, in the Australian Energy Market Commission’s (AEMC) May 2023 final report on the ‘Transmission Planning and Investment Review’, it noted that more extensive and earlier planning could mitigate the risk of significant project cost blow outs and delays.
In that report, the AEMC made recommendations for changes to the economic assessment process or transmission projects that would support timely and efficient project delivery – by supporting TNSPs to undertake more and earlier preparatory activities as well as early works.
Accordingly, TNSPs and other procuring bodies would benefit from considering a collaborative delivery model or at the very least incorporation of collaborative contracting principles – and should be supported in doing so.
Addressing price escalation
Collaborative delivery models also address price escalation in a transparent way designed to assist in avoiding disputes. With the open book approach to reimbursable costs, managing escalation risk is a lot easier as the owner can clearly see what has been allowed for in the price for escalation and then compare it to actual costs. Therefore, regardless of how the risk is allocated (shared or owner), the owner has full transparency of the allowance and the actual costs. Contrast this to other delivery models (eg, PPP or D&C) where even if the owner has transparency into the allowance, the model doesn’t envisage the contractor opening up its books to the owner to see the difference between the allowance and the actual costs.
Collaborative delivery models going forward
Notwithstanding the success that governments have had with the use of collaborative delivery models on large transport projects, there are likely to be barriers to adopting these models on all projects. Some of these barriers include navigating the complex economic regulatory framework that exists for transmission projects, and navigating the requirements in relation to private financing for those projects that may require it.
However, even on projects with these constraints, it is unlikely that the traditional PPP or other full risk transfer model will be acceptable to the market, particularly for the D&C component of the project. In relation to PPPs in particular, the approach adopted on NELP (or a similar variant) is likely to be the way forward on complex projects with large risks that the private sector is no longer prepared to accept. While not providing all the benefits of a full collaborative model, it will provide the construction industry with protection from substantial losses and increase the likelihood of a reasonable profit being made by contractors.
Packaging is key – projects should be planned in a manner that accommodates market capacity
With the rapid increase in the size of transport infrastructure projects, it was often not possible to engage only one market participant (even a Tier 1 contractor) to deliver an entire project. In some cases, even a joint venture between two Tier 1 contractors couldn’t provide the required resources and commercial capacity.
Given that the Tier 1 market is probably limited to 4 contractors, this also reduces the competition if joint venturing is necessary on a project. The packaging strategy, therefore, becomes critical to the success of the project – the package size needs to accommodate the market capacity and capability and not the other way around.
Recent feedback from the industry suggests that the maximum package size should not generally exceed $2 billion. Anything beyond that will require a JV with another contractor. From a tier 2 or 3 perspective, $300 to $500 million has been suggested as the ideal package size.
While these numbers are merely indicative and will change depending on the complexity of the project and an individual contractor’s circumstances, they do nevertheless indicate that a number of projects have been packaged up in a way that generally exceeds the ideal size for the contractor market. They also indicate that the size of each package has made it very difficult for Tier 2 or 3 contractors to participate in a project on a standalone basis.
In other words, unless Tier 2 or 3 contractors join with another contractor or become a subcontractor to a Tier 1 contractor, the project will not be fully utilising the available capacity across the entire contracting market. With the infrastructure pipeline set to significantly increase to meet the energy transition, it is vital that packaging strategies are adapted to accommodate market capacity from a delivery and commercial perspective and encourage participation from the Tier 2 and 3 market.
Gradual ramp-up of supply chain is needed and should be developed domestically
The supply chain needs to have an adequate ramp-up period and industry and government need to invest in developing the local supply chain. Without this, we will experience the same challenges as those that are being seen as part of the transport infrastructure boom: demand outstripping supply leading to delays, significant cost escalation, the reliance on imported goods and materials at a higher cost and lost opportunities to upskill workers and grow the workforce.
Supply chain projections developed in collaboration with AEMO should play a central role in guiding the public and private sectors in the development of local supply chains as well as the management of demands. They should also certainly form part of future AEMO ISPs. Together with appropriate pipeline planning and development, development of a domestic supply chain to respond to demands will be critical to enable successful delivery of the required infrastructure.
Apart from servicing the demand of the pipeline there are significant benefits to the community through the creation of new businesses, jobs and upskilling of the existing workforce. A prime example of this is the development of a standardised concrete ‘u-trough’ design for rail over road designs on the Victorian Level Crossing Removal Project, which resulted in a local manufacturer providing an important supply chain role in the rapid delivery of projects.
The AEMO ISP 2022 has rightly identified the ability to manage supply chains and secure the needed workforce and essential materials as being critical to delivering the energy transition. This is a particular challenge noting that these projects are often located in remote areas and are already (and will continue) competing with large metropolitan infrastructure projects for materials and workforce resources.
While AEMO and Infrastructure Australia partnered to deliver the ‘Market Capacity for Electricity Infrastructure’ analysis in 2021 to assess and understand the labor and material requirements for the projects identified in AEMO’s 2020 ISP, these projections and the analysis are yet to be updated. As an example, in the 2021 analysis, Infrastructure Australia has already projected both steel and concrete demand to nearly double by 2028 – equating to 8% of Australia’s annual crude steel production and 3% of its concrete production.
This is another example of an area where strong collaboration and communication with the construction sector would benefit. The construction sector will have a role to play in assisting to develop supply chains and secure the required workforce and we should be leveraging their know-how and experience.